On average, investing in index funds is your best bet.
For John and Jane Doe, index funds may well be the greatest financial innovation of the past half century, in that they open the doors to the investing arena at absurdly cheap ticket prices. Most index funds are broadly diversified and dirt-cheap. To be successful with investing, you do not need to analyze balance sheets and income statements. It’s sufficient to simply dollar cost average into low-cost indexes tracking the broad market. If you do not know GAAP, have never read a 10K, and don’t enjoy spending 5-20 hours per week analyzing and thinking about investments, just index. Otherwise, you’re gambling, not investing.
Key phrase 1: “I don’t know.”
Knowing that you don’t know something is the first step toward resolving the situation. Ignorance is a universal condition, albeit unevenly spread. If you’re reading this blog, you’re likely a voracious learner. Cook up a recipe for success by combining this appetite for knowledge with a keen self-awareness. A tremendous amount of information about investing is available, much of it hogwash. Read it, form your own informed opinions, and act according to your best judgment. We’ll try to present the best information as honestly as possible, but it’s up to you to call the shots.
Key phrase 2: “Too hard.”
Determining which late-stage pharmaceutical will emerge as the next Lipitor is too hard. Predicting the market composition for mobile phones in 10 years is too hard. Determining exactly when Sears Holdings Corp will go bankrupt is too hard. Losing sleep over potential margin calls in a leveraged account is too hard. Fortunately for you and us, we don’t have to complete or even attempt any of those tasks in order to compound our hard-earned savings at satisfactory rates. Know your limits and keep it simple.
Even if you buy funds, you hold individual equities.
One reason that we will discuss individual businesses is just about everyone owns some. Your 401(k) or IRA contains individual business, whether they’re held inside of a fund or not. If you invest in VLACX, Vanguard’s investor-level Large Cap Index, then every $10,000 you have in the fund is distributed as follows: $294 AAPL, $230 MSFT, $187 XOM, $157 JNJ, $157 BRK.B, $155 JPM, etc …
Whether it’s a mutual fund or an index fund, ultimately you can x-ray down into the individual holdings and see that a fund investor is no different than an investor who builds his/her own portfolio. The former simply pays a manager or a computer algorithm to do the allocations on his/her behalf.
We prefer a different allocation of equities, with lower turnover, at a lower cost.
When you purchase an S&P500 fund, you buy 500 stocks weighted by market capitalization in descending order, and you pay roughly 0.25% for the convenience. You’re instantly diversified. And that’s a wise decision. In some of our company-sponsored retirement accounts, we also go this route.
However, in accounts over which we can exercise more control, sometimes we find opportunities to buy equities directly, pay a one-time $7 – $10 fee, and we hold this purchase much longer than the average fund. The end result is a different basket of businesses, significantly lower expenses, and in many cases tax savings. With sufficiently large purchases, say $10,000, the fee amounts to a measly 0.07% and is paid only twice: once for the purchase and again for the eventual sale. When the initial investment compounds to a larger amount, we don’t owe ~$55 in year 10 to continue holding the equity; we owe exactly $0 that year.
Another advantage to rolling our own portfolios is that we can exclude crappy businesses. Historically, shipbuilders, miners, cruise ship operators, and airlines are absolutely terrible places to park your money. Why bother allocating a chunk of change to these sectors when you can buy more Johnson & Johnson or Nestle instead? Likewise, some businesses are fantastic but command such stunning multiples that the price of entry is too high to consider prudent. We exclude those, too. And every now and then, Mr. Market lobs a softball in our direction that is just destined to be a grand slam. If you saw a big pile of Benjamins with a sign that said “Free for the taking,” would you bring a measuring cup, a bucket, or a wheelbarrow? We prefer dump trucks, and using a portion of our overall portfolio to select individual equities allows us the opportunity to hear that glorious “Beep, beep, beep” when the time is right.
Think like a business owner, because you are a business owner.
