Lately it is almost impossible not to be overwhelmed by a never-ending stream of rhetoric that forecasts the markets’ demise. Should a global event or crisis cause a temporary market decline, the prognosticators of doom will resemble vultures ripping apart a carcass.
Do not waste your valuable time trying to analyze the latest, supposedly gruesome, development. Discerning market direction on an hour-by-hour or day-by-day basis is a meaningless undertaking. Even weekly trends are of little use. What is important are long-term macro-economic trends, combined with fundamental financial data, which enable your investment to return a reasonable compounded annual growth rate (CAGR) over a two-to three-year time frame.
It should be common sense that companies with superior products and significant market share, combined with a finely-honed distribution network, run by a seasoned management team, will see their share price increase over time, regardless of short-term market trends.
However, the real question is not about potential investments, that is the easy part. It is about you. If you cannot sleep at night because of market volatility, then please avoid Wall Street. You cannot put a price on peace of mind. However, after enduring the pain and suffering of the Great Recession, not to take advantage of the current ongoing equity rally is like not showing up to collect a well-deserved Oscar.
Degrading the blanket of investment trust, engendered by Wall Street over the years, has been an uprooting of the fantasy that Wall Street is a level playing field. To paraphrase a concept from the book “Animal Farm,” by George Orwell, published in 1945, “All investors are created equal, but the rich ones are more equal.”
Your defense is to create a diversified portfolio of dividend paying blue chip companies that have a high probability of providing a reasonable total return. You, in turn, must have the patience to allow share price performance to equate to corporate performance. Having a love affair with stocks is fine, but you need to let it develop into a long-term relationship, not just a passing infatuation.
The truth is that if you employ a combination of fundamental analysis and a bit of patience along with a modicum of common sense, your investments will do just fine. Yet it never fails to amaze me how intelligent and responsible people seem to disconnect their brain because of some off-the-wall piece of investment advice.
So how many stocks should you invest in? Well, if you have overwhelming confidence in your ability, then one stock should be all you need. Most of us are not that confident or that foolish.
Per modern portfolio theory, if you have a diversified portfolio of 15 or more stocks, you have removed individual stock risk. However, you still have market or systematic risk to deal with.
Often referred to as volatility, systematic risk consists of the day-to-day fluctuations in a stock’s price. Volatility is a measure of risk because it refers to the behavior, or “temperament,” of your investment rather than the reason for this behavior.
Interest rates, recession and political upheaval, represent sources of systematic risk because they affect the entire market and cannot be mitigated by diversification.
What kind of return should you expect from your portfolio? Warren Buffett once addressed this question very succinctly, pointing out that most investors’ expectations are overly optimistic.
“Stocks are a decent way to make 6 to 7 percent annually but anyone who expects to make 15 percent from the market, or by having a broker pick stocks, is living in a dream world.”
I would argue that it is possible to increase that number to 8 to 10 percent if you invest in companies with rising dividends.
Finally, never become so obsessed with Wall Street that you let it run your life. As Charlie Munger, the second in command at Berkshire Hathaway, once said, “If all you succeed in doing in life is getting rich by buying little pieces of paper, it’s a failed life.”
Lauren Rudd is a financial writer and columnist. You can write to him at Lauren.Rudd@RuddInternational.com. Phone calls accepted between 10 a.m. and 3 p.m. EST at (941) 706-3449. For back columns please go to www.RuddReport.com.