Beyond Buy-and-Hold #76

By Rob Bennett

Buy-and-Hold doesn’t work. Look around. it’s obvious.

But wait! The Buy-and-Holders have an explanation.

It’s the Economy! Buy-and-Hold is aces. It’s that darnned economy that is messing everything up. Buy-and-Hold cannot be expected to produce good results in the face of such a bad economy.

Trying to have it both ways

Please think over what is being said here. When Buy-and-Hold produces good results, we credit the investing strategy. When the results are poor, we place the blame elsewhere. As Church Lady might observe, “How convenient for the advocates of Buy-and-Hold!” It’s a “heads I win, tails you lose” approach to investing analysis.

And you know what? This isn’t the first time the Buy-and-Hold advocates have played this little trick on us.

This is the fourth time in U.S. history that The Stock-Selling Industry has been successful in persuading a large percentage of investors to follow a Buy-and-Hold strategy. The first time, Buy-and-Hold produced gangbuster results until an economic crisis ruined all the fun and we didn’t see acceptable stock returns for another 20 years.

The second time, Buy-and-Hold produced gangbuster results until an economic crisis ruined all the fun and we didn’t see acceptable stock returns for another 20 years. The third time, Buy-and-Hold produced gangbuster results until an economic crisis ruined all the fun and we didn’t see acceptable stock returns for another 20 years.

The fourth time (this time), Buy-and-Hold produced gangbuster results until an economic crisis ruined all the fun and we didn’t see acceptable stock returns for another 12 years (and counting).

Are you beginning to see a pattern?

There is a reason why it always plays out the same way. Economic crises always ruin the Buy-and-Hold game because the Buy-and-Hold game always causes an economic crisis. To say that “Buy-and-Hold isn’t working because of the economic crisis” is to say “Buy-and-Hold isn’t working because of what Buy-and-Hold is.

Buy-and-Hold is the investing strategy that says that stocks are worth buying at any price, that it is okay to stay at the same stock allocation no matter how high prices go. That can never, ever, ever work in the long term. It is a logical impossibility.

We often refer to stocks as “risky” without stopping to think about the nature of that risk. The risk is that stocks might some day become so high-priced as to provide poor long-term returns. Stocks never perform poorly when they are low-priced or fairly priced, stocks always perform poorly when they are high-priced. So the proper way to say it is to say that high-priced stocks are risky.

Stock prices are set by investors. If we all were concerned about our retirements, we could pump stock prices up to 10 times what they are today over the course of the next six months. Why don’t we do just that?

We don’t do it because our common sense tells us that it is a silly and dangerous game. Whenever we cause stock prices to increase more than the 6.5 percent gain justified by each year’s economic growth, we are borrowing the extra returns from future years, pumping up our returns in the now in exchange for poor returns a few years down the road. What’s the point?

Do you remember the “New Paradigm” in the economy and the stock market?

Common sense tells us not to play stupid games with our retirement money. Buy-and-Hold encourages us to play such games. Hey! Maybe this will be the first time in history when overpriced stocks provide good long-term returns! No one has a crystal ball. No one can say for certain.

The Buy-and-Holders encouraged us to play this game to the hilt in the 1990s, to pump and pump and pump stock prices and never to apply the brakes by lowering our stock allocations when risk got out of hand. When millions of investors agree to take on far more risk than they could handle, an economic crisis follows. And the Buy-and-Hold advocates then blame the economic crisis for their strategy failing once again.

Yuck!

It’s a dishonest game. It has hurt millions of people in very serious ways. I want no part of it. I am working hard to earn a reputation as the most severe critic of Buy-and-Hold alive on Planet Earth today.

If you are feeling the pain of this economic crisis, or if you know of others who are, I hope you will place the blame where it belongs. It is The Stock-Selling Industry and its reckless and relentless promotion of Buy-and-Hold investing strategies that brought on this crisis.

There’s nothing wrong with our economy. We should be grateful that our economy was strong enough to survive for a good number of years in the face of the relentless promotion of Buy-and-Hold strategies. We should all be doing whatever we can to bring our wonderful economy back to life. By making sure that Buy-and-Hold dies and is never permitted to come to life again.

Rob Bennett has identified the 23 most common and most costly investing mistakes. His bio is here.

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Get Rich Quick – What is it?

By Kevin M

Maybe I’m painting with a very broad brush here, but I think most people would like to be self-employed—if not now then “later”. At a minimum it’s a dream, even if it’s not being actively cultivated. What keeps that pursuit from coming into being varies by person, but I’m sure that fear of the unknown ranks real high on the list.

That fear, I think, often comes from the misguided notion that chance plays a primary role in the success or failure of a business venture, and people who have never had their own business might be unsure that Lady Luck will smile upon them should they decide to venture out on their own. There’s often the tendency to believe that the self-employed get to where they are by having special skills or talents, by being in the right place at the right time, or because they have the “right connections”.