This principle tends to trip up many investors. They sometimes think of “The Market” as an enigma with an omniscient mind of its own. Ever-present ticker prices can fool a person into thinking that the actual value of the businesses they hold fluctuates by the millisecond and is accurately recorded in Yahoo Finance. That’s simply not the case. We prefer to think of this information glut as “Mr. Market,” a sometimes drunken madman trying to buy your house at various prices throughout the day. You purchased a $150,000 rancher close to your job six years ago. Today, Mr. Market offers you $90,000 and next week he’s revised that up to $125,000. Does that mean you should cut your losses, ring the attorney on the front of the phone book, and rush to a title company to get to closing right away? Absolutely not; the idea is outrageous. You own a tangible piece of property that has intrinsic value. Treat your brokerage login with the same level of self-respect. It’s the same deal with your shares of businesses, except those businesses are better than a personal residence because they shower you with cash while you sleep! If the underlying fundamentals of your share have not changed, why should you care what Mr. Market is offering at 3:59 pm EST right before the closing bell sounds?
Long-term investing, not speculating, not trading.
Long-term investing means a timeframe of 5 years at the absolute minimum. Most often, we’re looking at 20+ year timeframes. This type of investing allows you to ride right through recessions and depressions unscathed. If we might need that $2,000 in the next five years for any reason whatsoever, we do not buy stocks with it.
This principle is the individual investor’s greatest advantage. Especially if you are young, you have time on your side, supporting your investing strategy in so many ways. First and foremost, you can harness the magic power of compounding over a long scale. Plug in $50,000 to Excel A1, then multiply it by 1.08 10 times down to A11. In year 10, your money has more than doubled! But if you’re in your 20’s and can drag this all the way down to A31, you burst through the $500,000 mark. That’s the power of compounding. Secondly, unlike most institutional and professional investors, you are not beholden to quarterly or annual performance metrics. This freedom allows you to look at the oil price crash of 2015 as a golden opportunity to load up on the world’s premier energy companies at sale prices. An investment manager might think twice about “catching a falling knife” and how it may affect his upcoming December report. When you’re on the beach on Labor Day 2015 looking out to year 2026, December 31st, 2015 is a joke, a blip. You can sleep soundly knowing that the supply and demand curve will work itself out in the next decade. An investment manager doesn’t have this luxury.
Buy and hold, generally.
The buying part is easy, but holding when your recent purchase drops by 30% is difficult psychologically. If you’re investing in common stocks – whether it’s a direct holding or an index – you absolutely must expect 30% drops. They’re par for the course every few years. On longer horizons, you need to be mentally prepared for 50-60% paper losses. Perhaps against intuition, the mathematical truth is that unrealized capital losses can have a supercharging effect on your overall returns if you’re reinvesting dividends or deploying new capital into the investment at suppressed prices. We’ll cover this concept in detail, but in the meantime, know that if you are a net buyer of equities in the short to intermediate future, then you should actually be cheering for lower stock prices.
Option strategies turn time into your enemy.
As part of the KISS principle, we avoid options strategies because they’re not necessary and are overly complicated. Beyond that simple justification, options and shorting stocks almost always include a timeframe < 2 years. If you pursue such financial bets, then go into it knowing that you curb stomped your best friend, Time, and it’s now your worst enemy. Not only do you have to be correct about the direction of the market, you have to be correct about the timeframe. Sometimes, we wonder why in the world people make investing harder than it has to be.
Technical analysis is worthless to an individual investor.
You cannot look at a chart with fancy lines and know whether or not to invest in a company. It’s the equivalent of betting on red or black because of your astrological sign and the current phase of the moon. Investing in companies requires research, skill, and knowledge. By itself, the historic price movement of a ticker symbol absolutely does not qualify, no matter how many candle sticks and moving averages you paint on the screen.
A couple notes about the upcoming articles
- We publish analyses, not recommendations.
You won’t see the words “Strong buy” or “Now’s the time to sell” on our website. We’re not your financial advisers, we’re not professional analysts, and you should never buy or sell an investment based solely on information you read on Duke of Dollars. Our intent with publishing analyses is to spur critical thinking about the investments you have made or might make. The articles are best served as a starting point for further research. The facts and figures that we cite are accurate at the time of publishing, to the best of our knowledge. We will try to provide primary sources for these claims wherever possible. But it’s your responsibility as a reader to verify that the information you read is correct and current.
- We will disclose every time we mention a specific equity if we are long or short.
If you find that we’ve missed a disclosure, please let us know via comments or the contact form, and we’ll correct the oversight ASAP.
Disclosure: as of the publishing date, both authors own large cap index funds and therefore hold long positions on all equities mentioned with the exception of Sears Roebuck Corp (SHLD), which was booted from the large cap funds a few years ago. We may begrudgingly hold a long position in this equity via mid-cap funds. One author is also directly long XOM, JNJ, NSRGY, and BRK.B.