THE FOUNDATION PORTFOLIO.
In this construct, each investor defines and manages a cornerstone foundation portfolio, which is long-term in nature and requires relatively less active management. Frequently, the foundation portfolio consists of retirement accounts (the paradigmatic long-term investment) and may include your personal residence or other long-lived personal or family a.s.sets, such as trusts, collectibles, and so forth. The typical foundation portfolio is invested to achieve at least average market returns through index funds, quality mutual funds, and some income-producing a.s.sets like bonds held to maturity. A foundation portfolio may contain some long-term plays in commodities or real estate to defend against inflation, particularly in such commodities as energy, precious metals, and real estate trusts. The foundation portfolio is largely left alone, although as with all investments it is important to check at least once in a while to make sure performanceand managers, if involvedare keeping up with expectations.
THE ROTATIONAL PORTFOLIO.
The second segment, the rotational portfolio, is managed fairly actively to keep up with changes in business cycles and conditions. It is likely in a set of stocks or funds that might be rotated or remixed occasionally to reflect business conditions or to get a little more offensive or defensive. More than the other portfolios, this portfolio follows the rotation of market preference among different kinds of businesses and business a.s.sets. The portfolio is managed to redeploy a.s.sets among market or business sectors, between aggressive and defensive business a.s.sets, from "large cap" to "small cap" companies from companies with international exposure to those with little of the same, from companies in favor versus out of favor, from stocks to bonds to commodities, and so forth. Sector-specific exchange-traded funds are a favorite component of these portfolios, as are cyclical and commodity-based stocks like gold mining stocks.
Is this about "market timing"? Let"s call it "intelligent" or "educated" market timing. Studies telling us that it is impossible to effectively time market moves have been around for years. It is impossible to catch highs and lows in particular investments, market sectors, or even the market as a whole. n.o.body can find exact tops or bottoms. But by watching economic indicators and the pulse of business and the marketplace, long-term market performance can be boosted by well-rationalized and timely sector rotation. The key word is "timely." The agile active investor has enough of a finger on the pulse to see the signs and invest accordingly.
While the idea isn"t new, the advent of "low-friction" exchange-traded funds and other index portfolios makes it a lot more practical for the individual investors. What does "low-friction" mean? They trade like a single stockone order, one discounted commission. You don"t have to liquidate or acquire a whole basket full of investments on your own to follow a sector. We should note that it"s been possible to rotate a.s.sets in mutual fund families for years with a single phone call, but most funds in these families are less "pure" plays in their sector, and most families do not cover all sectors.
THE OPPORTUNISTIC PORTFOLIO.
The opportunistic portfolio is the most actively traded portion of an active investor"s total portfolio. The opportunistic portfolio looks for stocks or other investments that seem to be notably under- or overvalued at a particular time. The active investor look for shorter-term opportunities, perhaps a few days, perhaps a month, perhaps even a year, to wring out gains from undervalued situations.
The opportunistic portfolio also may be used to generate short-term income through covered option writing. Options are essentially a cash-based risk transfer mechanism whereby a possible, but low probability, investment outcome is exchanged for a less profitable but more csertain outcome. A fee or "premium" is paid in exchange for transferring the opportunity for more aggressive gain to someone else. You collect this fee. Effectively, you as the owner of a stock can convert a growth investment into an income investment, paying yourself a dividend for the ownership of the stock by selling an option. Is this risky? Actually, it is less risky than owning the stock without an option.
Curiously, the main objective of this short-term portfolio is to generate income, or cash. Most traditional investors look at the long-term, more conservative components of a portfolio to generate income through bonds, dividend-paying stocks, and so forth. In this framework, the short-term opportunistic portfolio actually does the "heavy lifting" in terms of generating cash income. An active investor might look to trade those stocks with varying degrees of frequency or to sell some options to generate cash. These "swing" trades usually run from a few days to a month or so, and may be day trades if things work out particularly well and particularly fast. It should be emphasized again that day trades are not the active investor"s goal nor their typical practice.
ARE RETIREMENT ACCOUNTS ALWAYS PART OF THE FOUNDATION?.
The long-term objectives and nature of retirement accounts suggest normal inclusion as part of the foundation portfolio. In fact, retirement a.s.sets can be deployed as part of either the rotational or opportunistic portfolio. In fact, it might make a lot of sense. Why? Because returns generated are tax free, at least until withdrawn. Tax-free returns can compound much faster. Because of the importance of these a.s.sets, one should only commit a small portion to an actively managed opportunistic portfolio, but it can be a good way to "juice" the growth of this important a.s.set base.