Maybe luck does play a role in some situations, but speaking for myself and for other self-employed people that I know, mindset plays a bigger role in entrepreneurial success than anything else.

I came to that conclusion while writing How Blogging Solved My Mid-Life Career Crisis, where I described my journey to go from internet idiot to professional blogger status in under three years. Special skills or talents? Nope, I was a mortgage guy before I did this. The right connections? Didn’t have any on the web—all my “connections” were involuntarily retired mortgage people. Being in the right place at the right time? Maybe, but I can tell you for certain that my failures far outweighed my successes in the first year of the venture.

No, it isn’t luck or anything special. It IS very much a mindset–how you process what’s happening and how you’ll react to it. But that mindset isn’t a single thought, but a tapestry of thought processes that drive you forward even when it seems there is no way forward. I’ve identified ten of them, but I’m sure there are more.

1. I am responsible for my own future. When we work for someone else, we might unconsciously transfer this responsibility to our employers. This can include not only a paycheck, but also promotions, bonuses, benefits and retirement security. When you work for your self you must understand that none of that can exist unless you make it happen.

2. No one owes me anything. This is actually true no matter what your professional status, but it’s impossible to ignore when you have your own business. It isn’t about waiting your turn or going through the right channels until you’re properly recognized and compensated, but about understanding that nothing good happens without your dedicated efforts.

3. My income is somewhere “out there”—I need to go get it. A self-employed attorney friend said to me over lunch one day, “salaried people don’t understand our situation because they get paid no matter what; in our world we only eat what we can kill.” Your income and success are out there for you to find and acquire. You’re either a hunter, chasing down your paycheck, or a farmer, patiently planting and tending the crops that will eventually yield a harvest of riches. You’re never on cruise control waiting for the money to come rolling in.

4. I will learn what ever it is I need to know. You want to start your own business, but you’re certain you don’t know all that you need to know to make it happen. No problem! No one ever knows all that they need to run a given business—trial and error is a constant traveling companion. You should never let that stop you! You have to have the spirit of a permanent student, always prepared to learn what it is you don’t know. The internet, and YouTube in particular, make it easy to get what ever information you need. All you need is the commitment to learn and you’ll be fine.

5. I will network with others in the same business. It’s been said that each of us is the average of our five closest friends; what that means, if you’re going into business, is that you may need to find some new friends. This is especially true if all or most of your friends are employed by others. Keeping company with people who are already in the business you’re going into is probably the best way to fast-forward the process. The learning curve on a business can be brutal, so get some help.

6. There will be problems—and I’ll overcome them all. Self-employment is often a process of solving a perpetual string of problems—get used to it. Embrace problems as “technicalities to be overcome” and part of the price to be paid for being an entrepreneur. Yes, you’ll probably face more problems in your own business than on a job, but your ability to deal with them will be much greater. Eventually, solving problems becomes “part of your job description”, and it’s no longer the boogeyman it once was.

7. I will have both bad luck AND good luck. As human beings we can easily obsess on the “power” that luck has over us. Nonsense! Yes, you can have something unfortunate happen in your business, but you’ll also have more than your share of good luck (what we think of as “breaks”). Your business needs to be driven by effort, not by perceptions of luck, whether good or bad. To a large degree, we make our own “luck”!

8. There is no security. There is no security in a job or a business anymore, nor is there any in life itself. We’re born and we die, and what we do with the time in between is mostly up to us. We can cling to the perception of security, or we can step out and try to find who it is we’re meant to be. (Guess which one is more fun?)

9. I will focus only on that which is most important. This is probably the biggest discipline issue for the self-employed. A business means a multitude of responsibilities and it can get overwhelming. Many businesses never get off the ground because the owner spends most of his time “majoring on the minors”–taking care of the urgent at the expense of what’s truly important. How do you know what’s truly important and what you should focus on most? Hint: it’s the activities that have the greatest ability to put money in your pocket. Do that enough, and you can hire virtual assistants to take care of the rest. (True confession: I haven’t mastered this one yet, but I’m working on it.)

10. I will never quit. I’ve said in previous posts that this is the single most important indicator of success or failure. It’s one thing to quit a job, but when you quit on your business, you’re quitting on yourself. Where do you go after you’ve done that??? No matter what obstacles you face, resolve that you will go forward no matter what. And here’s something I’ve discovered about forward motion—as long as you’re going forward, your biggest obstacles and problems will kind of go away. Embrace this philosophy and the deck will be stacked heavily in your favor.

 
No matter what else you may think about self-employment, it is very much determined by psychology. To be self-employed, you have to think differently than your old salaried self. If you’ve never been self-employed, you will need to change your thinking. These 10 thoughts have helped me not only to get through the rough patches, but also to see a better future.

If you don’t have any of these philosophies now, don’t sweat it. If you’re determined to have your own business, you’ll begin to take them on one by one. Actions can control and change thoughts—resolve to go forward and it’ll all become obvious.

Are there other thought processes that you think are necessary to develop the self-employed mindset?

