Thursday, September 6, 2007

Staying Focused on Stock Market Basics

I've recently been reading about a number of investment "systems" designed to 'help' you beat the market using options or other hedging strategies. I am not going to say they are all worthless, but they do require a lot of extra work and time - something you may or may not have. Most are designed to benefit the writers, not those using these systems.

Many people don't want to even think about having to manage their investments. Can you blame them? To the average person Wall St. seems like a rigged crap game - no more than gambling. It helps if you have a business background, or better yet some education on the financial markets, but the truth is that with stocks the 'house' (albeit some exceptions, such as Worldcom and Enron) is mostly on your side.

There are some time-tested rules about investing, and they really aren't in serious risk of being challenged any time soon:
  1. Stocks are risky investments. There is no free lunch.
  2. Diversification across multiple companies, industries, sectors, and even asset classes reduces overall risk at the portfolio level (but also reduces overall potential returns).
  3. The longer the holding period, i.e. 3-5+ years instead of 3-6 months, the greater the chance that your investments in stocks will net a positive return overall.
Now, along with these basic tenets, I have a few of my own...

4. Own quality companies that pay increasing dividends, and that have the capacity to continue to grow their dividends faster than the rate of inflation. Own companies whose management is willing to pass on the profits of the
company directly to the shareholders (via dividends of course) while
retaining a more modest portion of profits for future growth. If the company changes from that approach, sell the stock and buy one that will.
5. Focus not on the day-to-day performance of individual stocks in the portfolio, but instead track how well or poorly the overall portfolio performs relative to a major market index, e.g. Wilshire 5000. Then make individual adjustments on that basis, if needed.
6. Look at the portfolio not as a capital appreciation vehicle per se, but as a cash flow growth vehicle. Chart your monthly cash flow, and concentrate on how to consistently grow that cash flow. Time is on your side. If you are just starting out, reinvest all dividends. If you have a sizable portfolio, collect enough dividend cash to buy a (100 share) lot of a new position or add to an existing one.
7. Mutual funds or ETFs can add easy diversification to complement individual stock holdings, but they do not come without a price, and that price is operating/ management fees. For me it makes sense to use them to obtain foreign stock or 'other asset' diversification, but little else.
8. Demand a higher yield for foreign stocks. You should expect a better cushion for the higher risk you are taking.
9. Most importantly...be patient. Be long-term focused (Warren Buffet is, and look how old he is), and trust time-tested approaches to investing. There is no free lunch, but expect long term rewards for your patience, persistence, and perseverance with weathering the risks of stocks. That's the closest thing to a credible guarantee you will ever find in the stock market.


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