Ask the Expert Retirement questions answered
How safe is too safe
By Walter Updegrave,
Money Magazine senior editor
November 10, 2008 5:18 pm
Question: Are stable-value funds a safe investment? —Rexford, Syracuse, New York
Answer: That depends on what you mean by safe.
Stable-value funds, which are available only in 401(k)s (and currently offered by more than half of such plans), invest for the most part in high-grade short- to intermediate-term bonds. The managers of these funds also buy “wrappers” - or contracts from insurance companies and banks - that guarantee principal and accumulated interest against loss.
As a 2007 study shows, the result is an investment that provides long-term returns similar to those you would get with intermediate-term bonds, but with stability comparable to a money-market fund’s.
Would I put stable-value funds in the same category as FDIC-insured bank deposits when it comes to principal protection? No. They’re not federally insured. But given the high quality of the funds’ underlying securities and the fact that they also diversify risk by purchasing wrappers from 10 or so financial institutions on average, I think it’s fair to say that stable-value funds provide a high level of security and adequate protection against losses.
So in that sense I’d say yes, they’re a safe investment.
Playing it too safe
But when it comes to investing for retirement, I believe you should to take a broader view of safety. Specifically, you’ve got to consider whether your investments are safe in the sense that they’re likely to deliver the returns you’ll need to build a nest egg large enough to support you comfortably in retirement.
And that’s where I think people who’ve been flocking to stable-value funds lately - in September alone, 401(k) investors switched $921 million out of stock funds and moved $733 million into stable-value funds - have to be careful.
Understandably everyone is freaked out about declining balances of 401(k)s. Those losses and fears that even more may lie ahead make investments that promise security especially appealing today. But you don’t want to plow too much of your money into investments that offer a refuge from market losses.
There may be few concepts you feel you can count on in the investing world today. But here’s one you can bank on: The more secure an investment is, the lower its long-term returns are likely to be. So by focusing too intently on safety in the short-term, you could jeopardize your long-term retirement security by sacrificing growth potential.
Which is why I think you shouldn’t view stable-value funds as a haven to flee to during periods of market turmoil, but as a core part of a diversified portfolio that also includes stocks and bonds. Basically, you should consider stable-value funds an investment choice for the fixed-income portion of your 401(k), along with bond funds.
As for how much of your 401(k) you should put in stable-value and bond funds, the answer largely comes down to how far along you are in your career and how much risk you’re comfortable taking. I know everyone is wary about investing in stocks right now. But if you’re young and early in your career, you don’t have to be so concerned about falling stock prices. You’ve got decades before you’ll tap your 401(k), so you should focus on getting a competitive long-term return. And that means keeping most of your money in stocks.
Although there’s no assurance stock prices won’t fall even farther from here, history shows that you’re likely to earn the best long-term returns from shares you buy in the wake of major market declines.
As you get closer to retiring, you still need long-term growth - after all, you may spend 30 or more years in retirement - but you also want more stability. You don’t have as much time to recoup losses. So you want to gradually increase the amount going into stable-value funds and bonds as you age.
So if it’s safety you’re looking for, yes, stable-value funds can be a reasonable choice. But make sure they’re part of a long-term investing strategy. Otherwise, the price of feeling safe today could be less retirement security down the road.
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Filed under Uncategorized16 Comments Add a Comment
Great article! Don’t worry and don’t to even bother your little head about “timing”. So many selfless professionals are dedicated to your prosperity.
Posted By M, GSO, NC: November 17, 2008 10:13 am
I agree with Charles Shaw in Liverpool NY. One way to restore confidence is for the top leadership of these failing banks and finanancial institutions to not be able to retire with massive golden parachutes, and for the average working person to see that justice really is served. Pauslon is now changing the rules midstream as to where all of our dollars will go. Why not have the wealthiest on Wall Street be forced to retire on “only” $100,000 a year and have the rest of their assets go to help those who were truly hurt by this mortgage crisis. The greed of those at the very top using mortgage debt and leveraging should be punished.
To Jonathan in Seattle: I am not sure who you were referring to in your comments, but it is not the “little guy” who is moving the market up and down these days with “panic selling.”Send your message to the big institutional investors and mutual fund managers who are the main ones moving this market.
Posted By Iris, Rochester NH: November 16, 2008 9:14 am
Inflation and taxes are unavoidable.
I would not invest my money in risky investmnts just to make a higher return. Investing is not about how much you mak, but about how much you keep.
The truth is that unless you make over $250,000 a year for 20 years or more and save at least an average of 10% a year, you are not going to be rich when you retire.
The median income is around $46,000 in America. If a person invests 10% of his gross income and makes around 5% a year, he will not have millions of dollars after 35 years.
The myth of retirement is going to terrorize many Americans in the next 20 years. Many of those who are retired and are too old to make a decent income will suffer. They will have reduced Social Security benfits to look forward to and little savings to live off of.
There is no such thing as playing it too safe. Either you have a lot of money, a little money, or no money. Those that have a lot of money or no money will get by just fine. Those with a little money, the middle class, will be taxed higher and will receive less benefits.
Posted By Yadgyu, Harkyville, TX: November 13, 2008 5:24 pm
I don’t why so call experts always keep on saying keep your money where they are or you’ll end up missing the upswing. If i had not moved my money to the stable fund, i would’ve easily lost 30-40% of my meager 401k fund. But now, I am still getting some returns and I am not throwing away monthly contributions. Wake up so called experts. It would take years for me to recoup the 30-40% I would’ve lost.
Posted By Jun, Brentwood, CA: November 13, 2008 2:53 am
People seem to lose track of the key points in these comments. 1)Stable funds are a fantastic capital preservation tool. 2)To build a 401K to the level needed to support decades of retirement(hopefully)you have to have the return rates that equities provide. There are two ways to do this. 2) a) Buy and hold. Or… 2) b) Market timing. There is a lot of literature that market timing doesn’t work. And yet… there is some evidence that you can sidestep the big drops sometimes. Not always. There have been two big market declines in the past 8 years, and foreseeing them was not very tough, if you are paying attention. The first one I didn’t have the confidence to manage. This time I slowly transitioned to my stable value fund. Always move in modest increments, because you could be wrong! In any case, I’m down 14% this year… that much only because I got over-burdened at work and home and acted later than I intended… however, I would otherwise be down 30-35% as of today. I love my stable value fund!! I’ll buy back equities slowly, maybe 5% per month, starting next year. Equities are still over-valued, given the level by which future earnings are over-stated by wall street. I may miss a few big up days… heck I missed the biggest one ever last week, but guess what? I can now buy at a lower price than before that run up. I have more to gain by misssing the big down days. I now have a 15% head start on the market, my opportunity cost is pretty small, and the beauty of it is I don’t need to ‘time’ to get back into the market. A little DCA does the trick.
Posted By John in Colorado: November 12, 2008 2:48 pm
To the first poster, commenting that he would have been better off in stable value for the last 25 years…The market is up roughly 600% over the last 25 years. How exactly would being in stable value make you better off than “riding the ups and downs” that have you up 600%?
Posted By Jon, Parsippany, NJ: November 12, 2008 9:26 am
People wake UP! There is nothing new under the sun. 8 years ago you were the same people saying we are on the brink of economic collapse. And you were saying the same thing in 1992, and during everyother economic pull back. Do yourselves (and us) a favor and put all of your money into a nice FDIC insured savings account, where you will get a negative return because of inflation. You’ll be poorer by the day but at least those of us who invest in the market won’t have to deal with your panic selling.
Posted By Jonathan Seattle, WA: November 12, 2008 2:45 am
I am not sure why we are still holding to the underlying assumption that we are going to “retire.” It may that this 20th-century invention will have to go the way of quill epns and inkwells.
Posted By Julieanne, Waterbury, CT: November 11, 2008 5:50 pm
You know what I think is safe, keeping my money, or spending it now.Why would I invest into anything in the market, when robber barons can steal my money, like they have this year? These crooks have had not one conviction, not one arrest, when any reasonable person knows this melt down was caused from insider trading and fraud.You want the return of confidence? Then somebody better start talking about the schemes that have lead to the greatest depression since 1929. The people will not feel their money is safe in any investment until we see justice done.Time to fill the jails up with the very well connected in Wall Street and Government who conspired to rob the American Citizen of their savings and retirement.
Posted By Charles L. Shaw, Liverpool, NY: November 11, 2008 4:56 pm
I have to agree with the commentor about the canned answer, but I disagree with the other commentors saying they are better off in stable income. BTW, 4.5% interest after an inflation of 3.5% (US Average) equals 1% real return; basically under the Rule of 72, it will take you 72 years to double your money after inflation.
The big problem is people are taking too much risk for their own good and thereby losing their shirts. Unfortunately people need to do their homework before investing. Face it folks a lot of the brokers out there are paid via commission and therefore may not have your best interests at heart.
I would recommend Bogle Heads Guide to Investing & Automatic Millionaire as good books to do some research about personal finance. You’ll be amazed how easy it is to save and invest after reading these two books. Just set and forget.
Another thing, do your age in bonds. If you are 30 years old, you should have 30% of your assets in bonds and/or stable income.
One other thing about stable income; remember these are insurance contracts, if the insurance company goes insolvant because too many bonds it backed turned to worthless paper, you could end up losing your cash.
Posted By Pat, Albany, NY: November 11, 2008 4:53 pm
i have made a ton on stocks in the past and of course i lost some recently, but the idea that we can only accept the good and have none of the bad will keep you poor and on the side lines, mad at those who succeed.
Posted By URB left coast CA.: November 11, 2008 4:36 pm
I’m done paying attention to all these financial “experts”….who advised me where to put my money the last 35 years. Let’s see …..one year I’ve lost 25%? Where were the experts when everything was melting down? Obviously they were pulling money out of equities while telling those of us in a 401K to “stay the course”!
Posted By Kay, Portland, Oregon: November 11, 2008 4:15 pm
Our financial system is completely broken and you are advising people, who have consistently been deceived by Wall Street, to do what now?
Posted By BxCapricorn, Vegas, NV: November 11, 2008 12:14 pm
In a diversified long-term portfolio, does it make sense to buy insurances against market losses in bonds instead of just investing directly in intermediate-term bonds to take maximum advantage of the benefits of diversification (bonds go up in many scenarios when stocks go down and vice-versa) instead of trying to guarantee a minimum level of return?
Posted By Andy from Miami, FL: November 11, 2008 11:44 am
As far as I am concerned, stable value funds are the ONLY way to go in today’s unstable market. I am 47-YO and THANKFULLY I have 100% of my 401K invested in stable value. While other funds offered in my plan are losing between 20 & 50% in value, I am getting approximately 4.1 to 4.2% return on my stable value fund. In essence, while the rest of the ‘world’ is losing the shirts off their backs, I am making money. It might not equate out to 10, 12, 15% return, but at least I am not LOSING anything that will take YEARS, and I DO MEAN YEARS to make up. Of course, I do have other SAFE Investments as well such as FDIC Insured Certificate of Deposit Accounts.
Posted By Jerry, Hagerstown, MD: November 11, 2008 10:31 am
I feel that the answer provided was too canned and does not take into consideration the historic events of the current economic crisis. Since there is nothing really to compare the current market to, saying that stable funds are “too safe” is very naive. A fund that is down 40 to 50% may take years and years to ever get back to 0, or may never. I have been investing in a 401K for over 20 years(I’m 45) and I may have been better off over those years putting the money in stable funds than riding the ups and downs of the market. Remember, it’s not “return on” any more, but “return of” our investments that we worry about.
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Friday 28 November 2008
**4 Lessons from the Financial Crisis
Complete Coverage Ask the Expert Retirement questions answered
4 lessons from the financial crisis
By Walter Updegrave, Money Magazine senior editor
November 17, 2008 5:13 pm
If you can learn from the mistakes of others, now is a great time to be an investor.
Question: I’m inexperienced when it comes to investing, but I want to build a more secure financial future. What tips or suggestions do you have for a young investor like me? —Caleb Bond, Denver
Answer: It’s a great time to be starting out as an investor. Yes, I know that might sound odd, given that the market and the economy are in shambles. But the fact that people are so fearful and the outlook is so uncertain can also have its advantages.
For one thing, much of the excess has been wrung out of stock prices over the past year or so. And while this hardly insures a quick rebound, the money you invest today is much more likely to earn a higher return than if you had invested before the meltdown.
Even more important, though, is that you now have a better sense of the real risks of investing. People who gain their investing experience during bull markets can easily be lulled into a false sense of security. They know that severe downturn occur and maybe could occur again, but the possibility of one happening to them seems remote.
Today, however, all you’ve got to do is look around you to see that risk is real, it can be devastating and it must be respected.
That said, there’s also the danger that someone surveying today’s scene might take away the wrong lessons. Already, some people are concluding that stocks, or financial assets in general, are just too risky. When it comes to important goals like retirement, they say, the experience of the last year or so shows you should stick to the most secure investments, FDIC-insured CDs and the like.
But that’s an overreaction. Risk is a natural part of investing, a part of life, for that matter. Eliminate it and you eliminate opportunity. The key is to understand how much risk you’re taking and manage it.
With that in mind, here are four lessons I think beginning investors should take from the financial crisis and apply to their investing decisions now and in the years ahead. Come to think of it, I think experienced investors should consider them as well.
Financial success isn’t just about investing.
We kind of lost sight of this fact because returns on financial assets had been so good from the early 1980s through the late ‘90s. And even after the dot-com bust we had another five-year bull run in stocks, not to mention heady gains in the real estate market. It became easy to assume that we could achieve financial goals like a secure retirement with a minimum of savings because we could count on the compounding effect of years of high returns.
That was always an unsound strategy, but it’s only now becoming clear how flawed. In fact, as a study by Putnam investments showed a couple of years ago, saving is just as important for building wealth, if not more so. We can’t be sure of the size of the investment gains we’ll earn, and we don’t have nearly as much control over them as we used to think. But we have much more control over how much we save.
And by saving more, we gain two big advantages: we don’t have to invest as aggressively to build a retirement nest egg or reach other financial goals; and, by socking more money away, we’ll have more of a cushion in the event of setbacks in the market.
Simplicity is better than complexity.
If I could ban two words from the vocabulary of investors, it would be these: “sophisticated investing.” I think more harm has been done by investors trying to boost their returns by creating arcane investing strategies or buying complicated investments they don’t understand than all the investment con men and rip-off artists combined.
I don’t want to sound like a Luddite. I’m all for using tools, calculators and software to help you create a retirement plan and an investing strategy. But you’ve also got to maintain a healthy sense of skepticism about how much fancy algorithms and intricate computer simulations can do.