Related Posts:

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By Kevin M

I’ve been writing a good bit in the past few weeks about the virtues of self-employment, based heavily on my own experience in turning this blog into a primary income generating venture. I believe that being self-employed may now be the new preferred way to “creating a career”, as opposed to the more traditional route of jumping on the corporate ladder—mainly since the ladder no longer seems to exist.

Today I want to take a look at contracting, since it’s become an increasingly common path into self-employment. For the record, I’ve done a good bit of contract work over the past few years so I won’t be talking (OK, writing…) hypothetically. And I still do take on contract work under the right circumstances.

OK, so you enter a contract arrangement—they have you sign a thick contract filled with rich legalese, they aren’t going to withhold taxes, you’ll be issued a 1099 at the end of the year (instead of a W2) and you’ll be required to file a Schedule C—Income from Self-employment, on your income tax returns. Wow, you’re self-employed now, right?

Not necessarily. And maybe not at all.

Many contract arrangements have nothing to do with self-employment. They’re mostly watered down jobs that have close to zero chance of ever being converted into entrepreneurship of any kind. They can be a trap if you take them on, thinking it’ll make you self-employed. No only will you not be self-employed, but you’ll be only minimally employed at that. It’s important to know when a contract arrangement really is a form of self-employment and when it’s something else.

When contracting is NOT self-employment

I’m tackling this one first because I think this is the more common situation. Some of the typical characteristics of non-self-employed contracting include:

1. You’re required to work full-time
2. You’re specifically prohibited from working for the company’s competitors (translation: you’re exclusive), a restriction that can even extend beyond termination
3. The company controls where you work and the hours you keep
4. Strict adherence to company guidelines and procedures are required—you have little or no flexibility in performing your work
5. Your pay is entirely dependent on hours, not the results of the job performed
6. The employer withholds no taxes—you’re paid by 1099 and must file a Schedule C with your income tax return (giving the appearance of self-employment for tax purposes)
7. You’re responsible to a specified chain of command, including an immediate supervisor
8. Your work is closely supervised and directed by an employee of the company—there’s no element of freelance here
9. You can be fired without notice or cause, though the process may be called something different
10. Since you technically aren’t an employee, you have no company benefits
11. Since you aren’t an employee, you have no right to sue for typical employee grievances
12. Any and all contract provisions are for the protection of the employer

A recruiter friend of mine tells me that these provisions are becoming extremely common. But a contract situation with even a few of these provisions is not self-employment in any way. And though the stipulations are quite common in today’s contract job market, a situation with even a few of these elements would not qualify as a contract situation under IRS guidelines either. That’s really a job, but one in which we, as the employees, have most of the responsibility and liability.

Employers love this arrangement because it a) relieves them of most administrative functions, including collecting and filing income taxes, b) circumvents providing employee benefits, c) allows them to terminate the “contract” at will, and d) generally denies the employee the right to bring a lawsuit for unfair practices, inadequate working conditions or for wrongful discharge.

Now if you take an assignment like this because you need a paycheck—as I have myself—you certainly have my respect. Just understand that it’s usually mostly a compromised job situation and in NO way self-employment or anything that will lead in that direction.

Your “self-employment” is only in the eyes of your employer, who loves it because it gives them all the advantages while denying you the same. The 1099/Schedule C arrangement is completely cosmetic and in no way proves self-employment status. Neither does the written contract you sign because it establishes an unequal partnership favoring the employer, and is also completely cosmetic.

When contracting IS self-employment

Recognizing that the situation described above is probably the more common contract arrangement, there are contract arrangements that very much are a form of self-employment. How do you know? Here are some clues…

1. You have a written contract with a company to provide specific services that can, but don’t necessarily, require a certain number of hours
2. The assignment is usually temporary, concluding when the specified services have been delivered
3. You are free to work with competing clients simultaneously or subsequent to the assignment
4. The client does not require you to work on site, or allows a certain amount of work to be done off site
5. Though you may have regular interaction with client management, you are not supervised by them
6. You can enter the contract and be compensated under your corporate name
7. You can bill the client for expenses, such as travel, incurred in connection with the assignment
8. Payment via 1099 (no withholding taxes) is legitimate because it’s understood by all parties that you will contract with multiple clients and may have legitimate business expenses to write off
9. The arrangement can be part-time, seasonal or as-needed
10. You have complete or substantial control of how the work gets done—the client specifies what they want done, but leaves it to you as a professional to make it happen
11. The contract itself is a fully negotiated document, prepared by and agreed to by both you and the client

Contracting with these provisions is a form of self-employment. The key element is flexibility—under this kind of arrangement you have considerable flexibility because the client is relying upon your specific skill set. Compare this with the tightly controlled job-posing-as-independent-contractor in the first example and you can easily see why that one isn’t really a form of self-employment.

Why does it even matter?

Employers are concocting all kinds of ways to cut payroll costs, and contracting has become an extremely common method. What’s important is that you don’t get caught up in the employer’s claims that you’re somehow self-employed just because they hire you as a “contractor” or some similar nomenclature.

