Commentary (Page 442)

It is common for stock investors to be compared to gamblers. This comparison is even more common when discussing stock traders or those that move in and out of their holdings more frequently. While I am sure there are some stock traders that are gamblers, some long-term investors would more readily match the image of a gambler, much to the long-term investor’s chagrin.

Before I defend the previous paragraph, I think it is necessary to provide assistance to those in need of help. If you believe that your stock trading activity has begun to affect your life in an unhealthy manner, please seek help. Gambler’s Anonymous is a great organization that can help those that have become addicted to gambling. Gamblers Anonymous is a fellowship of men and women who share their experience, strength and hope with each other that they may solve their common problem and help others to recover from a gambling problem.

One of the habits of an addicted gambler is to push hard on a losing position. You have seen this in movies for decades even if you haven’t seen it in person. The gambler is losing badly and continues to play the same game in the same manner. Typically, the gambler loses it all.

I hate to say this, but this behavior is often what I see in the most cautious of investors. The investor that thinks that loyalty to a stock somehow is the honorable thing. That loyalty extends to even when the stock price drops 10-50%. That loyalty often is accompanied with logic that says that if the asset is held long enough, the loss will turn into a gain.

I am sorry, but I believe this is reckless behavior. You should have no loyalty to any individual stock. You only need commitment to your family that is counting on you. They want you to develop a reasonable return on your investment to provide for the future acquisition of the nicer things in life. I guarantee that the CEO of the company will not be personally offended if you sell the stock of his company!

I publish my favorite stocks on my Watch List. These stocks have gone through a filter that the majority of stocks cannot survive. These few stocks are not blessed forever – I regularly revisit my analysis of each company and cut them from the list when they have failed to meet my criteria. I also sell all my holdings as soon as I can in each company that has failed my tests. I explain my criteria in my book, The Confident Investor.

Even the companies on my list don’t get a free pass. I monitor each one for upward momentum. I invest heavily in the ones that are increasing in value. I pull out of those that experiencing a short-term bull market. I explain this strategy in my book, The Confident Investor, and I call it Grow on Other People’s Money (GOPM for short).

You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.

As a stockholder (or partial owner) of a company, it is your responsibility to give the managers of the company advice on how to run the company. Since there will be hundreds of thousands of “partial owners” of a company, the company will set up a board of directors to represent your interest. These directors are usually elected by you and your fellow owners. You have one vote for each share that you own.

A shareholder will typically be asked to vote on board members and other issues that the board feels needs the input of the owners. Typically, these issues include the selling or buying of divisions of the company, compensation questions for key managers and board members, and company dividends. It is your responsibility as a company owner to vote when you are sent these requests.

There are some companies that have different types (or classes) of stock. For example, it is common to have voting stock and non-voting stock. If you have non-voting stock, you will not have the right to vote on issues nor will you be asked for your opinion on the board members. In general, you should avoid these types of companies since they almost always have interests that make them non-responsive to the best interest of the majority of their stockholders.

A company’s board of directors provides the company with direction and advice. It is the responsibility of the board of directors to ensure that the company fulfills its mission statement. The board of directors frequently sets the company’s overall policy objectives. A well-functioning board of directors acts as a top-level adviser to the company. A good board of directors will let the company know when it is drifting away from its goals and objectives. For these reasons, a good board of directors includes knowledgeable and experienced business people.

Typically, only one member of the board of directors is involved with the day-to-day activities of the company. This person is the Chief Executive Officer (CEO), and he or she acts as a liaison between the board of directors and the rest of the company. The CEO is responsible to the board of directors for the daily status of the company, and for the implementation of the vision and policy objectives of the board of directors. It is also the responsibility of the CEO to hire the other managers in the company. These managers, in turn, are responsible for the various departments and related employees.

It is becoming common for the board of directors to be held fiscally responsible for the performance of the company. While it is still rare for directors to be sued for something the company has or has not done, it can happen. Directors who have allowed a company to drift into bankruptcy have also been sued by the shareholders for negligence.

Occasionally, I will get a Tweet from a follower on Twitter or a communication from my site stating that the market is rigged against individual investors. I couldn’t disagree more. In fact, I think the stock market is probably set up better today for an individual investor than ever before.

I came across an article on Abnormal Returns and the author agrees with my stance. Here are the 5 reasons why he believed it was a great time:

1. It is easier to be an individual investor than ever before.
2. It is cheaper to do transactions than ever before.
3. There is a richer assortment of investment vehicles than ever before.
4. The social society of blogging and micro-blogging makes it easier to find out relevant information.
5. It is easier to be smarter than it ever has been. There are so many free portals of investment information that freely offer all of the data that an investor needs.