Fact is, the more complicated your investing strategy is, the more things there are that can go wrong, and the harder it will be for you to monitor and maintain it. A simple mix of stock and bond mutual funds may not be the sexiest strategy around. But if you use good common sense in putting that mix together - i.e., you diversify broadly as we recommend in our Asset Allocator tool - it will serve you well over the long term.
Allow for the possibility you may be wrong.
One of the most notable features of the real estate bubble was how sure people felt that prices would continue to go up, up, up. At the peak of the housing mania, I remember getting emails from firms that were inducing individuals to open self-directed IRA accounts so that they could then invest their IRA money in real estate. I wrote a column at the time suggesting that this might be a sign that the real estate market was getting frothy and warning people about staking their retirement on the housing market.
I got a lot of feedback on that column, alas, most of it from people who wanted to know how they could get in touch with those firms that could help them get rental houses into their IRAs. And although I and others pointed out that house prices had gone down in the past and stayed down for quite a while after big run-ups, no one seemed to believe that it could happen again.
Which is why it’s always important when you’re investing to give yourself a reality check. Are your assumptions realistic? Is there something you’re overlooking? Could you be wrong? What would the fallout be if you are? And, perhaps most important, are you interested in this investment because it fits in with your overall strategy or because it’s the investment everyone is talking about? Don’t get too euphoric during upswings or depressed during downturns.
When things are going well and the economy and the markets are on a roll, it’s easy to let the excitement cloud your judgment. After all, everywhere you look - the double-digit gains in the fund listings, the upbeat news in the newspaper’s business section, the cheerful banter on cable TV financial shows - you get positive reinforcement. You almost can’t help but believe that the good times will continue to roll.
So you begin to boost the percentage of stocks in your portfolio and put more money than you should into hot investments that now seem like good bets, such as emerging market stocks. In other words, you begin taking on more risk, although, you probably don’t see it that way. How can investing be risky when it seems the market only goes up?
This process kicks into reverse, of course, when the markets and economy change course and begin falling apart. Then the prevailing gloom and doom dominates your thinking. Everywhere you look - the double-digit losses in the fund listings, the downbeat news in the business section, the somber mood and dire pronouncements on the cable TV financial shows - you get negative reinforcement.
You become convinced that the hard times will get even harder. So you sell out of stocks and move into safe-haven investments you sneered at during boom times - bond funds, money-market funds, stable-value funds, even CDs. And you no doubt see this as a move to reduce risk. After all, aren’t you safer getting out of the market when it only seems to keep going down?
But there’s a risk here too: you may be selling at the worst time and positioning yourself to miss the recovery when it occurs.
These feelings and reactions are natural. We’re human. But it’s no news flash that markets and economies move in cycles. That we go through periods of excess on both the upside and downside. We’ve gone through such episodes before and we will again. So ideally you want to set a strategy that factors in such fluctuations, and then avoid the urge to abandon your strategy when your emotions are screaming you to do so.
I can’t guarantee that steering clear of the euphoria that leads to aggressive investing at market peaks and avoiding the despair that causes you to be too conservative after the market falls apart will assure you’ll earn the highest returns or sidestep big losses. But by doing so, you’ll probably be less vulnerable heading into downturns, and better positioned to take advantage of the upswing when it occurs.
Filed under Uncategorized22 Comments Add a Comment
I just want to caution everyone that before jumping back into the market that everyone has their credit cards paid off. Too quickly we forget that one of the lessons out of all of this is that we cannot live beyond our means.
Posted By Matt Malinowski, Lethbridge AB: November 19, 2008 12:04 am
Why would anyone advise someone to invest in the stock market now. In 1929 there was a major down turn in the market. And in the end the stock market DOW dropped over 80%. We are in a worst crisis than in 1929. The dollar is about to slide over a cliff. And the tax base is being eroded away so the government won’t be able to pay the interest on our loans. Next year we won’t be able to have foreigners buy our bonds. Because the feel they would be too risky because of all our debt. The credit rating of the US will be downgraded. With all the spending we are looking at a hyperinflation senario similar to Wienmar Germany. The article is dreamland. Tell the kid to invest in silver/gold. In the depression you could buy a house for a couple of ounces of gold and in Wienmar germany you could buy a house for one quarter ounce of gold.
Posted By Kevin Rathdrum, Idaho: November 18, 2008 11:18 pm
Save at least 10% of everything you earn. Like Buffett says, be greedy when others are fearful and fearful when others are greedy. Learn and follow the Elliot Wave Theory. Read and learn about investing. Develop and strictly adhere to a long term investment plan. Learn and apply the dynamics and psychology of market swings and how they work and learn how to make them work for you. In essence, educate yourself and apply your knowledge on a long term basis.
Posted By Ramundo A, Lincoln, Nebraska: November 18, 2008 9:53 pm
I’ll tell you what, its been black friday for a few weeks now and I’m loading up on these bank stocks. In a few years it’l rebound and I believe what I put in it over the next year will at least double my value. at least. its on sale! citi for example is 75% off!
Posted By Anonymous: November 18, 2008 8:02 pm
Nice article. Sad to see all these people near retirement that had more than half of their stash in stocks and real estate. What’s even sadder is considering the moral hazard of the government now helping “too much.”
Stock Market has some interesting features, not widely advertised, like a real return since 1871 less than 2% on price appreciation alone (most people don’t believe this, but take the SP500 data since it started and calculate it yourself). On the other hand, including dividends, real return is 6.4%. Kind of like a bond, to support the argument of another writer to this post (but a bond with a heckuva a lot of volatility).
It also seems to have a 35 year oscillation in peaks and troughs, and the next trough is 2018. Hopefully past performance doesn’t predict future results!
Posted By Dave, Houston, TX: November 18, 2008 7:26 pm
I think what Walter is trying to say is :
Keep it simple to keep it manageable.
Meanwhile:
There has been a phrase bandied about in the press “too big to fail”.
I think that phrase needs to be changed to “too big for their britches” because “Wall Street” has been demanding “more liquidity” from the Federal Government for years.
I think that was a cover-up for “we gambled and made some bad bets so we need to borrow more money even cheaper so when we win a big one we can pay you back but meanwhile we need to pay ourselves several million dollars because we are such darn smart and clever people.”
So when you do your own investing, don’t get too big for your britches thinking you are smarter than “Wall Street” because they have more OPM than you do.
OPM being “Other People’s Money”
Posted By Jason Stoons, Austin TX: November 18, 2008 7:10 pm
One fundamental problem with our economy and Government is the unhealthly focus on the spenders–we bend over backwards to encourage people to go into debt, while at the same time practically eliminate all incentives to save our money (painfully low savings rates)–America’s problems will continue to worsen as long as we continue to spend beyond our means…and I’m talking about both Government and personal spending.
Posted By Nairb Sreoom, Biloxi, MS: November 18, 2008 5:21 pm
The current economics is really a paradigm shift to some basics, that will really develope into a new reality, a new way of looking at things. The promoters of sliced and diced investment “opportunities” have been found out. The repercussions of this failure are yet to be determined. Your article really tells us that it is back to basics, keep your investment strategy simple and understandable. I think the future will be the best time in our history, but only after a lot of lessons are learned and pain obsorbed. If the government bails us out too much, we won’t have learned anything.
Posted By Don Miner, San Francisco,: November 18, 2008 4:41 pm
It’s a shame that there is no TV show about simple, sensible investing principles: keeping costs low, tax efficiency high, diversification high, and allocation appropriate. Although they are the optimal strategy for nearly everyone, can you imagine watching a show that told you to do the same basic thing every week for years on end? LOL They could call it “Don’t just do something, stand there”!
Posted By John, Phila PA: November 18, 2008 3:56 pm
forgetting reality because you are chasing pie in the sky is a tough one. Any reference librarian can help you look up the long term advantage that large cap stocks have delivered over government bonds — it is only about 5%.
Every time you think you’re going to do significantly better than that 5% [before taxes, too] you have to know that you’re chasing pie in the sky.
Can it be done? sure — by experts. Then you have to ask yourself if you’re an expert. something like 99.95% of us are not.
If you’re not an expert, can you hire an expert? Absolutely — if you have millions to invest. However, for the average family, the expert needs to get paid so much that you can’t afford him or her. That means you’ll get average results. period.
Build your plan as if you’ll get average results. Then start becoming an expert and maybe you’ll be able to do better than your plan.
Posted By Spock_rhp, Miami, FL: November 18, 2008 3:10 pm
Good Points. On the whole we forgot about risk. We forgot that trees DO NOT grow forever into the sky. The signs were there for the Dot Com bust and not the housing/sub-prime bust. We forgot to look both ways before crossing the ’street’ and got blind-sided.
I’m 55 years old and have been investing since the early 1980’s and went through the crash of 1987, but this time I see with different eyes. All of my equities will remain fully invested, and will be left alone “to fend” for themselves…hopefully their value will rebound in the next 10 or 20 years. I was 80/20 stock to bonds…that’s now become 70/30 ratio. I plan to continue to save 21% of my income, but these monies are going into a GIC fixed instrument within my company 401(k). The other thing that I am doing differently, is to get back (sold my house in April 2008)into Real Estate, and make it a larger percent of my investments.
Good luck to all!
Posted By BIZ, Dunedin Florida USA: November 18, 2008 2:11 pm
All this advice is great if you have a pension to fall back on in hard times IN ADDITION to your 401K.If you don’t, you can’t save enough for a comfortatble retirement before turning 70 with all this brutal cycling.
Posted By Pat Savu Maplewood, MN: November 18, 2008 2:10 pm
The present meltdown has also shown us how unethical many of the financial corporations are. From the companies that rated AIG “AAA” to the derivatives that were “invented” for fast profits and big bonuses, we have learned that Wall Street lies, cheats and steals, without penalty.
Posted By kate, boston, MA: November 18, 2008 1:50 pm
The author is wrong about “much of the excess wrung out” - PE ratios are still excessive and there’s more downside to come.
Posted By Jack Thomas, Tucson, AZ: November 18, 2008 12:55 pm
It is well written , it truly is the fact , putting the bad to the past ,thought the worst could not be over yet , you could expect another 20 % lower values in the stock market ,look out for the DOWJONES to come to level of 7000 to 7400 to enter the market and stay in the stock of atleast 6 months .to get real returns , if one can stay invested longer , better returns are expected .the market will come back to its original level in 3 years , there could not be a better time to get in to the market if one has the cash liquidity ,
Posted By mansoor ,moradabad ,india: November 18, 2008 12:30 pm
Excellent article
Posted By Anonymous: November 18, 2008 12:29 pm
Great aticle , the only way i can recover capital losses is by jumping back in and yousing my capital gains as tax write offs , it will take some time im not going to miss the rebound ive lost to much .
Posted By Bernie Blyth , Australia: November 18, 2008 12:28 pm
I think these are all good and positive ideas, but if we continue to think that the stock market will again go upwards like it did in the dot com peak and the housing market boom, we may be in for a surprise. With all of these bailouts and the companies not doing what they are supposed to do with taxpayer’s money, big business has learned nothing from this. All they will do is blow it and then turn to the government for help…AGAIN.
Posted By Lee, Shreveport, La: November 18, 2008 11:18 am
My advisor told me,rich,is when you marry it, inherit it or compound interest. Re invest the dividends back into the stocks. I believe him, and that is what I am doing, but only good stocks,like GE,Bristol Myers, and yes Visa is a great buy right now. As long as you have a cash reserve,buying into the good stocks, remember, the stock market has thrown out the “baby” with the wash. Take advantage of the blue chips.
Posted By Ken Wayne, Boca Raton,Fl: November 18, 2008 11:17 am
I agree with article - thanks
Posted By Terrace, Gulf Breeze, FL: November 18, 2008 10:22 am
all these principles are fine to write about but not practical given the current scenario. there can be only one Warren Buffet and one Bill Gates. while your house is burning you cant read or remember fire prevention rules or bye laws you have to act.Moreover today’s situation is s spill over of years of faulty financial expansionary policies & it will take a long time to reassert fundamentals which are neither so distorted nor flimsy
Posted By Aj missassauga ont.: November 18, 2008 10:09 am
Excellent article. Let’s remember that fear builds on fear and that is exactly what we’re seeing on today’s market. The smart investor today will analyze current fear trends and gradually inject back into the market when the underlying causes for concern have been dealt with.
There is always inherent risk in investment, but personally I’m excited about the opportunities that this is bringing. Also, I hope that a new generation of investors will be more atuned to the risks involved with investment and will be more ethically inclined in the future.
Posted By Mitesh Vashee, Dallas TX.: November 18, 2008 10:00 am
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4 lessons from the financial crisis
By Walter Updegrave, Money Magazine senior editor
November 17, 2008 5:13 pm
If you can learn from the mistakes of others, now is a great time to be an investor.
Question: I’m inexperienced when it comes to investing, but I want to build a more secure financial future. What tips or suggestions do you have for a young investor like me? —Caleb Bond, Denver
Answer: It’s a great time to be starting out as an investor. Yes, I know that might sound odd, given that the market and the economy are in shambles. But the fact that people are so fearful and the outlook is so uncertain can also have its advantages.
For one thing, much of the excess has been wrung out of stock prices over the past year or so. And while this hardly insures a quick rebound, the money you invest today is much more likely to earn a higher return than if you had invested before the meltdown.
Even more important, though, is that you now have a better sense of the real risks of investing. People who gain their investing experience during bull markets can easily be lulled into a false sense of security. They know that severe downturn occur and maybe could occur again, but the possibility of one happening to them seems remote.
Today, however, all you’ve got to do is look around you to see that risk is real, it can be devastating and it must be respected.
That said, there’s also the danger that someone surveying today’s scene might take away the wrong lessons. Already, some people are concluding that stocks, or financial assets in general, are just too risky. When it comes to important goals like retirement, they say, the experience of the last year or so shows you should stick to the most secure investments, FDIC-insured CDs and the like.
But that’s an overreaction. Risk is a natural part of investing, a part of life, for that matter. Eliminate it and you eliminate opportunity. The key is to understand how much risk you’re taking and manage it.
With that in mind, here are four lessons I think beginning investors should take from the financial crisis and apply to their investing decisions now and in the years ahead. Come to think of it, I think experienced investors should consider them as well.
Financial success isn’t just about investing.
We kind of lost sight of this fact because returns on financial assets had been so good from the early 1980s through the late ‘90s. And even after the dot-com bust we had another five-year bull run in stocks, not to mention heady gains in the real estate market. It became easy to assume that we could achieve financial goals like a secure retirement with a minimum of savings because we could count on the compounding effect of years of high returns.