If you want to be self-employed, then you need to make sure that the contract arrangement you’re agreeing to will be a step in that direction. A contract should allow you to be free to do the work the way you need to do it, and allow you to freely solicit and work for multiple clients. That’s being self-employed.

Contract arrangements that control your time and workflow, and prohibit outside activities are just jobs by another name. If your long-term plan is to become self-employed, either through contracting or by some other method, the first situation won’t help your cause.

If you want to be an entrepreneur, you need to learn the difference between the two contract arrangements. One will bring you to self-employment, the other is really a job—and a job with less security and fewer benefits than traditional employment.

Have you ever done contract work? Have you ever been in a contract arrangement that looked a lot like the first example? How did you feel about it?

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Guest Post

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Beyond Buy-and-Hold #75

By Rob Bennett

You’re a Phillies fan. You have hopes for the team winning the World Series next year. The manager is interviewed on television. You are reassured to hear him say that “pitching is what matters in this game, it’s all about pitching.”

The next day, the manager releases the team’s best five pitchers on waivers. You are shocked. You tune in to the news that night to hear his explanation. He says: “I strongly believe that pitching matters. That said, I know of no reason to believe that teams with better pitchers win more games. So I am not even a tiny bit concerned that we are losing all our best pitchers. I am convinced that pitching matters a great deal in baseball, but I also am confident that it has no effect on whether you win or lose games.”

That’s crazy talk. To say that pitching matters is to say that, all else being equal, teams with good pitchers win more games than teams with bad pitchers. The idea in the game of baseball is to win games. To say that something matters in baseball is to say that it helps you win games.

Everyone understands this logic for so long as the discussion relates to baseball. Things get foggy for many when we turn our focus to stock investing.

Valuations matter in stock investing

There is something close to a universal consensus on this point. I have talked to tens of thousands of investors and I have never met one who disagreed.

But I have met many investors who argue that, while valuations matter, paying attention to valuations will not help you achieve better investing results. That is, valuations matter, but having valuations on your side (by investing more heavily in stocks at times of low valuations than at times of high valuations) will not help you win at the game of investing.

All Buy-and-Holders believe this. If they didn’t, they wouldn’t be Buy-and-Holders. If you believe that having valuations on your side helps you win at investing, you would obviously set your allocation in such a way as to have valuations on your side. That is, you would go with a higher stock allocation when prices were low than you did when price s were high. Investors who do that are Valuation-Informed Indexers.

Valuations versus “anytime is a good time to be in the stock-market”

Why do Buy-and-Holders hold this contradictory belief? Why do they believe that valuations matter but that having valuations on your side does not help you win at the game of investing?

It’s because of a mistake that was made in the early 1970s. The people who developed the Buy-and-Hold Model discovered that short-term timing doesn’t work. They didn’t know at the time of the need to distinguish short-term timing from long-term timing; the research showing the importance of this distinction was not published until 1981. So they concluded that timing in general does not work. And they made that the fundamental premise of their investing model.

Having rooted all their beliefs about investing in a conviction that timing does not work, they didn’t pay much attention to the research showing that long-term timing always works when it was published. They ignored it. Then they ignored the confirmations of that research. Then they ignored the confirmations of the confirmations.

It’s getting harder to ignore the 30 years of research showing that the fundamental premise of Buy-and-Hold Investing is the opposite of the reality now that the widespread promotion of Buy-and-Hold has caused the second worst economic crisis in U.S. history. But the desire to ignore that 30 years of research is today greater than ever. Had the flaw in the Buy-and-Hold Model been acknowledged in 1981, when it was discovered in an intellectual sense, the model could have been changed before it did harm to anyone. It would have been a case of no harm/no foul. We cannot say that it is that today. Today we need to say that Buy-and-Hold has caused more human misery than any earlier idea in the history of personal finance.

The stock market and its affect on the economy

Will we ever be able to fix the mistake and bring our economic crisis to an end?

I sure hope so. I don’t think we can wait for the investing experts to come around. I have contacted many of them and have found them to be resolute in their conviction that these errors must never be publicly discussed or corrected. The Buy-and-Hold Model is going to be fixed when the investors suffering the losses resulting from the flaws in it demand that it be fixed, not before.

So we all need to begin asking ourselves some very basic questions about this wildly popular investing strategy. Does it make sense? If you are going to put your retirement money at stake on the merits of Buy-and-Hold, you had better be sure it is a strategy that at least makes some sense. Does it? Is there even a tiny bit of logic that supports the idea that valuations matter but that there is no need to change your stock allocation in response to big swings in valuations?

I submit to you that there is zero logic supporting that claim. Buy-and-Hold makes not a lick of sense. Going by logic, we should all expect Buy-and-Hold to cause the millions of middle-class investors following it to suffer frightening financial wipeouts, wipeouts big enough to cause the global economy to collapse.