I was a bit surprised that the author didn’t say that now individual investors have access to my book, The Confident Investor. With my book at your disposal it is now even easier to understand and beat the market. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in ebook formats for Nook, Kindle, and iPad.

Throughout this site and on my book, The Confident Investor, I encourage investors to have a balanced portfolio of stocks and index funds.  I have discussed mutual funds before but I need to discuss the reason for index funds, my preferred pooled investment vehicle.

First, let’s talk about what indexes are and why they exist. Most people recognize that Charles Dow published the first workable index in his newsletter Customer’s Afternoon Letter and then later in the Wall Street Journal. His average was eventually called the Dow Jones Industrial Average (often shortened to Dow, Dow Average or DJIA) and is the most widely quoted number regarding the movement of the US stock market.

A stock market index is a basket of securities designed to track market changes. The most widely followed US stock market indexes, along with the DJIA, are the S&P 500, and the Nasdaq Composite. Important international stock market indexes are the Nikkei 225 (Japan), FTSE 100 (UK) and Hang Seng (Hong Kong).

Each stock market index has its own way to combine the changes in index components. The Dow Jones, for example, is a price-weighted stock market index where an increase of $1 in the stock of a $300B company produces the same change as an increase of $1 in the stock of a $30M company stock. Most stock market indexes use capitalization-weighted adjustments to account for the differences in company size.

An index fund is an investment framework that tries to mimic the movements of a particular index. The fund is usually structured as a mutual fund or an exchange-traded fund (ETF). An index fund is created to hold all of the securities in the index or a representative set designed to mimic the entire index. Many index funds rely on computer models with little human input in the decision as to which securities to purchase. This is a form of passive management. The absence of active management usually provides the benefit of lower fees and lower taxes in taxable accounts.

EXAMPLE: An S&P 500 Index Fund takes all the stocks in the S&P 500 and buys enough shares in each company to represent the dollar value that each company represents as a percentage of that market. So, if the Acme Company represented 2% of the combined value of all the S&P 500 companies, then an S&P 500 Index Fund would have 2% of its dollar value in Acme stock.

Index funds frequently outperform and have lower fees than managed funds. Index funds are often a better investment alternative. I encourage you not to have too much of your portfolio in managed funds but instead focus on index funds.

It is easy to track the results of an index. If the S&P 500 went up 1.5% over a one week period, your S&P 500 Index Fund did too. The same would be true if it went down. Index funds can be part of a balanced stress-free portfolio. You can use them to buy a comprehensive “market” position.

The problem with index funds is that they only perform as well as the market. In any trading day, there are stocks that go up or down. This is the same over the period of a week, month, several months or even years. While an index fund is easy, it is not necessarily advantageous for your entire portfolio. You are, by definition, only doing “average” with your hard-earned money.

Also, the increase over the long term in any given index is almost always reduced by inflation. If the market increases 6% or 7% in a year, you can almost bet that inflation, measured by the consumer price index (CPI), rose two or three percentage points. You need to stay ahead of the CPI in order to be able to buy more things for you and your family.

Every year, Standard & Poor’s conducts a study of actively managed mutual funds. Some of the conclusions from one of its latest studies:

1. Over the five year market cycle from 2007 to 2011, the S&P 500 outperformed 59.4% of actively managed large cap funds. In the same period, the S&P MidCap 400 outperformed 63.5% of mid cap funds. Also, the S&P SmallCap 600 outperformed 63.1% of small cap funds. These results are similar to that of the previous five-year cycle.
2. It is a myth that bear markets favor active management. In the two true bear markets over the last decade, most active equity managers failed to beat their benchmarks.
3. Benchmark indices outperformed a majority of actively managed fixed income funds in all categories over a five-year horizon.

Note: You can read this yourself on the web by going to http://www.standardandpoors.com/indices/spiva/en/us.

Obviously, I do not want you to destroy your retirement! However, it is good to think about what you can do incorrectly that will hurt your financial future. By studying the mistakes, you can hopefully avoid them.

Yahoo Finance had a great article on the subject. You should jump over and read the entire article but here are the five ways that were identified.

1. Too much debt.
2. Spend your retirement savings on college.
3. No emergency plan.
4. No long-term investment strategy.
5. No retirement plan.

All of these are bad choices. If I had to pick a 6th one it would be to trust that the US government was going to provide for you. This is not a political site and I do not want to get into political arguments. I do encourage you to be pragmatic if you are under the age of 55 and definitely under the age of 40. Assume that Social Security as it exists at this writing will likely change before you need it.