That was always an unsound strategy, but it’s only now becoming clear how flawed. In fact, as a study by Putnam investments showed a couple of years ago, saving is just as important for building wealth, if not more so. We can’t be sure of the size of the investment gains we’ll earn, and we don’t have nearly as much control over them as we used to think. But we have much more control over how much we save.
And by saving more, we gain two big advantages: we don’t have to invest as aggressively to build a retirement nest egg or reach other financial goals; and, by socking more money away, we’ll have more of a cushion in the event of setbacks in the market.
Simplicity is better than complexity.
If I could ban two words from the vocabulary of investors, it would be these: “sophisticated investing.” I think more harm has been done by investors trying to boost their returns by creating arcane investing strategies or buying complicated investments they don’t understand than all the investment con men and rip-off artists combined.
I don’t want to sound like a Luddite. I’m all for using tools, calculators and software to help you create a retirement plan and an investing strategy. But you’ve also got to maintain a healthy sense of skepticism about how much fancy algorithms and intricate computer simulations can do.
Fact is, the more complicated your investing strategy is, the more things there are that can go wrong, and the harder it will be for you to monitor and maintain it. A simple mix of stock and bond mutual funds may not be the sexiest strategy around. But if you use good common sense in putting that mix together - i.e., you diversify broadly as we recommend in our Asset Allocator tool - it will serve you well over the long term.
Allow for the possibility you may be wrong.
One of the most notable features of the real estate bubble was how sure people felt that prices would continue to go up, up, up. At the peak of the housing mania, I remember getting emails from firms that were inducing individuals to open self-directed IRA accounts so that they could then invest their IRA money in real estate. I wrote a column at the time suggesting that this might be a sign that the real estate market was getting frothy and warning people about staking their retirement on the housing market.
I got a lot of feedback on that column, alas, most of it from people who wanted to know how they could get in touch with those firms that could help them get rental houses into their IRAs. And although I and others pointed out that house prices had gone down in the past and stayed down for quite a while after big run-ups, no one seemed to believe that it could happen again.
Which is why it’s always important when you’re investing to give yourself a reality check. Are your assumptions realistic? Is there something you’re overlooking? Could you be wrong? What would the fallout be if you are? And, perhaps most important, are you interested in this investment because it fits in with your overall strategy or because it’s the investment everyone is talking about? Don’t get too euphoric during upswings or depressed during downturns.
When things are going well and the economy and the markets are on a roll, it’s easy to let the excitement cloud your judgment. After all, everywhere you look - the double-digit gains in the fund listings, the upbeat news in the newspaper’s business section, the cheerful banter on cable TV financial shows - you get positive reinforcement. You almost can’t help but believe that the good times will continue to roll.
So you begin to boost the percentage of stocks in your portfolio and put more money than you should into hot investments that now seem like good bets, such as emerging market stocks. In other words, you begin taking on more risk, although, you probably don’t see it that way. How can investing be risky when it seems the market only goes up?
This process kicks into reverse, of course, when the markets and economy change course and begin falling apart. Then the prevailing gloom and doom dominates your thinking. Everywhere you look - the double-digit losses in the fund listings, the downbeat news in the business section, the somber mood and dire pronouncements on the cable TV financial shows - you get negative reinforcement.
You become convinced that the hard times will get even harder. So you sell out of stocks and move into safe-haven investments you sneered at during boom times - bond funds, money-market funds, stable-value funds, even CDs. And you no doubt see this as a move to reduce risk. After all, aren’t you safer getting out of the market when it only seems to keep going down?
But there’s a risk here too: you may be selling at the worst time and positioning yourself to miss the recovery when it occurs.
These feelings and reactions are natural. We’re human. But it’s no news flash that markets and economies move in cycles. That we go through periods of excess on both the upside and downside. We’ve gone through such episodes before and we will again. So ideally you want to set a strategy that factors in such fluctuations, and then avoid the urge to abandon your strategy when your emotions are screaming you to do so.
I can’t guarantee that steering clear of the euphoria that leads to aggressive investing at market peaks and avoiding the despair that causes you to be too conservative after the market falls apart will assure you’ll earn the highest returns or sidestep big losses. But by doing so, you’ll probably be less vulnerable heading into downturns, and better positioned to take advantage of the upswing when it occurs.
Filed under Uncategorized22 Comments Add a Comment
I just want to caution everyone that before jumping back into the market that everyone has their credit cards paid off. Too quickly we forget that one of the lessons out of all of this is that we cannot live beyond our means.
Posted By Matt Malinowski, Lethbridge AB: November 19, 2008 12:04 am
Why would anyone advise someone to invest in the stock market now. In 1929 there was a major down turn in the market. And in the end the stock market DOW dropped over 80%. We are in a worst crisis than in 1929. The dollar is about to slide over a cliff. And the tax base is being eroded away so the government won’t be able to pay the interest on our loans. Next year we won’t be able to have foreigners buy our bonds. Because the feel they would be too risky because of all our debt. The credit rating of the US will be downgraded. With all the spending we are looking at a hyperinflation senario similar to Wienmar Germany. The article is dreamland. Tell the kid to invest in silver/gold. In the depression you could buy a house for a couple of ounces of gold and in Wienmar germany you could buy a house for one quarter ounce of gold.
Posted By Kevin Rathdrum, Idaho: November 18, 2008 11:18 pm
Save at least 10% of everything you earn. Like Buffett says, be greedy when others are fearful and fearful when others are greedy. Learn and follow the Elliot Wave Theory. Read and learn about investing. Develop and strictly adhere to a long term investment plan. Learn and apply the dynamics and psychology of market swings and how they work and learn how to make them work for you. In essence, educate yourself and apply your knowledge on a long term basis.
Posted By Ramundo A, Lincoln, Nebraska: November 18, 2008 9:53 pm
I’ll tell you what, its been black friday for a few weeks now and I’m loading up on these bank stocks. In a few years it’l rebound and I believe what I put in it over the next year will at least double my value. at least. its on sale! citi for example is 75% off!
Posted By Anonymous: November 18, 2008 8:02 pm
Nice article. Sad to see all these people near retirement that had more than half of their stash in stocks and real estate. What’s even sadder is considering the moral hazard of the government now helping “too much.”
Stock Market has some interesting features, not widely advertised, like a real return since 1871 less than 2% on price appreciation alone (most people don’t believe this, but take the SP500 data since it started and calculate it yourself). On the other hand, including dividends, real return is 6.4%. Kind of like a bond, to support the argument of another writer to this post (but a bond with a heckuva a lot of volatility).
It also seems to have a 35 year oscillation in peaks and troughs, and the next trough is 2018. Hopefully past performance doesn’t predict future results!
Posted By Dave, Houston, TX: November 18, 2008 7:26 pm
I think what Walter is trying to say is :
Keep it simple to keep it manageable.
Meanwhile:
There has been a phrase bandied about in the press “too big to fail”.
I think that phrase needs to be changed to “too big for their britches” because “Wall Street” has been demanding “more liquidity” from the Federal Government for years.
I think that was a cover-up for “we gambled and made some bad bets so we need to borrow more money even cheaper so when we win a big one we can pay you back but meanwhile we need to pay ourselves several million dollars because we are such darn smart and clever people.”
So when you do your own investing, don’t get too big for your britches thinking you are smarter than “Wall Street” because they have more OPM than you do.
OPM being “Other People’s Money”
Posted By Jason Stoons, Austin TX: November 18, 2008 7:10 pm
One fundamental problem with our economy and Government is the unhealthly focus on the spenders–we bend over backwards to encourage people to go into debt, while at the same time practically eliminate all incentives to save our money (painfully low savings rates)–America’s problems will continue to worsen as long as we continue to spend beyond our means…and I’m talking about both Government and personal spending.
Posted By Nairb Sreoom, Biloxi, MS: November 18, 2008 5:21 pm
The current economics is really a paradigm shift to some basics, that will really develope into a new reality, a new way of looking at things. The promoters of sliced and diced investment “opportunities” have been found out. The repercussions of this failure are yet to be determined. Your article really tells us that it is back to basics, keep your investment strategy simple and understandable. I think the future will be the best time in our history, but only after a lot of lessons are learned and pain obsorbed. If the government bails us out too much, we won’t have learned anything.
Posted By Don Miner, San Francisco,: November 18, 2008 4:41 pm
It’s a shame that there is no TV show about simple, sensible investing principles: keeping costs low, tax efficiency high, diversification high, and allocation appropriate. Although they are the optimal strategy for nearly everyone, can you imagine watching a show that told you to do the same basic thing every week for years on end? LOL They could call it “Don’t just do something, stand there”!
Posted By John, Phila PA: November 18, 2008 3:56 pm
forgetting reality because you are chasing pie in the sky is a tough one. Any reference librarian can help you look up the long term advantage that large cap stocks have delivered over government bonds — it is only about 5%.
Every time you think you’re going to do significantly better than that 5% [before taxes, too] you have to know that you’re chasing pie in the sky.
Can it be done? sure — by experts. Then you have to ask yourself if you’re an expert. something like 99.95% of us are not.
If you’re not an expert, can you hire an expert? Absolutely — if you have millions to invest. However, for the average family, the expert needs to get paid so much that you can’t afford him or her. That means you’ll get average results. period.
Build your plan as if you’ll get average results. Then start becoming an expert and maybe you’ll be able to do better than your plan.
Posted By Spock_rhp, Miami, FL: November 18, 2008 3:10 pm
Good Points. On the whole we forgot about risk. We forgot that trees DO NOT grow forever into the sky. The signs were there for the Dot Com bust and not the housing/sub-prime bust. We forgot to look both ways before crossing the ’street’ and got blind-sided.
I’m 55 years old and have been investing since the early 1980’s and went through the crash of 1987, but this time I see with different eyes. All of my equities will remain fully invested, and will be left alone “to fend” for themselves…hopefully their value will rebound in the next 10 or 20 years. I was 80/20 stock to bonds…that’s now become 70/30 ratio. I plan to continue to save 21% of my income, but these monies are going into a GIC fixed instrument within my company 401(k). The other thing that I am doing differently, is to get back (sold my house in April 2008)into Real Estate, and make it a larger percent of my investments.
Good luck to all!
Posted By BIZ, Dunedin Florida USA: November 18, 2008 2:11 pm
All this advice is great if you have a pension to fall back on in hard times IN ADDITION to your 401K.If you don’t, you can’t save enough for a comfortatble retirement before turning 70 with all this brutal cycling.
Posted By Pat Savu Maplewood, MN: November 18, 2008 2:10 pm
The present meltdown has also shown us how unethical many of the financial corporations are. From the companies that rated AIG “AAA” to the derivatives that were “invented” for fast profits and big bonuses, we have learned that Wall Street lies, cheats and steals, without penalty.
Posted By kate, boston, MA: November 18, 2008 1:50 pm
The author is wrong about “much of the excess wrung out” - PE ratios are still excessive and there’s more downside to come.
Posted By Jack Thomas, Tucson, AZ: November 18, 2008 12:55 pm
It is well written , it truly is the fact , putting the bad to the past ,thought the worst could not be over yet , you could expect another 20 % lower values in the stock market ,look out for the DOWJONES to come to level of 7000 to 7400 to enter the market and stay in the stock of atleast 6 months .to get real returns , if one can stay invested longer , better returns are expected .the market will come back to its original level in 3 years , there could not be a better time to get in to the market if one has the cash liquidity ,
Posted By mansoor ,moradabad ,india: November 18, 2008 12:30 pm
Excellent article
Posted By Anonymous: November 18, 2008 12:29 pm
Great aticle , the only way i can recover capital losses is by jumping back in and yousing my capital gains as tax write offs , it will take some time im not going to miss the rebound ive lost to much .
Posted By Bernie Blyth , Australia: November 18, 2008 12:28 pm
I think these are all good and positive ideas, but if we continue to think that the stock market will again go upwards like it did in the dot com peak and the housing market boom, we may be in for a surprise. With all of these bailouts and the companies not doing what they are supposed to do with taxpayer’s money, big business has learned nothing from this. All they will do is blow it and then turn to the government for help…AGAIN.
Posted By Lee, Shreveport, La: November 18, 2008 11:18 am
My advisor told me,rich,is when you marry it, inherit it or compound interest. Re invest the dividends back into the stocks. I believe him, and that is what I am doing, but only good stocks,like GE,Bristol Myers, and yes Visa is a great buy right now. As long as you have a cash reserve,buying into the good stocks, remember, the stock market has thrown out the “baby” with the wash. Take advantage of the blue chips.
Posted By Ken Wayne, Boca Raton,Fl: November 18, 2008 11:17 am
I agree with article - thanks
Posted By Terrace, Gulf Breeze, FL: November 18, 2008 10:22 am
all these principles are fine to write about but not practical given the current scenario. there can be only one Warren Buffet and one Bill Gates. while your house is burning you cant read or remember fire prevention rules or bye laws you have to act.Moreover today’s situation is s spill over of years of faulty financial expansionary policies & it will take a long time to reassert fundamentals which are neither so distorted nor flimsy
Posted By Aj missassauga ont.: November 18, 2008 10:09 am
Excellent article. Let’s remember that fear builds on fear and that is exactly what we’re seeing on today’s market. The smart investor today will analyze current fear trends and gradually inject back into the market when the underlying causes for concern have been dealt with.
There is always inherent risk in investment, but personally I’m excited about the opportunities that this is bringing. Also, I hope that a new generation of investors will be more atuned to the risks involved with investment and will be more ethically inclined in the future.
Posted By Mitesh Vashee, Dallas TX.: November 18, 2008 10:00 am
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Help for Mounting Losses
Help for Mounting 401(k) Losses
by Walter Updegrave
Thursday, November 27, 2008
Question: I'm retired and my 401(k) has lost approximately 35% over the past year. My financial adviser tells me to stay the course, but the losses keep mounting. What should I do? -Dale Marcos, Lafayette, Indiana
Answer: For starters, you should demand a better answer from your financial adviser. Just telling someone to "stay the course" isn't an adequate answer any time an investor expresses doubt or confusion about an investing or planning strategy, and it's certainly not an acceptable reply given the virtually unprecedented turmoil and uncertainty we're experiencing today.
More from CNNMoney.com: • How to Bet on Emerging Markets • 4 Lessons From the Financial Crisis • Whatever You Do, Don't Buy Sears
You can't blame your adviser for not foreseeing the severity of this downturn before it occurred. Nobody's crystal ball is that clear. But an adviser, or at least a good one, is supposed to help you create an investing strategy and retirement plan that can see you through a variety of economic and market scenarios.
Your adviser can't immunize you against losses altogether. That would be unrealistic if you also want your retirement savings to grow and support you for the rest of your life. But the plan should balance upside potential with some measure of downside protection that makes sense given your age, risk tolerance and your financial resources.