My sense is that many of us had doubts all along. The story never held together. We should have spoken up. During the bull market, Buy-and-Hold became so popular that we permitted ourselves to become intimidated by its apparent success. Now we are paying the price for our cowardice. Now we are seeing not only a collapse of our economic system but even signs that our political system may be vulnerable to potential collapse.

Valuations matter. The Buy-and-Holders got that one right. Since valuations matter, investors must take valuations into consideration when setting their stock allocations. There’s no getting around it. Buy-and-Hold is dead. We need to get about the business of building an investing model that works.

Rob Bennett has written about the eight investing questions you need to ask before putting money on the table. His bio is here.

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By Kevin M

My friend Jay and I were talking about jobs this past weekend and he pointed out something that I hadn’t thought about: There are no astronauts any more! That may not mean too much if you’re under 30, but when he and I were growing up being an astronaut was the ultimate “hero career”. It was, as the kids say today, “the shit” among careers.

Back then it seemed that all of humanity would eventually be going to space—to find resources, to conquer new worlds or at least to alleviate overpopulation here on earth—and astronauts would lead us there. High minded and exciting, yes, except that it never happened!

If a career as cutting edge as astronauts is no longer secure, what can we say about the far more ordinary fields most of us regular folks work in?

You’ve heard it and read it before, and perhaps you’ve even been a casualty of one of the biggest phenomena of our time–the end of job security.

We have to do something about that, but what? Individually, there’s little any of us can do to create job security, but we can gravitate toward it’s close cousin, income security. If we have income security we might not even notice or care that we no longer have job security.

What is job security? What is income security?

Let’s face it, in order to function everyday and to have some sort of certainty about the future we need some measure of security when it comes to earning a living. For at least the past couple of generations that meant having a stable job, but the times they are a-changin’. Fast.

Job security implies that your job is safe for the foreseeable future and hopefully clean through to retirement. Your job IS your income—as well as your source of health insurance, retirement and other benefits, and even your self esteem and your standing in the community. All is well, and you even have income security, as long as your job is secure.

Most people seek job security because it’s a simpler way to earn a living—your employer has your job and your income “covered” freeing you to go about living your life. The downside is when your job is suddenly in jeopardy, because the entire financial component of your life is also at risk. It’s a classic case of having all of your eggs in one basket.

Income security means your income never comes from a single source. If one source fails, you have others to tap, and you can eventually replace the failed sources with new ones. You’re not overly concerned with any one income source, but with creating and maintaining a portfolio of income streams.

In the economic and employment conditions of our time, I think income security is the logical security to pursue.

Creating income security

Its one thing to know the difference between income security and job security, but ultimately it all comes down to making it happen and that’s not as easy. There are various ways you can begin creating income security and that can include just about any revenue sources you can think of.

Self-employment. This is the obvious first choice for providing an additional (or alternative) income source beyond a job. By its very nature, being self-employed is all about creating new revenue streams. If your business income is derived from several or many clients or customers (which it should), you’ll actually have a portfolio of income streams, and that’s the best income security you can have. Even if your income drops, you can still have at least some income from your business, as opposed to a job where your entire income will cease the day you’re let go.

Fortunately, the internet has made self-employment easier than ever and because it’s here and now and growing, that’s probably the first place you should look. It’s where I’ve decided to camp out and it’s working for me—and I’m not exceptional in any way, believe me.

Investment income. In an era of record low interest rates, this is more about turning small amounts of money into larger ones. There are various ways to do this and you should start investigating them. This is not about plunging into the stock market per se, but about developing the ability to identify under-priced securities that have the potential to grow well beyond conventional rates of return—then having the willingness to wait it out. It has nothing to do with get-rich-quick. It’s a skill, just like business- or job-skills are, and once you master it you’ll have created a whole new way to earn a living.

Forming business partnerships or investing in small businesses. One of the things you can do if you have a business is to partner with other businesses in ways that will enable both entities to grow. There are as many ways to do this as there are small businesses and people who own them. It can also be the middle ground between starting your own business and investing. And you can do this with skills as well as with capital.

Let’s say you have some capital but you’re spooked by the stock market; as an alternative you can invest some money in an existing small business (or several) as a way taking partial ownership of a growing business. Small businesses always need capital, but never more than now when getting a bank loan is harder than ever. Conversely, if you have certain skills needed by a small business, you may be able to join that business as an owner/partner. Marrying capital with management and skills is a time honored way for all parties to make money, and very the foundation of free enterprise.

Lowering your cost of living. Not many people think of this as an income source but it really is. When you lower your living expenses, you’re lowering the amount of income you need to earn—that’s the equivalent of a fresh income source, but it gets even better. The less income you need to live on, the less you need to earn, and the less you’ll need to pay in income taxes. That’s a double benefit. The biggest advantage here will come from lowering your biggest expenses, the ones that represent the biggest drain on your income. Less need for income means more freedom to pursue other income sources.

