We’re not speaking about a horse race lasting several minutes or some casino thrills here. We’re talking about serious, hard-earned capital that you’ll be investing. The research involved is often exhaustive—hardly the case with a casual gaming activity. Additionally, in the stock market you can also profit by correctly forecasting a decline in a stock (by “selling short”). No such option exists in the aforementioned activities. By the way, I’m not aware of any dividends paid by casinos or racetracks while you’re waiting for the outcome of those venues. Another key difference is that in a primary bull market, a large percentage of stocks will trend higher, increasing your chances of success. When was the last time you watched a horse race where most of the horses won, or sat at a slot machine where most of your pulls were winning ones? They’re in a totally different monetary world, far removed from the stock market arena. While they’re often referred to as “games of chance,” maybe a better phrase would be “games of no chance.” Enough said.
Moral: There is absolutely no comparison between the gaming venues mentioned above and investing in the stock market. They shouldn’t even be mentioned in the same breath. Supply and demand determine the direction of the latter, not preset odds that are stacked against you day in and day out.
Chapter 28
Dollar Cost Averaging
So you’ve decided to invest in the stock market by setting aside a certain amount of money each month (or other time frame) and placing it into a particular stock. I briefly discussed this concept earlier in chapter 14, “Hopes and Dreams.” People do this often. It’s called dollar cost averaging. The premise seems (be careful of that word) to make sense. By investing a set dollar sum in a stock on a regular basis, you’ll buy more shares when the price is down and fewer shares when the price is up. Those lower-priced holdings will prove to be smart purchases when the shares rebound, or so the reasoning goes. To those who believe that the underlying company looks sound and has bright prospects, the approach makes sense. But hold on.
Folks who follow the dollar cost averaging method don’t stop to consider a scenario in which the stock fails to rebound. The fact is that many stocks don’t come back—some not for years, some not at all! If you regularly commit capital to a stock that’s lodged in what analysts like me call a “major downtrend,” you’ll usually run out of capital to invest well before the shares in question hit bottom. The market’s staying power is greater than yours. Remember that. Go online and look at the household-name companies whose shares are significantly off their peaks. Some are selling at fractions of what they once were; some have gone through bankruptcy, slashed or omitted dividend payments, or suffered through a nasty bear market.
If we look at dollar cost averaging in terms of dating, the shortcomings are noteworthy. It’s like chasing a person who is poor match for you, practically begging them to get involved in a serious relationship, and then, as it becomes increasingly clear how incompatible the two of you are, marrying them, buying a home, and starting a family. It’s as if you’re saying, “Look, Jeff, since we’re basically incompatible, don’t really share similar interests, and don’t care greatly for or trust one another much, let’s become more deeply involved in our dysfunctional relationship by going shopping for an engagement ring, planning a wedding neither of us really want, and look forward to a probable deteriorating bond over time complete with a mortgage and kids.” Any clear-thinking person would halt such a relationship immediately! (That’s why I think relating investment behavior with one’s capital to personal behavior in one’s life makes sense. It allows for a clearer take.) You can’t afford to be seriously hurt financially by adding hard-earned capital to a steadily sinking stock. Personally, I’ve never used that approach, nor will I ever.
A broker called me many years ago and related how he was using the dollar cost averaging concept (I’ll never call it an investment strategy) to purchase shares of a particular stock at regular intervals. As I looked at the chart patterns and gathered other technical analysis information on the stock, my frown grew increasingly pronounced. I remember telling him not to proceed with his plan, that the signs suggesting that the shares’ supply-demand relationship was improving were absent. He told me he wasn’t concerned because if the stock continued to go lower, he would simply keep buying those shares at increasingly attractive prices. Is ugly beautiful? Is down up? Is bad good? Is lower higher? That’s basically the philosophy you’re resigning yourself to when continually buying a stock in decline. You’re doing things backwards—upside down, in fact. In this particular case, I suspect that the young broker was calling me for an affirmation of his plan. He had decided to pursue it regardless of my counsel. But as I said earlier, what I tell others to do with their money is based on what I would do in that very same situation with my own money.
After trying to convince him, to no avail, that this was not a course of action to take based on my brand of research, I decided to ask him the following question: “Based on what you’re telling me, why don’t you hope that the underlying company goes bankrupt?” I think the question got to him, because he paused before responding that if the underlying company went bankrupt, his shares would go to zero. Whereupon I remarked, “Yes, but look at all the extra shares your monthly allocation can buy then.” As best as I can recall, I never heard another word from him.
Sometimes I have to be blunt by way of example, especially in this case where the broker was relatively new to the business of investing and probably hadn’t experienced the negative side effects of following potentially dangerous market beliefs like this one. I suppose I needed to convey it to him in a way that wouldn’t soon be forgotten.
