|
One of my readers
pointed out to me yesterday that I have had a case of tunnel vision on mining
stocks and he was right. Mining stocks does not an investment portfolio make.
Therefore today I wanted to spend some time on the difference between
investing vs. speculation.
To begin I must tell
you the golden rule of investing. "The most powerful tool an
investor has is dividend reinvesting over time."
I characterize investments as stocks that have been around for
a long time. My personal advice is not to hold more than 5 or 6 stocks. That
will give you plenty of diversification. The stocks should have a yield of
4-5%, they should have a relatively low P/E, an earnings per share that
reflects stable income year over year and a market capitalization of at least
25 million dollars.
It is amazing that by
taking the dividends that these stocks kick off and reinvesting them back
into the stock, the stock will compound quickly making your portfolio grow.
There are many companies that allow you to dividend reinvest so choose a
company you feel comfortable with. You don’t have to do anything except
set up your portfolio to dividend reinvest. If from time to time you find
that you have some extra money send it to them and they will buy even more
shares. Even better, if you can afford it, have $100 a month automatically
deducted from your checking account to buy more shares. Just make sure you
are not stretching yourself to thin. This will only lead to frustration and
in time you will give up. Setting up a dividend reinvestment portfolio is
like getting married. You have to be fully committed.
So what does a
diversified portfolio mean? It means that your stocks are in different
sectors. I will use this proxy to demonstrate what I mean. I have holdings in
Altria (MO) which
yields 5.4%, is considered a consumer discretionary stock, Con Ed (ED) which
yields 4.60% is considered a utility stock, Exxon Mobile (XOM) which yields 2.30% is considered an oil stock, Verizon (VZ) which
yields 5.40% is considered a communications stock, Johnson and Johnson (JNJ) which yields 3.40% is considered
a pharmaceutical stock, and Lockheed Martin (LMT) which yields 3.70% is considered a defense
stock. To review you can see that my diversification is in consumer staples,
oil, utilities, communications, pharmaceuticals and defense. This is a well
balance portfolio.
Under any
circumstances, however, what you never want to do is “have all your
eggs in one basket.” You would never want to hold 5 financial stocks
because they have high yields. Financials is a perfectly fine sector but it
is one sector. Never own more than one stock in a sector. Diversification is
the only "free lunch" we have as investors.
I would suggest that
you do not hold more than five or six stocks. It becomes overwhelming and
while you never want to trade these companies it is important that you watch
them and stay on top of any “Black Swans” that might affect how
they perform. I suggest you review these companies every six months to make
sure that there has been no fundamental change in them. If you feel that
nothing is broken don’t fix it! Leave them alone and continue to let
them dividend reinvest. I know I'm repeating myself but I believe it's worth
saying twice. The golden rule in investing is “dividend
reinvestment over time is the most powerful tool an investor has.”
Now I’d like to
speak about speculation. Rule number 1, 2 and 3 is never; ever turn a
speculative trade into an investment. Speculation is the “art” of
finding a stock that you think will perform in a certain way and dollar cost
average into it as the price rises. Before you buy the stock you must know
how low the stock will go, how high the stock will go and what the time frame
is. The great financier Bernard Baruch taught us that to be successful
speculating in the market you only have to be right 4 out of 10 times. In
this hypothetical if you are wrong 6 times you have a net loss of $0.50 per
share but if you are right 4 times you have a net gain of $15.00 per share.
So you buy a small stake of ABC at $10.00 and you think it
might go as low as $9.50 and the upside is $25.00 within six months.
When
you buy the stock at $10.00 you put a stop under the stock at $9.50 because
you have determined that you will not sustain a loss greater than 5% for this
stock. What you and you alone must determine is an acceptable loss you are
willing to sustain. I know people that use stops of 3% and some that use 10%
stops. That is something that you must determine by understanding the
fundamentals and the charts before you even buy a share.
If
the stock acts as you thought it would you buy a little more and you raise
you stop to 5% below the new price. It is a very hard concept to understand
but the successful speculators buy a stock high and sell it higher. Denis
Gartman uses the analogy of grabbing onto a rocket that has taken off and
holding on as it moves higher. If however the stock drops past your stop get
out and don’t ever look back.
The
tricky part is to know when to get out. A study of the charts will often give
me a clue as the stock becomes over bought but I have found that by
consistently raising my stops as the stock moves up I am able to lock in my
hard earned gains. As an editorial note I would like to add is that I,
personally, do not use triggered stops but rather mental stops because along
the way institutional buyers will short the stock to shake out the “faint
of heart investors” so by using mental stops I can sell when I see that
this is really the time to get out or if it is simply a
“shakeout”. This comes with time and experience so in the
beginning use triggered stops because nobody ever got hurt taking a profit.
So to quickly review, we have determined that there is
investing and there is speculation. I believe as we grow older, investing
should be a greater part of our portfolio but when we are young we have time
on our side so to be a little more risky is not such a bad thing.
Again if you have any questions
about what I have written please leave me a message and I will be happy to
reply.
|