Jobs. I gotcha on this one, didn’t I? If there’s no job security and we need to pursue income security instead, why discuss jobs? Because jobs are, first and foremost, a source of income! The topic of income security isn’t a self-employment is good/having a job is bad debate—any legal income source is a valid one. That includes jobs. Income from a job is good, it’s the complete reliance on it that creates the problems. If you can keep a job while developing additional revenue streams, you’ll achieve income security in addition to having a job. Your job is then part of the income mix, but not the sole source.

One more point about jobs: if you intend to keep one in an era where there is no job security, it’s important that you emphasize skills over the job itself. Transferability is the key, and only a strong set of skills can give you that.

 
You’re creating income security in your life when you start receiving income from sources other than your employer. That point is important in itself—you shouldn’t quit your job to create income security—you can and should do it while you have a job. In fact it will be easier to do it this way, and your job itself can be part of the security you’re working to build.

At a time where there isn’t much in the way of job security, what steps are you taking to build your income security? Are there any ways I didn’t mention?

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7 Reasons Why Self-Employment is More Secure than a Job

Beyond Buy-and-Hold #74

By Rob Bennett

At what price are stocks no longer worth buying?

That’s the question that should terrify Buy-and-Holders, for two reasons. One, it is a question that demands an answer. And, two, Buy-and-Holders are not able to come up with one.

Before you buy a car, you check Edmunds.com or some such site to identify the fair selling price. If you are in desperate need of a car, you might be willing to pay a bit more. But there are limits. You won’t pay $60,000 for a car that properly should go for $20,000.

Why doesn’t it work that way with stocks? Stocks were selling for three times fair value in 2000. Investors were buying like crazy. Why? Why don’t we care about getting ripped off when it comes to how we invest our retirement money?

Should “sky’s the limit” be the rule with stocks?

Say that you think it is okay to pay three times fair value. There still has to be a limit. Would you be willing to pay six times fair value? Would you be willing to pay ten times fair value? Shouldn’t there be some price at which you would conclude that stocks are not worth buying?

People don’t even want to think about the question. It is a disturbing question. The suggestion contained in the question is that we can know when stocks are worth buying and when they are not. Which would of course be a wonderful thing. And we of course can indeed do this. So why don’t we? Thinking about that one is the disturbing part of the project.

Why don’t we want to know when stocks are worth buying?

Why don’t we want to know when we have had too much to drink? Why don’t we want to know when we have had too many candy bars? Why don’t we want to know when we have been at the gambling tables too long? Why don’t we want to know when our current flame is bad news?

We like to tell lies to ourselves. That’s why.

How stocks become overpriced

There’s only one way in which stocks can become overpriced. It happens when gains are excessive for a number of years in a row. We want to count those gains as real. It brings us closer to retirement to count the gains as real. We want.

Our minds won’t let us have what we want. Our minds are logical. Our minds tell us that the excessive gains don’t count, that they don’t bring us lasting wealth and that they don’t bring us closer to retirement. So we turn off our minds. We become Buy-and-Holders and count those excessive gains. Then they treat them as real and they depend on them.

If we all spent time thinking about at what price stocks are no longer worth buying, we all would be better investors. But there would be a price for heading down this road. We could no longer indulge our fantasies of being able to retire early by taking advantage of the phony gains we enjoy during bull markets.

The key to smart investing: facing the truth

Smart investors are honest with themselves. They always want to know where they stand. They use accurate numbers because they understand that financial planning is a sick joke when the plans are based on phony numbers. Getting the numbers right is important.

Buy-and-Holders cannot stand the thought of using accurate numbers. Using accurate numbers slows you down. Using accurate numbers means having to save all the money you need for retirement, no fudging permitted. No fair! No fun!

We all know we are kidding ourselves. I know this because of my nine years of talking these issues over with tens of thousands of middle-class investors. I have never met a Buy-and-Holder who was not defensive about his insistence on using inaccurate numbers. I have never met a Buy-and-Holder who dared to answer the question of when stocks are so overpriced as to not be worth buying.

It’s a sad situation. We do ourselves great harm by fooling ourselves. And we are all aware on some level of consciousness that that is what we are doing. But we fight efforts to get a discussion going out in the open. We prefer to live in pain over facing the struggle it would take to adopt honest investing practices.

Here’s my challenge to you: Start small. Pick one aspect of the investing project and be honest with yourself about it. If you can handle that much, I am confident you can move on to great things.

Answer the question: At what price are stocks no longer worth buying? You don’t have to answer the question in the way I would. But, if you are to claim to be a rational investor, you need to have some answer to the question.

What is it?

Are stocks worth buying when they are selling at two times fair value?

How about three times?

How about six times?

How about ten times?

At what price are stocks no longer worth buying? Do you know? Are you able to put forward any justification for not being able to advance a simple and clear and confident response to this basic question?

Rob Bennett writes about how to obtain lasting investor confidence. His bio is here.