Most important, your adviser should be willing to get together with you in times like these to go over the plan, see if it's working as expected and discuss whether or not it needs to be revised.
On the face of it, a 35% decline over the past 12 months seems a bit much for someone who's retired. Given that stocks are down about 40% over that period and the broad bond market is flat to slightly up, that suggests a stock allocation somewhere between 80% and 90%. That strikes me as pretty risky for a retiree. But without more information about your overall finances - like whether the decline you cite includes withdrawals, what other investments you own and how heavily you'll be relying on your 401(k) for living expenses - I can't say for sure whether your 401(k) is invested too aggressively.
Ask for More Transparency
Whatever the particulars of your situation, this much is clear: You are upset about the performance of your account and you aren't getting enough feedback from your adviser to know whether the path he wants you to stay on is the right one.
Here's what I recommend. Go back to your adviser and explain that you need to know what course it is exactly that you are on and why you should stick to it. I'd ask to see how my portfolio is divvied up between stocks and bonds (as well as among different types of stocks and bonds) and I'd want an explanation of why that allocation makes sense given today's conditions.
I'd also want to see some sort of analysis that shows how much income I can reasonably expect throughout retirement from my investments, Social Security and pensions, if any, and how that income compares to my projected living expenses.
Move On
If your adviser can't or won't do this, you have two choices. You can take this kind of comprehensive look at your retirement finances on your own by revving up an online tool like Fidelity's Retirement Income Planner or T. Rowe Price's Retirement Income Calculator.
Or you can switch to an adviser who is willing to do this type of assessment for you. If you do move on to another adviser, be careful. There are lots of people with impressive-sounding credentials who really operate more as a salesman than financial adviser, looking to take advantage of fearful investors in uncertain times like these. To find a reputable adviser, search the Financial Planning Association Web site or the Garrett Planning Network.
Who knows, maybe your adviser has already revisited the advice he or she gave to you and other clients and crunched the numbers again. Perhaps that's why your adviser can so confidently tell you to stay the course. But if I were as worried as you seem to be, I'd want more convincing (and maybe a look at some alternatives) before I went along.
E-mail Updegrave at wupdegrave@moneymail.com.
Copyrighted, CNNMoney. All Rights Reserved.
http://finance.yahoo.com/focus-retirement/article/106216/Help-for-Mounting-401(k)-Losses;_ylt=ApmNvqTpXRlKoIp6cJnk1T67YWsA?mod=retirement-401k
by Walter Updegrave
Thursday, November 27, 2008
Question: I'm retired and my 401(k) has lost approximately 35% over the past year. My financial adviser tells me to stay the course, but the losses keep mounting. What should I do? -Dale Marcos, Lafayette, Indiana
Answer: For starters, you should demand a better answer from your financial adviser. Just telling someone to "stay the course" isn't an adequate answer any time an investor expresses doubt or confusion about an investing or planning strategy, and it's certainly not an acceptable reply given the virtually unprecedented turmoil and uncertainty we're experiencing today.
More from CNNMoney.com: • How to Bet on Emerging Markets • 4 Lessons From the Financial Crisis • Whatever You Do, Don't Buy Sears
You can't blame your adviser for not foreseeing the severity of this downturn before it occurred. Nobody's crystal ball is that clear. But an adviser, or at least a good one, is supposed to help you create an investing strategy and retirement plan that can see you through a variety of economic and market scenarios.
Your adviser can't immunize you against losses altogether. That would be unrealistic if you also want your retirement savings to grow and support you for the rest of your life. But the plan should balance upside potential with some measure of downside protection that makes sense given your age, risk tolerance and your financial resources.
Most important, your adviser should be willing to get together with you in times like these to go over the plan, see if it's working as expected and discuss whether or not it needs to be revised.
On the face of it, a 35% decline over the past 12 months seems a bit much for someone who's retired. Given that stocks are down about 40% over that period and the broad bond market is flat to slightly up, that suggests a stock allocation somewhere between 80% and 90%. That strikes me as pretty risky for a retiree. But without more information about your overall finances - like whether the decline you cite includes withdrawals, what other investments you own and how heavily you'll be relying on your 401(k) for living expenses - I can't say for sure whether your 401(k) is invested too aggressively.
Ask for More Transparency
Whatever the particulars of your situation, this much is clear: You are upset about the performance of your account and you aren't getting enough feedback from your adviser to know whether the path he wants you to stay on is the right one.
Here's what I recommend. Go back to your adviser and explain that you need to know what course it is exactly that you are on and why you should stick to it. I'd ask to see how my portfolio is divvied up between stocks and bonds (as well as among different types of stocks and bonds) and I'd want an explanation of why that allocation makes sense given today's conditions.
I'd also want to see some sort of analysis that shows how much income I can reasonably expect throughout retirement from my investments, Social Security and pensions, if any, and how that income compares to my projected living expenses.
Move On
If your adviser can't or won't do this, you have two choices. You can take this kind of comprehensive look at your retirement finances on your own by revving up an online tool like Fidelity's Retirement Income Planner or T. Rowe Price's Retirement Income Calculator.
Or you can switch to an adviser who is willing to do this type of assessment for you. If you do move on to another adviser, be careful. There are lots of people with impressive-sounding credentials who really operate more as a salesman than financial adviser, looking to take advantage of fearful investors in uncertain times like these. To find a reputable adviser, search the Financial Planning Association Web site or the Garrett Planning Network.
Who knows, maybe your adviser has already revisited the advice he or she gave to you and other clients and crunched the numbers again. Perhaps that's why your adviser can so confidently tell you to stay the course. But if I were as worried as you seem to be, I'd want more convincing (and maybe a look at some alternatives) before I went along.
E-mail Updegrave at wupdegrave@moneymail.com.
Copyrighted, CNNMoney. All Rights Reserved.
http://finance.yahoo.com/focus-retirement/article/106216/Help-for-Mounting-401(k)-Losses;_ylt=ApmNvqTpXRlKoIp6cJnk1T67YWsA?mod=retirement-401k
Thursday 27 November 2008
**Understanding the Power of Compounding
Understanding the Power of Compounding
Compounding in Action
The investment rate assumes a return net of taxes and fees.
The effect of inflation on the purchasing power of the FV can be offset by increasing your annual contributions by a like percentage. As your income increases, so too should your investment contributions.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 6% for the number of years are as shown below:
Rate 6%
Years... FV
10 years 13,181
20 years 36,786
30 years 70,058
40 years 154,762
50 years 290,336
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 7,360
20 years 11,470
30 years 13,765
40 years 15,046
50 years 15,762
A lump sum of $7360 invested for 10 years at 6 percent will produce the same FV ($13,181) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 8% for the number of years are as shown below:
Rate 8%
Years... FV
10 years 14,487
20 years 45,762
30 years 113,283
40 years 259,057
50 years 573,770
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 6,710
20 years 9,818
30 years 11,258
40 years 11,925
50 years 12,233
A lump sum of $6,710 invested for 10 years at 8 percent will produce the same FV ($14,487) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 10% for the number of years are as shown below:
Rate 10%
Years... FV
10 years 15,937
20 years 57,275
30 years 164,494
40 years 442,593
50 years 1,163,909
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 6,145
20 years 8,514
30 years 9,427
40 years 9,779
50 years 9.915
A lump sum of $6,145 invested for 10 years at 10 percent will produce the same FV ($15,937) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 12% for the number of years are as shown below:
Rate 12%
Years... FV
10 years 17,549
20 years 72,052
30 years 241,333
40 years 767,091
50 years 2,400,018
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 5,650
20 years 7,469
30 years 8,055
40 years 8,244
50 years 8,304
A lump sum of $5,650 invested for 10 years at 15 percent will produce the same FV ($17,549) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 15% for the number of years are as shown below:
Rate 15%
Years... FV
10 years 20,304
20 years 102,444
30 years 434,745
40 years 1,779,090
50 years 7,217,716
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 5,019
20 years 6,259
30 years 6,566
40 years 6,642
50 years 6,661
A lump sum of $5,019 invested for 10 years at 15 percent will produce the same FV ($20,304) as $1000 a year for 10 years.
-----
Note:
It is not so much the increase in FV over the early 10-year periods of the savings plan, but the increase over the final 10-year period that yields the big bucks.
For instance, if we reference the compounding at 10 percent, FV increased by $41,338 between years 10 and 20, while the increase between years 40 and 50 was $721,316.
Thereafter, if you start your investment plan at age 30 rather than 20, the $1,000 a year you spent before that rather than invested will have cost you $721,316.
The greatest deterrent to an investment plan is not so much the fortitude to put aside a small percentage of income, but the willpower not to steal from the fund until your regular employment income ceases. Anyone can become rich if they start an investment plan early in life.
Of course, the more you love your work, the longer you will be employed and the more savings you will accumulate. If you find the thought of working until you are 70 abhorrent, then the thought of working at 30 or 40 years of age will be even less attractive; in which case, investing is probably irrelevant because you’re going to have a miserable or unfulfilled life anyway. People who hate working are more likely to become welfare dependent.
Lump sum investing
A lump sum of $7,360 invested for 10 years at 6 percent will produce the same FV ($13,181) as $1,000 a year for 10 years.
A lump sum of $9,779 invested for 40 years at 10 percent will produce the same FV ($442,593) as $1,000 a year for 40 years.
If the same lump sum were invested 10 years earlier – that is, allowed to compound for 50 years, rather than 40 – the nest egg will be boosted by a further $705,372 to $1,147,965.
Have you ever thought about putting something aside for your kids that they can’t touch for 50 years?
Sentiment and moral gratification usually centre on diminishing their incentive to achieve their own sense of self-satisfaction by helping them when they get married or want to buy a house.
If they are like 98 percent of people, the time they really need financial help is after they have lived the good life and have limited savings and no career income.
Material assets are not so important when you have the greatest asset of all: youth.
Related readings:
Oriental Holdings Bhd: The Buy-Hold Advantage
http://www.horizon.my/2008/11/oriental-holdings-bhd-the-buy-hold-advantage/
Oriental Holdings Berhad - What if You had Bought and Held? I happened to be reading the Annual Report of Oriental Holdings Berhad (ORIENT) the other day and came across a statement by Chairman Dato Loh Cheng Yean:
“A holding of 1,000 stocks in Oriental when it was listed in 1964 would translate into 40,255 Oriental stocks worth RM263,670, based on the share price of RM6.55 at the end of 2007. In addition the stocks would have earned a total gross dividend of RM137,660. The gross dividends received and the appreciation in value is equivalent to a remarkable average rate of return of 14.60% for each of the 44 years.”
This sounds pretty good… see once again we’re talking 40 years. I find Oriental Holdings to be quite “remarkable” because it is such a diverse collection of different businesses which include auto assembly, auto parts manufacturing, oil palm, hotels, property etc. But 85% of its RM498 million Operating Profit is from auto and oil palm.
The Story of Anne Scheiber
http://www.horizon.my/2008/11/the-story-of-anne-scheiber/
Maxwell recounts the story of Anne Scheiber, an elderly and thrifty lady who lived in New York and worked for the Inland Revenue Service. When Scheiber retired at age fifty-one, she was only making $3,150 a year. She was treated poorly by her employer and was never promoted. Yet when Anne Scheiber died in 1995 at the age of 101, it was discovered that she left an estate to Yeshiva University worth US$22 million!
How did a public service worker with minimal salary accumulate such a staggering wealth?
Comments by: banking88 on November 25th, 2008 12:13 pm
yes, the key is to invest for the long-term…your wealth would multiply with componding returns…now it’s a good time to enter the market using the dollar cost averaging method…
Compounding in Action
The investment rate assumes a return net of taxes and fees.
The effect of inflation on the purchasing power of the FV can be offset by increasing your annual contributions by a like percentage. As your income increases, so too should your investment contributions.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 6% for the number of years are as shown below:
Rate 6%
Years... FV
10 years 13,181
20 years 36,786
30 years 70,058
40 years 154,762
50 years 290,336
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 7,360
20 years 11,470
30 years 13,765
40 years 15,046
50 years 15,762
A lump sum of $7360 invested for 10 years at 6 percent will produce the same FV ($13,181) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 8% for the number of years are as shown below:
Rate 8%
Years... FV
10 years 14,487
20 years 45,762
30 years 113,283
40 years 259,057
50 years 573,770
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 6,710
20 years 9,818
30 years 11,258
40 years 11,925
50 years 12,233
A lump sum of $6,710 invested for 10 years at 8 percent will produce the same FV ($14,487) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 10% for the number of years are as shown below:
Rate 10%
Years... FV
10 years 15,937
20 years 57,275
30 years 164,494
40 years 442,593
50 years 1,163,909
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 6,145
20 years 8,514
30 years 9,427
40 years 9,779
50 years 9.915
A lump sum of $6,145 invested for 10 years at 10 percent will produce the same FV ($15,937) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 12% for the number of years are as shown below:
Rate 12%
Years... FV
10 years 17,549
20 years 72,052
30 years 241,333
40 years 767,091
50 years 2,400,018
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 5,650
20 years 7,469
30 years 8,055
40 years 8,244
50 years 8,304
A lump sum of $5,650 invested for 10 years at 15 percent will produce the same FV ($17,549) as $1000 a year for 10 years.
-----
The Future Value of investing $1,000 per annum, when compounded by the annual rate of 15% for the number of years are as shown below:
Rate 15%
Years... FV
10 years 20,304
20 years 102,444
30 years 434,745
40 years 1,779,090
50 years 7,217,716
The once-only lump sum invested at the same annual rate for the years to provide the same FV as the corresponding sum are as shown here:
Years... Initial once-only lump sum
10 years 5,019
20 years 6,259
30 years 6,566
40 years 6,642
50 years 6,661
A lump sum of $5,019 invested for 10 years at 15 percent will produce the same FV ($20,304) as $1000 a year for 10 years.
-----
Note:
It is not so much the increase in FV over the early 10-year periods of the savings plan, but the increase over the final 10-year period that yields the big bucks.
For instance, if we reference the compounding at 10 percent, FV increased by $41,338 between years 10 and 20, while the increase between years 40 and 50 was $721,316.
Thereafter, if you start your investment plan at age 30 rather than 20, the $1,000 a year you spent before that rather than invested will have cost you $721,316.
The greatest deterrent to an investment plan is not so much the fortitude to put aside a small percentage of income, but the willpower not to steal from the fund until your regular employment income ceases. Anyone can become rich if they start an investment plan early in life.