A cousin of dollar cost averaging, kind of like “Son of Godzilla,” is the “I’ll just buy more” investment method. This is a strategy I hear when I ask investors the point at which they’d consider selling their shares if the position wasn’t working out. Rather than investing a predetermined dollar amount in the same security over regular intervals to buy more shares as it weakens in price and potentially lose money in an orderly fashion, this “seat of the pants” approach seeks to add capital to a declining position in a haphazard way to potentially lose serious amounts of capital. Both cases suffer from the same investment ill: chasing poor performance. And, may I say, refusing to acknowledge the potential for loss.
Moral: Getting more deeply involved in a losing situation is often a detrimental choice in one’s personal or monetary life. And justifying why we made the wrong decision instead of extricating ourselves from it is a ticket to remaining aboard that sinking ship. Dollar cost averaging may sound sensible, but theory and practice couldn’t be further apart when it comes to investing in the stock market.
Chapter 29
College Bound
Kids grow up so fast. One moment they’re in our arms, the next they’re on our nerves (but we love them dearly anyway) and getting set for college. Emotions are rarely stronger than when you leave your child after moving her in to face freshmen year.
I can remember my parents paying the tidy sum of approximately $450 per semester for me to attend Rutgers University back in 1974. How times have changed! Remember chapter 9, “It Lives,” where I jokingly discussed how a stock seems to know what you paid for it just as you’re about to break even, and often has no intention of accommodating your desires? Let’s apply this rule to investing for college.
Just because your kid is going to attend college in some future year does not automatically mean that the stocks or mutual funds you own will appreciate by enough to achieve your monetary goals. In fact, there’s a distinct possibility that they won’t. They may even post a loss. Some will reason that the number of years remaining until their child reaches college age somehow assures a favorable investment outcome or insulates their portfolio from losses. Besides, they argue, the stock market generally rises over time.
That’s a bold assumption to make when investing for college, however, because you’re dealing with a sp
ecific time period in which that appreciation will need to occur. You’re basically saying to the investment vehicle you’re counting on to help you pay that college tuition that it needs to appreciate by a certain amount by a certain time. But the market doesn’t take orders well. It’s the boss, not you. Remember, the stock market does not know your personal status, nor does it care.
While I’m well aware that many equity instruments have performed well enough to assist parents with paying the high (to put it mildly) costs associated with college these days, that isn’t always the case. And in those instances where sums earmarked for college were held in technology shares in early 2000, in an assortment of equity-related instruments during the major market setback of late 2007 to early 2009, or in most energy-related equity vehicles from their 2008 or 2014 peaks, funds destined for higher education declined. Just look at the monetary evaporation in gold and silver mining shares (whose peaks generally date back to 2011) through 2016’s first-quarter troughs. Even the widely watched Standard & Poor’s 500 Index took more than thirteen years to move convincingly above its March 2000 peak of 1552 (it temporarily topped that mark in October 2007 before collapsing). It took more than fifteen years for the NASDAQ Composite Index to better its March 2000 peak of 5132—from which it proceeded to tumble by 78 percent over the next thirty-one months ending in October 2002.
Simply because college considerations are years away is no guarantee that your investments, which have slid in value in the meantime, will recover in time. In many cases, even getting back to a break-even result will be a tall order by the time the tuition bill comes due. True, in many cases the market does recover—eventually. Will it be in time to cover those educational costs though?
However well known or highly regarded a company may be is not indicative of whether its underlying shares will appreciate by enough (or at all) to have a positive effect on your kids’ educational funds. Despite having years left before being college bound, many equity-based kids’ accounts haven’t performed nearly as well as planned. That’s why a risk management strategy needs to implemented—yes, even with funds earmarked for your child’s education. Bear markets don’t spare those funds, either. Your personal status, as I’ve already remarked, is of no concern to the market.
In no way do I want you to think that I’m a perpetual investment “glass is half empty” person. Brokers who know me from my career at some of the major Wall Street wire houses can tell you about my bullish market stances for lengthy periods during that span. I can remember having the honor of being the featured guest on Wall Street Week with Louis Rukeyser in May 1992. I wouldn’t put a lid on how high I thought the market could eventually travel. I described the primary market trend for part of the 1990s as a Buzz Lightyear market with stop orders, taken from the popular Toy Story character who uttered the phrase “to infinity and beyond.” The stop orders part was my own, of course, as I have never ceased (no matter how favorably disposed I was to the stock market) to emphasize my unwavering risk management beliefs and downside market warnings time and time again. One must never, ever forget that the stock market is a two-way street and that it sinks faster than it rises. And in case you do, you’ll be reminded—often in the harshest of financial terms. Always remember, as I’ve already said, that it only takes one bear market for which you’re unprepared to inflict lasting financial damage. Let’s remember that logo: IOTO—it only takes one.