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Guest Post

Having a low credit score can be a big problem. Not only will you be restricted to bad credit loans, if you are able to get loans at all, but you will also pay higher interest rates any time you borrow. A bad credit score can necessitate that you put down a larger down payment for utilities and a cell-phone service. It can make your insurance rates go higher and disqualify you from certain jobs or make it harder to get a job when your employer runs your credit.

Bad credit and lots of debt can even affect your health, as studies show that people tend to sleep less and turn to comfort food more when they are in debt, which can actually contribute to making them sick.

If you are struggling with bad credit, it’s time to pull yourself out of the bad situation you are in and take steps to improve your credit score once and for all.

How to Fix Bad Credit

The first thing to understand about fixing bad credit is that it is going to take time. Negative information will drop off your credit report within seven to ten years, depending upon the type of information that it is. Even bankruptcies and foreclosures will be off your credit report within this time frame. If you simply wait long enough, a lot of the things that are dragging down your credit score will resolve themselves.

Of course, few people can actually wait years to get a credit card, car loan or home mortgage. Waiting as long as you can is a good idea, because the older the derogatory marks are, the less impact they have on your score. Taking active steps to improve your credit is also essential, as doing the right things can help bring up your credit score much more quickly.

Replacing the Bad Credit with the Good Credit

The key to improving your credit score is that you need to show lenders that you have now become responsible, even if you weren’t before. Ironically, this means that you have to get credit in order to improve your credit score. If your credit is truly terrible, you may need to look into bad credit loans or secured credit cards in order to be able to find someone to lend to you. While the interest rates may be high, it is still worth taking these types of loans, so you can start to establish a positive credit history that will outweigh your previous bad one.

Take on your new loan or secured credit card debt and make payments in full and on time every month. You don’t have to borrow a lot or carry a balance; just one or two small purchases that you pay off on time will start to build a history of positive reporting of payments and will start to bring your score up.

You should also work to pay down debt, as credit utilization is one factor that affects your score. When you eliminate a lot of your debt, you’ll be a less risky proposition for creditors to lend to.
These options, along with possibly talking to your creditors about settling debt and removing derogatory remarks from your credit report, can be the best way to improve your credit enough that you will no longer be reliant on bad credit loans for your borrowing needs.

This article is a guest post from Money Supermarket.

Guest Post

It is quite unfortunate that the majority of investors approach investing with the mind set that they need to find stocks that will provide the greatest return in the shortest possible time. The entire day trading industry is built upon this need for instant gratification. Brokers are all too happy to fill this need by offering low trading commissions and beautiful charting and trading tools. As is often the case, constant portfolio turnover and churn is where the real money is for the brokers. “Making it up in volume” may not work for Detroit any more, but it works very well for the discount brokerage industry.

Investors who get seduced by these tools and the hope of a quick profit, tend to significantly under perform the market. Step back for a moment and consider this: The total market return (for example an index such as S&P 500) is the sum of the returns of all the individual investors in that market, institutional investors such as funds, less the commissions and fees they pay out to their brokers.

The problem is that of the three main participants in the market, individual investors are the only ones who are completely dependent on good stock picking for their profits:

1. Brokers: They typically do not care about which stocks are up and which are going down. As long as their customers are buying and selling, they make money in form of commissions and the spread between bid and ask. The greater the trading activity, the better it is for them.
2. Funds (mutual funds, pensions, hedge funds, etc.): Fees and expense ratios are the main source of income. Hedge funds do have a part of their fees tied to performance, but they are also guaranteed a part of their income as a percentage of Assets Under Management (AUM). Performance plays a role in attracting new customers but it is unlikely that the fund company will operate under loss as long as it has a good size asset base.
3. Individual investors: Completely dependent on the returns of their investments for their profit.

The intermediaries provide a service and get paid for it. Nothing wrong with it, except that the goals of an individual investor and the brokers/fund companies are not necessarily aligned at all times. The stock market may or may not be efficient, but I can tell you this – the industry is extremely efficient at extracting every cent of profit from the investing public – that is, from YOUR investment returns.

Fortunately, Successful Long Term Investing is Not Complicated

Your investing success depends on you, and no one else. No one has the same incentives as you do. It is not complicated, but unless you have a well defined process and the discipline to stay with it, it is going to be very hard. It also requires a change in the way most of us think about investing and stocks. Stop thinking about rate of return and beating the market and start focusing on a solid investment plan and process and your returns will take care of themselves. Use the following principles and you will be on your way to create a good plan that works for you.