Of course, the more you love your work, the longer you will be employed and the more savings you will accumulate. If you find the thought of working until you are 70 abhorrent, then the thought of working at 30 or 40 years of age will be even less attractive; in which case, investing is probably irrelevant because you’re going to have a miserable or unfulfilled life anyway. People who hate working are more likely to become welfare dependent.
Lump sum investing
A lump sum of $7,360 invested for 10 years at 6 percent will produce the same FV ($13,181) as $1,000 a year for 10 years.
A lump sum of $9,779 invested for 40 years at 10 percent will produce the same FV ($442,593) as $1,000 a year for 40 years.
If the same lump sum were invested 10 years earlier – that is, allowed to compound for 50 years, rather than 40 – the nest egg will be boosted by a further $705,372 to $1,147,965.
Have you ever thought about putting something aside for your kids that they can’t touch for 50 years?
Sentiment and moral gratification usually centre on diminishing their incentive to achieve their own sense of self-satisfaction by helping them when they get married or want to buy a house.
If they are like 98 percent of people, the time they really need financial help is after they have lived the good life and have limited savings and no career income.
Material assets are not so important when you have the greatest asset of all: youth.
Related readings:
Oriental Holdings Bhd: The Buy-Hold Advantage
http://www.horizon.my/2008/11/oriental-holdings-bhd-the-buy-hold-advantage/
Oriental Holdings Berhad - What if You had Bought and Held? I happened to be reading the Annual Report of Oriental Holdings Berhad (ORIENT) the other day and came across a statement by Chairman Dato Loh Cheng Yean:
“A holding of 1,000 stocks in Oriental when it was listed in 1964 would translate into 40,255 Oriental stocks worth RM263,670, based on the share price of RM6.55 at the end of 2007. In addition the stocks would have earned a total gross dividend of RM137,660. The gross dividends received and the appreciation in value is equivalent to a remarkable average rate of return of 14.60% for each of the 44 years.”
This sounds pretty good… see once again we’re talking 40 years. I find Oriental Holdings to be quite “remarkable” because it is such a diverse collection of different businesses which include auto assembly, auto parts manufacturing, oil palm, hotels, property etc. But 85% of its RM498 million Operating Profit is from auto and oil palm.
The Story of Anne Scheiber
http://www.horizon.my/2008/11/the-story-of-anne-scheiber/
Maxwell recounts the story of Anne Scheiber, an elderly and thrifty lady who lived in New York and worked for the Inland Revenue Service. When Scheiber retired at age fifty-one, she was only making $3,150 a year. She was treated poorly by her employer and was never promoted. Yet when Anne Scheiber died in 1995 at the age of 101, it was discovered that she left an estate to Yeshiva University worth US$22 million!
How did a public service worker with minimal salary accumulate such a staggering wealth?
Comments by: banking88 on November 25th, 2008 12:13 pm
yes, the key is to invest for the long-term…your wealth would multiply with componding returns…now it’s a good time to enter the market using the dollar cost averaging method…
To Upgrade the Quality of Your Portfolio
To upgrade the quality of your portfolio
For those who already hold a portfolio of stocks that may have been selected without reference to value, a culling approach to upgrade the quality of your portfolio by replacing overpriced stocks with those offering better value, would be suggested.
Although it is probable that you hold some stocks that should be sold immediately, in making that determination you must be sure of what you are doing and not act with undue haste.
Solicit advice and input from others you respect, but keep your own counsel and do not be influenced by those whose knowledge is unlikely to be superior to your own.
Let’s also consider some basic selling issues:
Tax
Let’s say you buy a stock for $5 and it rises to $15 when its value is $11. If you sell it for $15 and the $10 profit was subject to 40 percent tax, you would be left with $11. If you consider that $11 would be a good price at which to buy the stock, there is not much point in selling at the same net price.
Management
Great businesses with sound corporate management are quite rare. If you are invested in such a company, selling and attempting to find a replacement with similar management qualities is likely to be difficult. Buffett says he is wary of the risk in switching allegiance to people less well known to him.
Fear of not being able to buy back at a better price.
For those who already hold a portfolio of stocks that may have been selected without reference to value, a culling approach to upgrade the quality of your portfolio by replacing overpriced stocks with those offering better value, would be suggested.
Although it is probable that you hold some stocks that should be sold immediately, in making that determination you must be sure of what you are doing and not act with undue haste.
Solicit advice and input from others you respect, but keep your own counsel and do not be influenced by those whose knowledge is unlikely to be superior to your own.
Let’s also consider some basic selling issues:
Tax
Let’s say you buy a stock for $5 and it rises to $15 when its value is $11. If you sell it for $15 and the $10 profit was subject to 40 percent tax, you would be left with $11. If you consider that $11 would be a good price at which to buy the stock, there is not much point in selling at the same net price.
Management
Great businesses with sound corporate management are quite rare. If you are invested in such a company, selling and attempting to find a replacement with similar management qualities is likely to be difficult. Buffett says he is wary of the risk in switching allegiance to people less well known to him.
Fear of not being able to buy back at a better price.
Think Availability of Opportunities
Think Availability of Opportunities; Not Diversification or Acting Contrary to the Market
Portfolio Diversification
Towards the end of a bull market, when selling presents more opportunities than buying, the cash and interest-bearing securities will be quite high. In the tail-end of a bear market, when opportunities are more plentiful, the cash and interest-bearing securities might be close to zero.
The amount of cash and interest-bearing securities you carry will depend on several factors, not the least important of which is your comfort level with the price volatility of equities.
Think of the Availability of Opportunities
Conventional wisdom tells us a portfolio should be spread over a diversified range of industries on the premise that a downturn in one sector of the economy will only affect a portion of your portfolio. A contrarian would argue that you should only buy into an industry that is suffering a downturn because prices will be cheap.
However, think not in terms of diversification or acting contrary to the market, but of the availability of opportunities.
Remember Mae West’s words: “Too much of a good thing can be wonderful”. Mae, however, was a woman of experience with the ability to know a good thing. Lacking that same experience, or the necessary time to acquire it, it’s easier to recognize and avoid what is not a good thing.
This approach will not guarantee that every selection will be wonderful. It may even eliminate a few stocks that may have turned out to be wonderful, but in eliminating most of what is likely to be a lot less than wonderful, it should deliver above-average results.
Portfolio Diversification
There can be no hard and fast rules about diversifying. However, a portfolio should contain a certain amount of cash and interest-bearing securities. These should be weighted towards
- higher yielding secure preference shares that have no downside price risk on conversion and
- property trusts or REITS that have low profit and price volatility.
Towards the end of a bull market, when selling presents more opportunities than buying, the cash and interest-bearing securities will be quite high. In the tail-end of a bear market, when opportunities are more plentiful, the cash and interest-bearing securities might be close to zero.
The amount of cash and interest-bearing securities you carry will depend on several factors, not the least important of which is your comfort level with the price volatility of equities.
Think of the Availability of Opportunities
Conventional wisdom tells us a portfolio should be spread over a diversified range of industries on the premise that a downturn in one sector of the economy will only affect a portion of your portfolio. A contrarian would argue that you should only buy into an industry that is suffering a downturn because prices will be cheap.
However, think not in terms of diversification or acting contrary to the market, but of the availability of opportunities.
Remember Mae West’s words: “Too much of a good thing can be wonderful”. Mae, however, was a woman of experience with the ability to know a good thing. Lacking that same experience, or the necessary time to acquire it, it’s easier to recognize and avoid what is not a good thing.
This approach will not guarantee that every selection will be wonderful. It may even eliminate a few stocks that may have turned out to be wonderful, but in eliminating most of what is likely to be a lot less than wonderful, it should deliver above-average results.
How many stocks should you hold?
How many stocks should you hold?
The proprietor or manager of a business is likely to have only one investment, his or her business – nothing wrong with that.
Most equity funds hold many stocks – nothing wrong with that either. In recognizing its limitations, management is minimizing the impact of mistakes. The last thing you want if someone who doesn’t know what he or she is doing investing your money in a handful of stocks.
As an individual investor, having a few hundred dollars in each of very many stocks is obviously not economical in terms of brokerage fees, administration and time devoted to following each stock. Availability of worthwhile opportunities, aversion to risk, size of portfolio and level of expertise all contribute to the number of stocks you should hold.
If you know what you are doing and have the time to do research, as a rough guide, the maximum stocks to be held should be the lesser of 15 or the square root (to the nearest whole number) of the collective market prices of the portfolio divided by 1000. So a portfolio priced at $9000 would contain 3 stocks. (Square root of 9000/1000 = square root of 9 = 3)
For example:
Value of portfolio…. Maximum Number of stocks
$4000……..2
$9000……..3
$16,000…….4
$25,000…….5
$36,000…….6
$49,000…....7
$64,000…....8
$81,000…....9
$100,000…..10
$121,000…..11
$144,000…..12
$169,000…..13
$196,000…..14
$225,000+…..15 (Maximum)
The proprietor or manager of a business is likely to have only one investment, his or her business – nothing wrong with that.
Most equity funds hold many stocks – nothing wrong with that either. In recognizing its limitations, management is minimizing the impact of mistakes. The last thing you want if someone who doesn’t know what he or she is doing investing your money in a handful of stocks.
As an individual investor, having a few hundred dollars in each of very many stocks is obviously not economical in terms of brokerage fees, administration and time devoted to following each stock. Availability of worthwhile opportunities, aversion to risk, size of portfolio and level of expertise all contribute to the number of stocks you should hold.
If you know what you are doing and have the time to do research, as a rough guide, the maximum stocks to be held should be the lesser of 15 or the square root (to the nearest whole number) of the collective market prices of the portfolio divided by 1000. So a portfolio priced at $9000 would contain 3 stocks. (Square root of 9000/1000 = square root of 9 = 3)
For example:
Value of portfolio…. Maximum Number of stocks
$4000……..2
$9000……..3
$16,000…….4
$25,000…….5
$36,000…….6
$49,000…....7
$64,000…....8
$81,000…....9
$100,000…..10
$121,000…..11
$144,000…..12
$169,000…..13
$196,000…..14
$225,000+…..15 (Maximum)
Wednesday 26 November 2008
Dollar cost averaging investor
By investing equal amounts of cash each year, fewer stocks will be acquired when prices are higher and more when prices are lower. It is therefore an ideal way of investing for those with a regular savings plan.
In disaster years when the market was down, the price value of the investor's holding bottomed, but it was the additional units bought in these disaster years when prices were low that enabled a positive overall return. A particular year that was considered to be a great year for the stock market, was also the worst year for our dollar cost averaging investor.
By investing a portion of annual income once a year in good businesses, young investors need not care what happens to the price. Rather than cause for gloom, market crashes are a reason for celebration.
In disaster years when the market was down, the price value of the investor's holding bottomed, but it was the additional units bought in these disaster years when prices were low that enabled a positive overall return. A particular year that was considered to be a great year for the stock market, was also the worst year for our dollar cost averaging investor.
By investing a portion of annual income once a year in good businesses, young investors need not care what happens to the price. Rather than cause for gloom, market crashes are a reason for celebration.
Slow consistent accumulation through the power of compounding
Investing is not about making a quick kill, but slow and consistent accumulation through the power of compounding.
Sometimes, exceptional results will occur through the catch-up process of buying underpriced stocks or excessive market pricing, but unless you really know what you are doing, never gamble on chasing quick returns by being enticed to buy on margin.
Most individuals trading in highly leveraged futures are eventually wiped out by their lack of staying power when exceptional price volatility extinguishes their small percentage of equity. Losing a bet in which you can be 100 percent right with your choice but 1 percent wrong with the timing doesn't seem very good odds. Making money is nice, but peace of mind is much more valuable.
Sometimes, exceptional results will occur through the catch-up process of buying underpriced stocks or excessive market pricing, but unless you really know what you are doing, never gamble on chasing quick returns by being enticed to buy on margin.
Most individuals trading in highly leveraged futures are eventually wiped out by their lack of staying power when exceptional price volatility extinguishes their small percentage of equity. Losing a bet in which you can be 100 percent right with your choice but 1 percent wrong with the timing doesn't seem very good odds. Making money is nice, but peace of mind is much more valuable.
Best companies to invest in
Positive attributes to look for
So long as ROE is not overly leveraged by too much interest-bearing debt, the best companies in which to invest have a high ROE and a proven ability to reinvest a good proportion of profits without negatively affecting their ROE.
A company with a high ROE that distributes all, or close to all, profits is telling you that while it's a good business, it lacks the opportunity to grow. For instance, the sole local newspaper might be highly profitable by virtue of its monopoly, but opportunities to start a new paper or to buy an existing paper at a favourable price are likely to be rare. Profit growth is therefore limited to circulation growth. Such companies have the investment characteristics of an interest-bearing security - yield, but little or no growth - and must be valued accordingly.
Businesses that have historically long-term high ROEs with a high reinvestment rate have a sustainable competitive advantage that is difficult to duplicate. They have established brand-name products or services, patent rights, an established market niche or an innovative business model.
Although businesses with these qualities will not be selling at bargain prices, we can afford to pay a premium for a great business and still achieve a high return in the long term. The club of great businesses is not a closed shop, so watch out for new additions among smaller, less recognized companies that display these attributes.
So long as ROE is not overly leveraged by too much interest-bearing debt, the best companies in which to invest have a high ROE and a proven ability to reinvest a good proportion of profits without negatively affecting their ROE.
A company with a high ROE that distributes all, or close to all, profits is telling you that while it's a good business, it lacks the opportunity to grow. For instance, the sole local newspaper might be highly profitable by virtue of its monopoly, but opportunities to start a new paper or to buy an existing paper at a favourable price are likely to be rare. Profit growth is therefore limited to circulation growth. Such companies have the investment characteristics of an interest-bearing security - yield, but little or no growth - and must be valued accordingly.
Businesses that have historically long-term high ROEs with a high reinvestment rate have a sustainable competitive advantage that is difficult to duplicate. They have established brand-name products or services, patent rights, an established market niche or an innovative business model.
Although businesses with these qualities will not be selling at bargain prices, we can afford to pay a premium for a great business and still achieve a high return in the long term. The club of great businesses is not a closed shop, so watch out for new additions among smaller, less recognized companies that display these attributes.
Tuesday 25 November 2008
Ben Graham Checklist for Finding Undervalued Stocks
In addition to identifying and quantifying important value components, Graham left us with an assortment of general stock selection rules. He created a number of checklists at different times in his career to serve different investment objectives and portfolio strategies. The checklists review different aspects of a company's financial strength, intrinsic value, and the realtionship with price.
Here is a
Ben Graham Checklist for Finding Undervalued Stocks
Criterias
Risk
1. Earnings to price (the inverse of P/E) is double the high-grade corporate bond yield. If the high-grade bond yields 7%, then earnings to price should be 14%.