So what would I suggest considering? As soon as my kids were born, I started buying them “zero coupon” Treasury bonds. These are usually highly liquid debt instruments, backed by the full faith and credit of the United States government. Prices vary depending on factors including the length of time they have until maturity and the interest rate at which your money will be compounding. As the name implies, you receive no interest payments, but rather a lump sum ($1,000 per bond) at the end of the investment period. In the interim they fluctuate; the longer the time period until maturity, the more volatile the “zero” will be in relation to interest rate fluctuations. So if you sell them before maturity, you could have either a profit or a loss. Unlike investing in stocks, you’ll know right off the bat what your funds will be worth if held to maturity. For a newborn, you’d probably want to consider buying zero coupon Treasury bonds (also referred to as strips) maturing in seventeen to twenty-one years—the period when your child will be attending college. (By the way, it’s often not a good idea to tell your kids about money you’ve saved or invested for them until you can assess their monetary habits. Being satisfied with the way my kids have turned out—thanks totally to my wife—I mentioned the subject to them at a relatively early age.)
After telling my story at a public speaking appearance in Worcester, Massachusetts, some years back on a snowy April evening, a nicely attired man in the audience stood up and remarked that his kid would never have enough money to go to an Ivy League school by investing only in zero coupon bonds (because the yield wasn’t high enough to produce the necessary funds with the amount he had to invest). In response, I replied that “at least you won’t lose a good state school education” by taking this relatively conservative investment route. The answer seemed to satisfy him.
I’m not suggesting that you necessarily do the same as I. Times change. At this writing, interest rates on zero coupon bonds are visibly lower than where they stood when my kids were born, and there are investment options available today that weren’t when I invested for my children. Additionally, we’re all in different circumstances with varying financial considerations. And as I emphasize below, you’ll want to speak to your financial advisor and accountant before investing in these or other investment vehicles to understand their particulars from varying angles.
I often tell people that the reason I put a healthy percentage (meaning most) of my kids’ investable funds into zero coupon bonds was to protect them from my own genius. It wasn’t a market-based decision. I wanted to give my kids at least that state school education. It’s the same concept in life; we don’t want to sacrifice what we’ve already worked so hard to build by trying to stretch for that little bit extra. At least that was my thought process with my kids’ funds. Remember, going for more reward entails more risk. You need to determine your own balance between the two.
Speaking for myself, if I were a proud new parent today, I’d probably still purchase some zeros for my kid’s account, even at today’s low-looking rates. It’s always nice to know beforehand that you’ll have some funds available for that state school education, and there’s nothing wrong with getting a good night’s sleep besides while dreaming happy thoughts about your Ivy League college–bound youngster.
Moral: Time is not automatically on your side simply because your children are in their grade school years and college expenses are a distant consideration. Don’t take on so much added risk trying to make extra funds to keep pace with those college costs that you jeopardize the money you’ve already saved for that purpose. Remember, our “capital preservation comes before capital appreciation” philosophy is easily applied to investing for college as well. One suggestion is to buy enough zeros (or similarly safe vehicle) to ensure a reasonable amount of funds for college and take the stock market’s movements out of the equation. Then you can decide whether to purchase equities to have an opportunity to turbocharge your portfolio. Be sure to consult with your accountant and financial consultant prior to doing so due to considerations relating to the types of accounts that zeros should be purchased in. They may have other investment avenues for you to consider as well.
Chapter 30
The Fallacy of Fees
Perhaps no other topic concerning the stock market receives so much attention as fees but deserves so little. Think about it. The key question shouldn’t be what your transaction costs are (as long as they’re well within reason), but whether you’re making the right investment move in the first place. Even if you’re trading for free, it doesn’t matter if your investment decisions are wrong. My view is to
concentrate first and foremost on making the correct investment decisions, not on the commission costs. After all, if you’re seeking advice, isn’t it a potentially worthwhile investment to pay more for quality counsel from a seasoned and knowledgeable investment professional who has many years of experience in both bull and bear markets and a respectable track record emphasizing risk management? Investment performance during a bear market span is the key consideration, in my view.
One of the investment strategies I discussed earlier was buying and selling shares on multiple occasions. The latter pertained to the setting of stops on the downside. Never have I worried about how much in commission costs I’m paying to execute these trades one by one instead of all at once. Besides, I want to assess whether my market thinking was correct before deciding whether or not to add more funds or continue to liquidate a position. The added cost is well worth the flexibility I gain. I’m not one who believes in playing an “all or nothing” market game and purchasing my full share position all at once. Doing so is like proposing to someone after an initial phone conversation. It’s too soon.
In my four decades in this business I have yet to hear someone exclaim, “Hey, Jeff, I lost a significant amount of capital in the market but paid really low fees!” Emphasizing trading costs in the investment equation is like bragging about the tasty after-dinner mint in the context of an unappetizing full-course meal. If you were researching which dating service to use to find your potential life partner, you wouldn’t automatically go with the cheapest alternative, nor would you unduly obsess over the fees. You would simply go with the best—as well you should.
Relationship Investing Page 9