1. Invest in businesses, not stocks – A stock is just a way of gaining a part ownership in a business. Do not think of a stock as a bet. Only buy stock in a company that you will be happy to run yourself if you were to own it outright. So you will need to think about profits, customer loyalty, growth prospects and competition. You should really consider all aspects of the business before you invest in it. Spend more time choosing your investments than you would, for example, in choosing a new microwave oven.
2. Do not over pay – It is one thing to buy a company that is profitable and has a strong competitive position. It is another to buy it at a price that will ensure profits for you. If you pay a premium for your stock, that is when the stock is overvalued, the company may continue to rake in profits and cash flow for the next ten years and your stock may not move. This is because over time, all stock prices approximate the intrinsic value per share of the company. However, at any given instant of time, the stock prices may be out of whack with the value as it is more dependent on the investor sentiment and the demand/supply of the stock in the market. You may want to read my thoughts on how to buy stocks at a discount to understand better how this process works.
3. Ignore the market, turn the TV off, cancel CNBC – If you are following the two principles laid out above, you are more 80% there. However, if you are the kind that panics when the market does, you are likely to sell off your good stocks at the worst possible time. If the investment merit of the stock has not changed, there is no reason to sell it. It is just better to tune out the unnecessary noise.
4. A down market is an opportunity, a buoyant market is scary – When your barber starts giving you stock tips, it is most likely the time to sell. When the IPO market heats up, sell. When everyone sells their stocks and hides their cash under the mattress, buy. When the number of new investing blogs in a year exceed the number of new “frugal” blogs, sell. You get the idea. The trick is to buy low and sell high. The days after the Lehmann Bros collapse were some of the best days to scoop up sound and profitable companies such as American Express.
5. Do not, and I mean this, do not be afraid of cash – It is surprising how so many investors feel compelled to buy a stock, any stock, if they have cash sitting in their brokerage account. The only valid reason to invest in a stock is if you have researched the business and decided it has investment merit. When the market is overvalued and there is a paucity of good investment values, it is prudent to stay in cash. Buying an iffy stock that eventually loses money is neither macho, nor sexy.
6. Get in with the correct process – The correct process, and the mind set for successful investing, is not to buy stocks that will go up. The correct process is to buy ownership in a company that makes money for its owners without overpaying for the share. Sure there may be times when you judge wrong, and there may be times when you have to be patient for years to profit, but if you do this long enough, with good number of stocks, you will eventually win out over the market and the average unenlightened investor. If you do not use the correct process, just know that there are many businesses out there just waiting for you to hand them your hard earned money.

If you have stayed with me so far, you are probably asking this obvious question: How do I find time and help to research the stocks and the businesses in the manner you are suggesting? In the old days, only investors with considerable assets, who could afford a full service broker and their custom advice, bought stocks. Today, technology and new financial products such as funds and etfs have brought in many new investors in the market and discount no frills brokers have thrived. The fact is, if you can’t afford good advice, you will have to make time to research your stocks. There is no way around this. Even if you have a good advisor, I recommend you do not buy any stock that you do not understand yourself. Then by all means take advantage of low commissions offered by discount brokers.

Shailesh Kumar, perhaps better known as Arohan, runs the popular value investing site Value Stock Guide where he doles out stock advice and recommends undervalued stocks to buy to new investors and stock market grey beards alike.

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Guest Post

Reaching a point when you can grow your money via investments is an exciting time. But there are many factors that affect investors’ decisions. These are normally guided by investment strategies, which are influenced by investment goals, risk tolerance, and your future needs for capital.

There are three basic types of investment strategies: growth investing, income investing and value investing, with the greatest thing separating them generally being the level of risk involved. Many younger investors have greater tolerance to risk as they can bank on having more time to make up losses, while investors closer to retirement may favour a conservative approach that’s protective towards their assets.

The basic investment strategies

Growth investors look for companies in markets that traditionally have high earnings and take risks buying stock from promising start-ups in the hope that the companies will grow into industry leaders. Value investors, by contrast, search for stocks that might have been overlooked by the market. Undervalued as opposed to low priced, these stocks represent a good deal to savvy investors. Income investing is a more conservative strategy that targets companies that consistently pay out high stock dividends.

Most investment strategies have risk guidelines that separate the risk averse from the moderately tolerant. Someone who is risk averse will prefer transactions with lower risk, even if it means losing out on higher rates of return. Research has indicated that investors who prefer this type of trading generally stick to index funds and government bonds.

Investment strategies aim to balance risk with reward through asset allocation, using an investor’s assets and unique risk tolerance profile to deliver returns. All assets – equities, fixed-income and cash and equivalents – represent different levels of risk and behave differently, hence the complexity of allocation.

Finding winning investments

Very rarely can investors pick stock market winners by intuition. Following set goals and guidelines has proven to be a far more successful method. Many investors choose to research companies within a certain industry or within certain financial criteria. Owing to the large amount of information that’s freely available today, it’s possible to find company information including financial data such as total and net assets, turnover, profit and stock information by using a business directory.

There is no one strategy that is fool proof. Developing investment strategies is as much about understanding the investor’s strengths and weaknesses as it is about understanding the market. For example, a person who is good at research and analysis will be good at finding opportunities in company accounts, and know when to buy and sell.

Becoming a good investor means not only developing an investment style but also learning how to process large amounts of company information. By first understanding asset allocation and risk guidelines, and second processing company data, you too can leverage the stock market to your benefit.

This article is brought to you by Duedil, the largest database of free company financials in the world.