2. P/E ratio that is 0.4 times the highest average P/E achieved in the last 5 years.
3. Dividend yield is 2/3 the high-grade bond yield.
4. Stock price of 2/3 the tangible book value per share.
5. Stock price of 2/3 the net current asset value.
Financial strength
6. Total debt is lower than tangible book value.
7. Current ratio (current assets/current liabilities) is greater than 2.
8. Total debt is no more than liquidation value.
Earnings stability
9. Earnings have doubled in most recent 10 years.
10. Earnings have declined no more than 5% in 2 of the past 10 years.
If a stock meets 7 of the 10 criteria, it is probably a good value, according to Graham.
If you're income oriented, Graham recommended paying special attention to items 1 through 7.
If you're concerned about growth and safety, items 1 through 5 and 9 and 10 are important.
If you're concerned with aggressive growth, ignore item 3, reduce the emphasis on 4 through 6, and weigh 9 and 10 heavily.
Again, these checklists are a guideline and example, not a cookbook recipe you should follow precisely. They are a way of thinking and an example of how you may construct your own value investing system.
The criteria mentioned above are probably more focussed on dividends and safety than even today's value investors choose to be. But today's value investing practice owes an immense debt to this type of financial and investment analysis.
Spreadsheet for finding Undervalue Stocks
http://spreadsheets.google.com/pub?key=tZGNWHLD2d2nTgCcxSKyoCA&output=html
Reference: 20.11.2008 - KLSE MARKET PE
Here is a
Ben Graham Checklist for Finding Undervalued Stocks
Criterias
Risk
1. Earnings to price (the inverse of P/E) is double the high-grade corporate bond yield. If the high-grade bond yields 7%, then earnings to price should be 14%.
2. P/E ratio that is 0.4 times the highest average P/E achieved in the last 5 years.
3. Dividend yield is 2/3 the high-grade bond yield.
4. Stock price of 2/3 the tangible book value per share.
5. Stock price of 2/3 the net current asset value.
Financial strength
6. Total debt is lower than tangible book value.
7. Current ratio (current assets/current liabilities) is greater than 2.
8. Total debt is no more than liquidation value.
Earnings stability
9. Earnings have doubled in most recent 10 years.
10. Earnings have declined no more than 5% in 2 of the past 10 years.
If a stock meets 7 of the 10 criteria, it is probably a good value, according to Graham.
If you're income oriented, Graham recommended paying special attention to items 1 through 7.
If you're concerned about growth and safety, items 1 through 5 and 9 and 10 are important.
If you're concerned with aggressive growth, ignore item 3, reduce the emphasis on 4 through 6, and weigh 9 and 10 heavily.
Again, these checklists are a guideline and example, not a cookbook recipe you should follow precisely. They are a way of thinking and an example of how you may construct your own value investing system.
The criteria mentioned above are probably more focussed on dividends and safety than even today's value investors choose to be. But today's value investing practice owes an immense debt to this type of financial and investment analysis.
Spreadsheet for finding Undervalue Stocks
http://spreadsheets.google.com/pub?key=tZGNWHLD2d2nTgCcxSKyoCA&output=html
Reference: 20.11.2008 - KLSE MARKET PE
Impact of Interest Rates on Stock Prices
Impact of Interest Rates on Stock Prices
Warren Buffett highlighted the impact of interest rates on the Dow in a speech he gave on the stock market in July 1999. To demonstrate the correlation between interest rates and stock prices, with the exception of the inflation figures, he provided the data below which depicts two 17-year periods, between 1964 and 1981, and 1981 to 1998.
31st December
Gain in GNP over each 17 year period (%)
1964 – 1981…..373
1981 – 1998…..177
DJIA
1964—874
1981-- 875
1998--9181
Interest on long term government bonds (%)
1964-- 4.20
1981-- 13.65
1998-- 5.09
Increase in consumer price index over each 17 year period (%)
1964 – 1981…..201
1981 – 1998……74
Note:
The inflationary effect on asset values together with retained profits and new capital issues would have significantly increased the book values of the companies comprising the Dow during the first period 1964 – 1981. Yet, in spite of the huge increase in GNP, the 1964 index figure was basically the same 17 years later. Prices had been subdued by a more than threefold increase in interest rates.
In the second 17-year period from 1981 to 1998, in spite of GNP growth and inflation being less than 50 percent of the first period, the Dow increased by 949 percent. The driving factor was declining interest rates that diverted money out of interest-bearing securities into equities.
Interest rates increase at times of high inflation partly to offset the diminishing value of money and the government’s desire to curb demand in what is seen to be, as measured by GNP, a fast-growing economy. Conversely, when inflation subsided in the second 17-year period, interest rates declined.
Warren Buffett highlighted the impact of interest rates on the Dow in a speech he gave on the stock market in July 1999. To demonstrate the correlation between interest rates and stock prices, with the exception of the inflation figures, he provided the data below which depicts two 17-year periods, between 1964 and 1981, and 1981 to 1998.
31st December
Gain in GNP over each 17 year period (%)
1964 – 1981…..373
1981 – 1998…..177
DJIA
1964—874
1981-- 875
1998--9181
Interest on long term government bonds (%)
1964-- 4.20
1981-- 13.65
1998-- 5.09
Increase in consumer price index over each 17 year period (%)
1964 – 1981…..201
1981 – 1998……74
Note:
The inflationary effect on asset values together with retained profits and new capital issues would have significantly increased the book values of the companies comprising the Dow during the first period 1964 – 1981. Yet, in spite of the huge increase in GNP, the 1964 index figure was basically the same 17 years later. Prices had been subdued by a more than threefold increase in interest rates.
In the second 17-year period from 1981 to 1998, in spite of GNP growth and inflation being less than 50 percent of the first period, the Dow increased by 949 percent. The driving factor was declining interest rates that diverted money out of interest-bearing securities into equities.
Interest rates increase at times of high inflation partly to offset the diminishing value of money and the government’s desire to curb demand in what is seen to be, as measured by GNP, a fast-growing economy. Conversely, when inflation subsided in the second 17-year period, interest rates declined.
Economic Impact of Interest Rates and the Japanese Economy
Economic Impact of Interest Rates
There is a tendency to forget that for every borrower there is a lender and that interest rates work both ways. Less interest paid by borrowers means less interest received by lenders. When interest rates rise or fall, total disposable income doesn’t change; it simply redistributes.
Effect of rising interest rates on consumers
1. Consumer demand declines because the forced reduction in consumption by the greater number of borrowers is greater than the increased consumption of the lesser number of lenders.
2. Reduced demand is said to dampen inflationary impact of rising prices.
3. Budget-strapped families are forced to work extra hours or family member to seek part-time work.
4. The subsequent increase in availability of labour reduces pressure on wage demands.
Effect of interest rates rise on highly leveraged businesses
1. Profitability of highly leveraged businesses is reduced by their high cost of debt. Main impact on profitability is felt by exporters.
2. More foreign capital inflows are attracted by the higher interest rates which increases the exchange rate, consequently reducing the value of exports in the domestic currency.
3. Lower export output means reduced demand for labour and consequent further restraint on wage increases.
4. Higher exchange rate also means that the lower cost of imports will reduce prices
5. Reduced labour demand in industries competing with imported goods stabilizes costs by again increasing the availability of labour.
Effect of falling interest rates
1. Debtors are rewarded and more inclined to be financially irresponsible.
2. Those who have been prudent in accumulating savings in interest-bearing securities are penalized and less inclined to be prudent in the future. (Given the impact of a 40 percent tax rate and 3 percent inflation on an interest rate of 5 percent, the zero return (5 percent x 60 percent – 3 percent) provides zero incentive for prudence.)
3. Although serving short-term political objectives and rescuing overleveraged debtors, the longer-term effects of artificially low interest rates have proven to be undesirable.
Low Interest rates and The Japanese Economy
Any doubt about the effectiveness of low interest rates to stimulate the real economy should have been dispelled by the well-publicised Japanese experience. In spite of having interest rates close to zero and the government running a huge annual deficit, thus leaving more disposable income in the hands of the consumers, Japan has suffered a lingering recession since 1990.
The Nikkei 225 index’s loss of one-third of its value in the past 20 years can only be attributed to the low profitability of Japan’s corporations. Even with the leverage of close to zero interest rates, the ROE of Japan’s large nonfinancial firms fell from 8.2 percent in 1988 to an average of 3.1 percent between 1992 and 1999. It has since recovered to roughly 10 percent in 2007, but still lags a long way behind higher-interest-rate countries.
The real determinant of economic viability, ROFE (Returns on Funds Employed), would obviously be considerably lower than the quoted ROEs. When debt servicing is of no concern, inefficiencies creep into the business and the economic viability of capex becomes less important.
The prices of those wonderful products we buy from Japan are subsidized by shareholders of Japanese corporations. Little wonder that Buffett, when asked about investing in Japan in 2007, wryly commented that the profitability of Japanese companies was too low for Berkshire’s liking.
Although Japanese corporate profitability is improving, by Western standards most of its major corporations have not been economically viable in the past, and if required to pay equitable rates of interest, would be in serious financial difficulty.
The high Nikkei index PE ratio in 2007 of 18 (price-to-book value of 1.9) on average ROEs of 10 percent is influenced by the meager average dividend yield of 1.1 percent still being better than leaving money in the bank.
With so little incentive to invest and debt so cheap, it is not surprising that in 2005 Japan was the world’s largest consumer of luxury goods, accounting for 41 percent. Rather than working in favour of Japanese investors, low interest rates over the past 20 years have decimated their funds. Although low domestic rates persist, demand for Japanese stocks will remain high and they will therefore continue to be grossly overpriced.
The reason Japan keeps rates so low is to encourage an outflow of capital to dampen the yen exchange rate to help its exporters. In other words, domestic employment is the prime motivation. If Japan’s trade surplus were repatriated, rather than being left abroad, the US dollar would crumble and the yen appreciate to a level that would make life even tougher, perhaps impossible, for many Japanese exporters.
Here is a simple question to see whether you have been following the argument.
Given a Nikkei index figure of 16,500 and the abovementioned ROE (10 percent) and price to book value (1.9), what would the Nikkei index need to be to achieve a 10 percent return from an index fund that replicated it? Answer: 8684
When ROE and RR (Rate of Return) are equal, value is equal to book value. Therefore, 16,500 / 1.9 (price to book value) = 8684.
These are the sorts of things to consider when thinking about investing in international funds.
Related article: 20.11.2008 - KLSE MARKET PE
There is a tendency to forget that for every borrower there is a lender and that interest rates work both ways. Less interest paid by borrowers means less interest received by lenders. When interest rates rise or fall, total disposable income doesn’t change; it simply redistributes.
Effect of rising interest rates on consumers
1. Consumer demand declines because the forced reduction in consumption by the greater number of borrowers is greater than the increased consumption of the lesser number of lenders.
2. Reduced demand is said to dampen inflationary impact of rising prices.
3. Budget-strapped families are forced to work extra hours or family member to seek part-time work.
4. The subsequent increase in availability of labour reduces pressure on wage demands.
Effect of interest rates rise on highly leveraged businesses
1. Profitability of highly leveraged businesses is reduced by their high cost of debt. Main impact on profitability is felt by exporters.
2. More foreign capital inflows are attracted by the higher interest rates which increases the exchange rate, consequently reducing the value of exports in the domestic currency.
3. Lower export output means reduced demand for labour and consequent further restraint on wage increases.
4. Higher exchange rate also means that the lower cost of imports will reduce prices
5. Reduced labour demand in industries competing with imported goods stabilizes costs by again increasing the availability of labour.
Effect of falling interest rates
1. Debtors are rewarded and more inclined to be financially irresponsible.
2. Those who have been prudent in accumulating savings in interest-bearing securities are penalized and less inclined to be prudent in the future. (Given the impact of a 40 percent tax rate and 3 percent inflation on an interest rate of 5 percent, the zero return (5 percent x 60 percent – 3 percent) provides zero incentive for prudence.)
3. Although serving short-term political objectives and rescuing overleveraged debtors, the longer-term effects of artificially low interest rates have proven to be undesirable.
Low Interest rates and The Japanese Economy
Any doubt about the effectiveness of low interest rates to stimulate the real economy should have been dispelled by the well-publicised Japanese experience. In spite of having interest rates close to zero and the government running a huge annual deficit, thus leaving more disposable income in the hands of the consumers, Japan has suffered a lingering recession since 1990.
The Nikkei 225 index’s loss of one-third of its value in the past 20 years can only be attributed to the low profitability of Japan’s corporations. Even with the leverage of close to zero interest rates, the ROE of Japan’s large nonfinancial firms fell from 8.2 percent in 1988 to an average of 3.1 percent between 1992 and 1999. It has since recovered to roughly 10 percent in 2007, but still lags a long way behind higher-interest-rate countries.
The real determinant of economic viability, ROFE (Returns on Funds Employed), would obviously be considerably lower than the quoted ROEs. When debt servicing is of no concern, inefficiencies creep into the business and the economic viability of capex becomes less important.
The prices of those wonderful products we buy from Japan are subsidized by shareholders of Japanese corporations. Little wonder that Buffett, when asked about investing in Japan in 2007, wryly commented that the profitability of Japanese companies was too low for Berkshire’s liking.
Although Japanese corporate profitability is improving, by Western standards most of its major corporations have not been economically viable in the past, and if required to pay equitable rates of interest, would be in serious financial difficulty.
The high Nikkei index PE ratio in 2007 of 18 (price-to-book value of 1.9) on average ROEs of 10 percent is influenced by the meager average dividend yield of 1.1 percent still being better than leaving money in the bank.
With so little incentive to invest and debt so cheap, it is not surprising that in 2005 Japan was the world’s largest consumer of luxury goods, accounting for 41 percent. Rather than working in favour of Japanese investors, low interest rates over the past 20 years have decimated their funds. Although low domestic rates persist, demand for Japanese stocks will remain high and they will therefore continue to be grossly overpriced.
The reason Japan keeps rates so low is to encourage an outflow of capital to dampen the yen exchange rate to help its exporters. In other words, domestic employment is the prime motivation. If Japan’s trade surplus were repatriated, rather than being left abroad, the US dollar would crumble and the yen appreciate to a level that would make life even tougher, perhaps impossible, for many Japanese exporters.
Here is a simple question to see whether you have been following the argument.
Given a Nikkei index figure of 16,500 and the abovementioned ROE (10 percent) and price to book value (1.9), what would the Nikkei index need to be to achieve a 10 percent return from an index fund that replicated it? Answer: 8684
When ROE and RR (Rate of Return) are equal, value is equal to book value. Therefore, 16,500 / 1.9 (price to book value) = 8684.
These are the sorts of things to consider when thinking about investing in international funds.
Related article: 20.11.2008 - KLSE MARKET PE
Berkshire Hathaway's Stock Price
Compound Annual Growth Rate from 1990 to 1996 approximately: 26%
Compound Annual Growth Rate from 1996 to 2000 approximately: 18%
Compound Annual Growth Rate from 2001 to 2005 approximately
(still positive CAGR but well below Buffett's goal of 15%): 4%
Compound Annual Growth Rate from 2006 to Mid 2008 approximately: 31%
Berkshire Hathaway played a serious game of catchup during this short time frame.
Compound Annual Growth Rate from 1990 to Mid 2008 approximately: 17%
Berkshire Hathaway has exceeded the goal of 15% CAGR over a 17.5 year period.
Berkshire Hathaway has exceeded the goal of 15% CAGR over a 17.5 year period.
----------
Of course there are some companies that exceeded 100% CAGR on their stock price during the 1990's.
It is interesting to note that RedHat (ticker: RHT) had more than a 14000% CAGR from August 11, 1999 until December 9, 1999 when the share price went from $54.50 to $286.25.
Of course it also had a very bad CAGR of -89% from December 9, 1999 until September 18, 2001.
During this time the stock had a 2 for 1 stock split on January 10, 2000. On a split adjusted basis, the stock went from $143.12 to $3.02 per share.
Educational experience with an outcome other than expected
During bull markets owning stocks and calls on underpriced stocks should increase the value of the portfolio.
Bear markets should benefit positions in your portfolio that are either short overpriced companies or own puts on the overpriced stock.
Income may be generated by selling covered calls or credit spreads during a neutral market.
Please note that I have made extensive use of the words "should" and "may". Please do not invest any money that you can not afford to lose. Everyone has a different tolerance for risk. It is important that you do your own homework and take responsibility for any decisions that you make.
When investing, it doesn't take very long to have an educational experience with an outcome other than expected.
http://hyperdiversification.com/default.aspx
Bear markets should benefit positions in your portfolio that are either short overpriced companies or own puts on the overpriced stock.
Income may be generated by selling covered calls or credit spreads during a neutral market.
Please note that I have made extensive use of the words "should" and "may". Please do not invest any money that you can not afford to lose. Everyone has a different tolerance for risk. It is important that you do your own homework and take responsibility for any decisions that you make.
When investing, it doesn't take very long to have an educational experience with an outcome other than expected.
http://hyperdiversification.com/default.aspx
In Warren Buffet's 1992 letter to the share holders he discussed the following:
- During 1992, their Book Value had increased by 20.3%
- Between 1964 and 1992 book value per share (BVPS) had increased from $19 to $7745 resulting in a CAGR of 23.6%.
- Used book value for intrinsic value.
- CAGR goal 15%
- The number of outstanding shares has changed very little between 1964 and 1992 (1,137,778 vs. 1,152,547 respectively)
- Requiring a significant Margin of Safety (MOS) when purchasing stock in another company as a cornerstone of Berkshire Hathaway's success
My mom bought her first new car back in 1965. It was a Ford Falcon. She really liked the car. I wonder how much higher her networth would be if she would have bought a used car and invested the difference in Berkshire Hathaway. ;) Of course BH is the exception and not the norm. :))
http://hyperdiversification.com/cagr_main.aspx
Learn from:
Our focus is to protect and accumulate wealth for our clients. To do that, we are guided by one core principal. DON'T LOSE MONEY. It seems simple, but is by far one of the most challenging endeavors an investor can undertake.
In order to achieve the goal of capital preservation, the Strategy must protect previously earned gains while allowing an investor to profit from a market rebound after a substantial market decline. In other words, the Strategy wants to profit from bull markets and protect the portfolio in bear markets. http://www.swaninvesting.com/home
High-net-worth Investors & Listed Options
Portfolio Management Strategies for Affluent Investors, Family Offices, and Trust Companies http://www.swaninvesting.com/HighNetWorthInvestors.pdf
Monday 24 November 2008
What do all Berkshire Hathaway companies have in common?
What do all Berkshire Hathaway companies have in common?
They are profitable, safe and solid.
They are easy to understand with simple business models.
They produce plenty of cash flow to reinvest.
They are unique businesses with strong market positions and franchises.
They have solid, trustworthy management.
They were bought at reasonable prices.
We ordinary value investors can't assemble this kind of portfolio, but we can learn from what makes Berkshire Hathaway and its master tick.
Ref: Berkshire Hathaway's SEC filing
http://www.hoovers.com/free/co/secdoc.xhtml?ID=10206&ipage=6253178
They are profitable, safe and solid.
They are easy to understand with simple business models.
They produce plenty of cash flow to reinvest.
They are unique businesses with strong market positions and franchises.
They have solid, trustworthy management.
They were bought at reasonable prices.
We ordinary value investors can't assemble this kind of portfolio, but we can learn from what makes Berkshire Hathaway and its master tick.
Ref: Berkshire Hathaway's SEC filing
http://www.hoovers.com/free/co/secdoc.xhtml?ID=10206&ipage=6253178
Berkshire Hathaway's Acquisition Criteria: Telling it like it is
Take a look at the following set of "acquisition criteria," straight from the 2006 Berkshire Hathaway Annual report. Straight, clear, to the point - and never before have we seen anything like this - including the commentary - in a shareholder report.
ACQUISITION CRITERIA
We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
1. Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units).
2. Demonstrated consistent earning power (future projections are of no interest to us, nor are "turnaround" situations).
3. Businesses earning good returns on equity while employing little or no debt.
4. Management in place (we can't supply it).
5. Simple businesses (if there's lots of technology, we won't understand it).
6. An offering price (we don't want to waste our time or that of the seller by talking, even preliminary, about a transaction when price is unknown).
The larger the company, the greater will be our interest. We would like to make an acquisition in the $5-20 billion range. We are not interested, however, in receiving suggestions about purchases we may make in the general stock market.
We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer - customarily within five minutes - as to whether we're interested. We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don't participate in auctions.
ACQUISITION CRITERIA
We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
1. Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units).
2. Demonstrated consistent earning power (future projections are of no interest to us, nor are "turnaround" situations).
3. Businesses earning good returns on equity while employing little or no debt.
4. Management in place (we can't supply it).
5. Simple businesses (if there's lots of technology, we won't understand it).
6. An offering price (we don't want to waste our time or that of the seller by talking, even preliminary, about a transaction when price is unknown).
The larger the company, the greater will be our interest. We would like to make an acquisition in the $5-20 billion range. We are not interested, however, in receiving suggestions about purchases we may make in the general stock market.
We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer - customarily within five minutes - as to whether we're interested. We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don't participate in auctions.
It is not about diversification
Why diversify your portfolio? Is this the key to investing success?
Diversification provides safety in numbers and avoids the eggs-in-one basket syndrome, so it protects the value of a portfolio.
But the masters of value investing have shown that diversification only serves to dilute returns. If you're doing the value investing thing right, you are picking the right companies at the right price, so there's no need to provide this extra insurance. In fact, over-diversification only serves to dilute returns.
However, perhaps diversification isn't a bad idea until you prove yourself a good value investor. Diversification may suggest 'conservative' style, but diversification per se is not a value investing technique.
Diversification provides safety in numbers and avoids the eggs-in-one basket syndrome, so it protects the value of a portfolio.
But the masters of value investing have shown that diversification only serves to dilute returns. If you're doing the value investing thing right, you are picking the right companies at the right price, so there's no need to provide this extra insurance. In fact, over-diversification only serves to dilute returns.
However, perhaps diversification isn't a bad idea until you prove yourself a good value investor. Diversification may suggest 'conservative' style, but diversification per se is not a value investing technique.
Margin of Safety in Value Investing
The idea of buying a company at a bargain price is to achieve a margin of safety. This is important to provide a buffer if business events don't turn out exactly as predicted (and they won't).
- The value investing style calls for building in margins of safety by buying at a reasonable price.
- The style also suggests finding margins of safety within the business itself, for instance, so-called "moats" or competitive advantages that differentiate the business from its competitors.
- Also, a large cash hoard or the absence of debt offers a financial margin of safety.
Sunday 23 November 2008
Choosing a Discount Assumption
Choosing a discount assumption
In theory, the discount rate should be your own personal cost of capital for this kind of investment. If you have a million dollars and can invest it with no risk in a Treasury bond at 6 percent, your cost of capital is the risk-free 6 percent you would forgo by not investing in the bond. So the implied cost of your dollars made available to invest in Business XYZ starts at 6 percent. Financial types refer to this opportunity cost as the risk-free cost of capital.
But implicitly, Company XYZ common stock is riskier than the bond investment. Sales, earnings, and myriad other intrinsic things can change, as can markets and the market perception of XYZ’s worth. So an equity premium is added to the risk-free cost of capital rate. In effect, the total cost of capital is your required compensation, or hurdle, for the opportunity you’ve lost by not buying the bond, plus the assumption of risk by investing in XYZ.
Much has gone into identifying appropriate risk premiums and the like. Modern portfolio theory and its reliance on beta – a measure of relative stock price volatility – doesn’t really do much for most value investors. (Remember: Price doesn’t determine value.)
The keep-it-simple-safe (KISS) approach used by most value investors, including Warren Buffett, is to discount at a relatively high rate, usually higher than the growth rate. Buffett uses 15 percent as a discount, or “hurdle” rate – investments must clear a 15 percent “hurdle” before clearing the bar. The 15 percent hurdle incorporates a lot of risk, especially in today’s environment of relatively low interest rate and inflation. Conservative value investors usually use discount rates in the 10 to 15 percent range.
As you build and run models, you’ll see firsthand how the discount rate affects the resulting intrinsic value. Here are a few points to remember:
In theory, the discount rate should be your own personal cost of capital for this kind of investment. If you have a million dollars and can invest it with no risk in a Treasury bond at 6 percent, your cost of capital is the risk-free 6 percent you would forgo by not investing in the bond. So the implied cost of your dollars made available to invest in Business XYZ starts at 6 percent. Financial types refer to this opportunity cost as the risk-free cost of capital.
But implicitly, Company XYZ common stock is riskier than the bond investment. Sales, earnings, and myriad other intrinsic things can change, as can markets and the market perception of XYZ’s worth. So an equity premium is added to the risk-free cost of capital rate. In effect, the total cost of capital is your required compensation, or hurdle, for the opportunity you’ve lost by not buying the bond, plus the assumption of risk by investing in XYZ.
Much has gone into identifying appropriate risk premiums and the like. Modern portfolio theory and its reliance on beta – a measure of relative stock price volatility – doesn’t really do much for most value investors. (Remember: Price doesn’t determine value.)
The keep-it-simple-safe (KISS) approach used by most value investors, including Warren Buffett, is to discount at a relatively high rate, usually higher than the growth rate. Buffett uses 15 percent as a discount, or “hurdle” rate – investments must clear a 15 percent “hurdle” before clearing the bar. The 15 percent hurdle incorporates a lot of risk, especially in today’s environment of relatively low interest rate and inflation. Conservative value investors usually use discount rates in the 10 to 15 percent range.
As you build and run models, you’ll see firsthand how the discount rate affects the resulting intrinsic value. Here are a few points to remember:
- The higher the discount rate, the lower the intrinsic value – and vice versa.
- The second-stage discount rate should always be higher than the first stage. Risk increases the farther out you go.
- If you choose an aggressive growth rate, it makes sense also to choose a higher discount rate. Risk of failure is higher with high growth rates.
- If the discount rate exceeds the growth rate, intrinsic value will be low and implode more quickly the larger the gap. Aggressive growth assumptions with low discount rates yield very high intrinsic values.
If you’re worried about earnings and earnings growth consistency and want to factor it in somehow, but don’t want to do a deep statistical analysis on a zillion numbers, Value Line does one for you. At the bottom right corner of the Value Line Investment Survey sheet is a figure called “Earnings Predictability” if the Survey covers the company you’re evaluating.
It’s really a statistical predictability score normalised to 100 (100 is best, 0 is worst). A score of 80 and higher indicates relative safety; below 80 means that you may want to attenuate growth rates or bump up the discount rate to account for uncertainty.
Here again is the set of growth and discount assumptions used for an example. Consistency is important, but growth rates will vary for each company, and discount rates may change also with differing risk assessments.
First-stage growth 10%
Second-stage growth 5%
First-stage discount rate 12%
Second-stage discount rate 15%
Intrinsic Value Model
Intrinsic value is driven by current and especially future earnings. Projecting future growth in these earnings is vital to determining intrinsic value.
First-stage growth
Near-term growth is by nature easier to model, and as a result of the discounting process, they contribute more towards the final result anyway. So intrinsic value models are set up to specifically value a first stage in detail, year-by-year. Typically, the first stage is 10 years, although in some analyses it may be more or less.
More often than not, the first stage is assumed to have a higher growth rate and a lower discount rate than the second stage.
Second-stage growth
The second stage covers the more nebulous period of business life beyond the first stage. Second-stage returns are harder to project accurately, so intrinsic value models use one of two assumptions to estimate what’s known as continuing value:
- Indefinite life: The indefinite life model assumes ongoing returns and uses a mathematical formula to project returns over an indefinite period and assign a value to those returns.
- Acquisition: Want a convenient way to bypass mathematical approximations? Assume that someone will come along and buy your business after the first stage at a reasonable valuation. Returns include all future payouts, including lump sums, so this method works too, so long as resale value is projected reasonably.
Summary.
Each stage of a business life has a growth rate and discount rate applicable to that stage. One growth rate and one discount rate is applied to the first stage, and another growth and discount rate to the second. Then, you calculate net future earnings by first compounding growth over the first stage and then discounting that value back to the present. A generalised formula, either indefinite life or acquisition-based, is applied to the second stage. The value attributed to the second stage is called continuing value.
**Appraising the Value of a Business
Appraising the Value of a Business
Investment is most intelligent when it is most business-like.
( Benjamin Graham)
Value investing means treating an investment as though you were buying the entire business. If you were indeed buying a business, you would look for the following:
1. Income: Profits and strong positive operating cash flows exceeding capital requirements are good thing. A company starting at a loss and banking on future profits is starting in the hole, particularly considering the time value of money. Look for companies that produce more capital than they consume.
2. Income Growth: If income and cash flow are steady but unlikely to grow, there can be value. Without growth, time value depreciates earnings value over time. And competition and declining marketplace acceptance can erode the business. There’s little to make a stock price rise unless the market values the steady income stream incorrectly in the first place. Value investors should ignore the common “growth versus value” paradigm and consider growth part of the value equation.
3. Productive Capital Investment: If a company is able to invest additional capital productively – at a greater return than it would get by putting it in the bank – that indicates future value if the capital is available. A company should be able invest capital more productively than you can; otherwise, it makes sense for the company to return the capital to you, and for you to invest the capital elsewhere. If the company doesn’t have productive places to invest but pays you a good return (dividends or share buybacks), the company has value, but growth potential may be in question.
4. Rising Productivity and Falling Expenses: A good business makes increasingly better use of assets and creates more output per unit of input. Businesses that can do so are likely to generate more income sooner.
5. Predictability: Generally, a business with a predictable, steady income stream is more valuable than a company that has erratic or cyclical earnings. The erratic company may return as much money in the long run as the steady company, but the uncertainty surrounding the earnings stream requires a higher discount rate or margin of safety because you just don’t know. The higher discount rate reduces value. Look for simple and steady businesses that you understand.
6. Steady or Rising Asset Values: To the extent that asset values, particularly current assets, are steady or rising, higher returns, if and when paid out to the owners, will ultimately be the result. A company with falling asset values is suspect unless its productivity gains are significant.
7. Favourable Intangibles: Many things can affect or serve as leading indicators of business value. Management effectiveness, market presence, brand strength, customer base, intellectual property, and unique skills and competencies all play a part in driving business value. By nature, these items are hard to quantify but are part of the valuation playing field. Look for companies that do things right in the marketplace.
Investment is most intelligent when it is most business-like.
( Benjamin Graham)
Value investing means treating an investment as though you were buying the entire business. If you were indeed buying a business, you would look for the following:
1. Income: Profits and strong positive operating cash flows exceeding capital requirements are good thing. A company starting at a loss and banking on future profits is starting in the hole, particularly considering the time value of money. Look for companies that produce more capital than they consume.
2. Income Growth: If income and cash flow are steady but unlikely to grow, there can be value. Without growth, time value depreciates earnings value over time. And competition and declining marketplace acceptance can erode the business. There’s little to make a stock price rise unless the market values the steady income stream incorrectly in the first place. Value investors should ignore the common “growth versus value” paradigm and consider growth part of the value equation.
3. Productive Capital Investment: If a company is able to invest additional capital productively – at a greater return than it would get by putting it in the bank – that indicates future value if the capital is available. A company should be able invest capital more productively than you can; otherwise, it makes sense for the company to return the capital to you, and for you to invest the capital elsewhere. If the company doesn’t have productive places to invest but pays you a good return (dividends or share buybacks), the company has value, but growth potential may be in question.
4. Rising Productivity and Falling Expenses: A good business makes increasingly better use of assets and creates more output per unit of input. Businesses that can do so are likely to generate more income sooner.
5. Predictability: Generally, a business with a predictable, steady income stream is more valuable than a company that has erratic or cyclical earnings. The erratic company may return as much money in the long run as the steady company, but the uncertainty surrounding the earnings stream requires a higher discount rate or margin of safety because you just don’t know. The higher discount rate reduces value. Look for simple and steady businesses that you understand.
6. Steady or Rising Asset Values: To the extent that asset values, particularly current assets, are steady or rising, higher returns, if and when paid out to the owners, will ultimately be the result. A company with falling asset values is suspect unless its productivity gains are significant.
7. Favourable Intangibles: Many things can affect or serve as leading indicators of business value. Management effectiveness, market presence, brand strength, customer base, intellectual property, and unique skills and competencies all play a part in driving business value. By nature, these items are hard to quantify but are part of the valuation playing field. Look for companies that do things right in the marketplace.
**A Seven-Step Process for investing in New Assets
Advice for investment accumulators
By Christopher M. Flanagan, J.D.
Published January 1998
React to this article in the Discussion Forum.
Frequently, people make investment decisions based not so much on what they know or what their experiences have been but, rather, on how they acquire assets. In other words, how investors build their portfolios often is driven by how they acquire their investable cash. For example, one might be a partner in a medical or law firm and receive a partnership distribution. Or, perhaps he or she is a corporate executive who receives a yearly bonus. In either case, assets are received in stages or "chunks," and the individual must now determine an investment route for these new assets. The result of this piecemeal approach now is a collection or accumulation of investments. It is a difficult process if you have a goal of being consistent with an overall plan.
A Flawed Investment Process
After receiving that Christmas bonus, or perhaps liquidating part of a business, the accumulator’s investment process typically takes the following path. First, current market trends are considered, e.g., "Blue chip stocks seem to be doing well," or "There are global opportunities, but market volatility is a concern." Ideas are then checked with a knowledgeable person whom the investor respects (stockbroker or relative). Next, the investor reviews his or her current portfolio and considers whether to add to existing investments, e.g., "I might want to add money to my common stock fund." Finally, the money is invested. The process appears logical to the accumulator, but it is flawed in that it typically takes into account only "this year’s" money and not all of the investor’s assets. The result is a collection of investments, rather than a portfolio with a comprehensive strategy.
A Seven-Step Process
While everyone’s situation is unique and financial needs can be met and addressed in a multitude of ways, the process for identifying what those needs are revolves around the same fundamental issues. At the risk of oversimplification, applying the following seven-step process would enable the accumulator to make smarter investment decisions for the long-term and not just for the moment.
Establish an investment goal. Establishing investment goals amounts basically to writing down, in language someone else would understand, one’s personal investment goals. It can be in very general terms, such as "I want to have enough money for a comfortable retirement," or "I want to make sure I can put three children through college," or perhaps, "I never want to run out of money." That’s pretty plain language, but it certainly does the job of identifying an individual’s financial ambitions and concerns.
Determine the ability to tolerate investment risk. Understanding how much risk someone can tolerate is a very personal thing, but one rule of thumb can help an individual know when they’ve exceeded that comfortable level. Again, it is a basic guideline, but one should "never own any investment that will cause you to lose even five minutes’ sleep at night." Investors frequently ignore this guideline in an "up" market.
Calculate the annual return objective: what kind of performance do you need to get from your investments. The next step is to calculate the average annual return the investor needs or wants, and there are a couple of ways to do this. Begin by looking back at the personal investment goals. As an example, let’s use the goal of a college education for three children. If an individual needs $100,000 a year in today’s dollars—and knowing how much he or she has today and how much will be put aside going forward—you can go through the mathematical calculations of figuring out exactly what annual return on the money is needed to reach the goal. The individual can then get a sense for whether his or her expectations are realistic and whether he or she is setting enough aside to invest for future use. Another method is to take a look at the historical performance data, not over a one-year period, but over a ten-, thirty-, and fifty-year period. Studying long-term performance results will help to keep in line the investor’s expectations for future returns.
Select asset allocation among types of investment vehicles. The next step is determining the asset allocation that best meets investment objectives. Arguably, this is the most critical step and one where individuals could benefit from some professional advice. Asset allocation, the buzz words in financial services today, is how assets are apportioned among various asset classes (stocks, bonds, etc.). The goal is to achieve the highest return at a risk level the investor is comfortable with. Achieving the highest return for any given level of risk is an efficient portfolio mix. Generally speaking, we know that between 65 percent and 85 percent of a portfolio’s performance will be dictated by the structure of the portfolio—the mix of asset classes—rather than the specific individual investments that are held within it. Consequently, it is more important to figure out what portion of a portfolio should be in stocks, etc., rather than which stocks to select. Here is where someone might call on expert assistance. Chart first how much risk exists in the current portfolio (it is often more than expected). Next, determine if it is possible to increase potential returns without increasing your risk and identify the ideal mix of investment types, (stocks, bonds, etc.) necessary to accomplish this.
Choose specific investments. Based on the investment types identified, it is now time to choose the specific investments that are most appropriate. This is where most of the investment "clutter" happens: comparing which stocks did better than others, which funds outperformed benchmarks, etc. And it is here that one needs to have a well-diversified portfolio. Once again, though, while investment selection undeniably impacts the overall performance of a portfolio, it is more important that those investment selections are diversified within the investment types that best support the investor’s long-term investment strategy.
Monitor portfolio performance quarterly. While it isn’t necessary to get mired in every single week’s or month’s worth of statements, it is important to review results on a quarterly basis. Take a hard look at the percentage returns on the entire portfolio during the past quarter. How do those results compare to the annual percentage return objective and to the long-term goal? Were performance expectations met, and were they realistic? Does the investment strategy need to be adjusted?
Revisit steps 1-5 annually. Once a year, walk through the above steps for making smarter decisions. Revisit (perhaps revise) investment goals, as they can and should change over time. With the current appetite for risk in mind, calculate the annual percentage return objectives. Accurately select the asset allocation that will help to meet those goals, and the result will be a successfully structured portfolio.
Ironically, "investment accumulators" usually don’t appreciate how successful they truly are. Because they didn’t inherit their money or win a lottery, but rather just worked for it a little at a time over the years, they don’t think of themselves as "wealthy" or even financially successful. Consequently, they may not be giving their investment portfolio the respect it deserves.
Christopher M. Flanagan, J.D., is a regional manager for Mellon Private Asset Management, a service mark of Mellon Bank Corporation and its subsidiaries.
http://www.physiciansnews.com/finance/198.html
By Christopher M. Flanagan, J.D.
Published January 1998
React to this article in the Discussion Forum.
Frequently, people make investment decisions based not so much on what they know or what their experiences have been but, rather, on how they acquire assets. In other words, how investors build their portfolios often is driven by how they acquire their investable cash. For example, one might be a partner in a medical or law firm and receive a partnership distribution. Or, perhaps he or she is a corporate executive who receives a yearly bonus. In either case, assets are received in stages or "chunks," and the individual must now determine an investment route for these new assets. The result of this piecemeal approach now is a collection or accumulation of investments. It is a difficult process if you have a goal of being consistent with an overall plan.
A Flawed Investment Process
After receiving that Christmas bonus, or perhaps liquidating part of a business, the accumulator’s investment process typically takes the following path. First, current market trends are considered, e.g., "Blue chip stocks seem to be doing well," or "There are global opportunities, but market volatility is a concern." Ideas are then checked with a knowledgeable person whom the investor respects (stockbroker or relative). Next, the investor reviews his or her current portfolio and considers whether to add to existing investments, e.g., "I might want to add money to my common stock fund." Finally, the money is invested. The process appears logical to the accumulator, but it is flawed in that it typically takes into account only "this year’s" money and not all of the investor’s assets. The result is a collection of investments, rather than a portfolio with a comprehensive strategy.
A Seven-Step Process
While everyone’s situation is unique and financial needs can be met and addressed in a multitude of ways, the process for identifying what those needs are revolves around the same fundamental issues. At the risk of oversimplification, applying the following seven-step process would enable the accumulator to make smarter investment decisions for the long-term and not just for the moment.
Establish an investment goal. Establishing investment goals amounts basically to writing down, in language someone else would understand, one’s personal investment goals. It can be in very general terms, such as "I want to have enough money for a comfortable retirement," or "I want to make sure I can put three children through college," or perhaps, "I never want to run out of money." That’s pretty plain language, but it certainly does the job of identifying an individual’s financial ambitions and concerns.
Determine the ability to tolerate investment risk. Understanding how much risk someone can tolerate is a very personal thing, but one rule of thumb can help an individual know when they’ve exceeded that comfortable level. Again, it is a basic guideline, but one should "never own any investment that will cause you to lose even five minutes’ sleep at night." Investors frequently ignore this guideline in an "up" market.
Calculate the annual return objective: what kind of performance do you need to get from your investments. The next step is to calculate the average annual return the investor needs or wants, and there are a couple of ways to do this. Begin by looking back at the personal investment goals. As an example, let’s use the goal of a college education for three children. If an individual needs $100,000 a year in today’s dollars—and knowing how much he or she has today and how much will be put aside going forward—you can go through the mathematical calculations of figuring out exactly what annual return on the money is needed to reach the goal. The individual can then get a sense for whether his or her expectations are realistic and whether he or she is setting enough aside to invest for future use. Another method is to take a look at the historical performance data, not over a one-year period, but over a ten-, thirty-, and fifty-year period. Studying long-term performance results will help to keep in line the investor’s expectations for future returns.
Select asset allocation among types of investment vehicles. The next step is determining the asset allocation that best meets investment objectives. Arguably, this is the most critical step and one where individuals could benefit from some professional advice. Asset allocation, the buzz words in financial services today, is how assets are apportioned among various asset classes (stocks, bonds, etc.). The goal is to achieve the highest return at a risk level the investor is comfortable with. Achieving the highest return for any given level of risk is an efficient portfolio mix. Generally speaking, we know that between 65 percent and 85 percent of a portfolio’s performance will be dictated by the structure of the portfolio—the mix of asset classes—rather than the specific individual investments that are held within it. Consequently, it is more important to figure out what portion of a portfolio should be in stocks, etc., rather than which stocks to select. Here is where someone might call on expert assistance. Chart first how much risk exists in the current portfolio (it is often more than expected). Next, determine if it is possible to increase potential returns without increasing your risk and identify the ideal mix of investment types, (stocks, bonds, etc.) necessary to accomplish this.
Choose specific investments. Based on the investment types identified, it is now time to choose the specific investments that are most appropriate. This is where most of the investment "clutter" happens: comparing which stocks did better than others, which funds outperformed benchmarks, etc. And it is here that one needs to have a well-diversified portfolio. Once again, though, while investment selection undeniably impacts the overall performance of a portfolio, it is more important that those investment selections are diversified within the investment types that best support the investor’s long-term investment strategy.
Monitor portfolio performance quarterly. While it isn’t necessary to get mired in every single week’s or month’s worth of statements, it is important to review results on a quarterly basis. Take a hard look at the percentage returns on the entire portfolio during the past quarter. How do those results compare to the annual percentage return objective and to the long-term goal? Were performance expectations met, and were they realistic? Does the investment strategy need to be adjusted?
Revisit steps 1-5 annually. Once a year, walk through the above steps for making smarter decisions. Revisit (perhaps revise) investment goals, as they can and should change over time. With the current appetite for risk in mind, calculate the annual percentage return objectives. Accurately select the asset allocation that will help to meet those goals, and the result will be a successfully structured portfolio.
Ironically, "investment accumulators" usually don’t appreciate how successful they truly are. Because they didn’t inherit their money or win a lottery, but rather just worked for it a little at a time over the years, they don’t think of themselves as "wealthy" or even financially successful. Consequently, they may not be giving their investment portfolio the respect it deserves.
Christopher M. Flanagan, J.D., is a regional manager for Mellon Private Asset Management, a service mark of Mellon Bank Corporation and its subsidiaries.
http://www.physiciansnews.com/finance/198.html
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