100 Best Stocks and the Segmented Portfolio.
The next natural question is"So how do I use the 100 Best Stocks to construct my portfolio tiers?" The answer is really that selections from the 100 Best list can be used in all tiers, depending on your time horizon and current price relative to value. If you see a stock on the 100 Best list take a nosedive, and feel that nosedive is out of proportion to the real news and near-term prospects of the company, it may be a candidate for the opportunistic portfolio. If the stock makes sense as a long-term holding (as many on our list do), it"s a good candidate for the foundation portfolio. Likewise, if you feel that, say, health care stocks are, as a group, likely to be in favor and are undervalued now, you can pick off the health care stocks on the 100 Best list as a rotational portfolio pick. Similarly, if you feel that large-cap-dividend paying stocks will do well; again, you can use the 100 Best list to feed into this hunch.
Not surprisingly, we feel the 100 Best stocks are of the highest quality, and can be used with relatively less risk that most other stocks to achieve your objectives.
When to Buy? Consider When to Sell.
If it"s hard to figure out when to buy a stock, it"s even harder to figure out when to sell. People "get married" to their investment decisions, feeling somehow that if it isn"t right, maybe time will help, and things will get better. Or they"re just too arrogant to admit that they made a mistake. There are lots of reasons why people hold on to investments for too long a time.
Here"s the fundamental truth: Buying and selling should be much the same process. Let"s look at it from the point of view of selling. When should you sell? Simply, when there"s something else better to buy. Something else better for future returns, something else better for safety, something else better for timeliness or synchronization with overall business trends. That something else can be another stock, a futures contract, or a house. It can also be cashsell that stock when ... when what? When cash is a better investment. Or when you need the money, which is another way of saying that cash is a better investment.
Similarly, if you think of a buy decision as a best-possible deployment of capital, as a buy because there"s no better way to invest your money, you"ll also come out ahead. It really isn"t that hard, especially if you"ve done your homework. And it"s also made easier if you avoid rash over-commitments; that is, you avoid buying all at once in case you"ve made a mistake or in case better prices come later down the road.
Investing for Retirement.
Most of us don"t invest just for the sake of investing. We"re not so much like players at a poker table who not only enjoy winning money but the process of winning. We"re more interested in the result of investing than the process. We may like to invest, like to do research, like to see things come out the way we had in mind. But the main reason we do it is to make money.
And why do we want to make money? Well, for some of us, it"s about buying homes, paying for college, or just having a little extra spending money. But for a great many of us, especially those of us for whom there"s no defined-benefit pension awaiting us when we retire, we invest because we want a more secure, comfortable retirement years down the road.
So how should one invest for retirement? Should one invest any differently than they would for any of the other objectives we just mentioned? Mostly, investing is investing, and the goal is to make money over the intended period of time one invests. Retirement investing isn"t that much different, except there is a greater emphasis on the long term, and for many, a greater need for safety.
The retirement planning process starts with creating a goal, that is, estimating what you will need during retirement to live on. The "what you"ll need" is referred to euphemistically as your "number an amount that willwith carefully planned withdrawalsservice your needs net of government (Social Security) and other pensions until you and your spouse die. There are many ways to calculate this "number," and financial advisers have a bag of tricks and fancy spreadsheets. We like to use a permanent withdrawal rate rule of thumbthat is, you can draw down 4 percent of your a.s.set base each year in retirement. So if you need $2,000 a month (plus Social Security) to live, that"s $24,000 a year; $24,000 a year is 4 percent of (multiply by 25) $960,000 you"ll need in your retirement account on Retirement Day 1. This number, however, a.s.sumes that market returns are steady and there won"t be any severe market corrections during your retirement. The reality is that you can keep withdrawing a constant percentage; it may just be that the base amount, and thus your income, fluctuates. If you must keep your income steady, the 4 percent rule can be jeopardized in down or very volatile markets. You can see how complex the calculation can become.
But that"s not the point of reading 100 Best Stocksthe point is to get some tips on where and how to invest to achieve the number. We offer the following: * Stay diversified. You"ve read about how Enron shareholders had their entire retirement tied up in company stock. If the company fails, you fail twice. It"s probably best to not even invest most of your retirement a.s.sets in the same industry you work in. A good portfolio of stocks or funds (seven or so different stocks, three or so different funds) is probably optimal. But don"t over-diversifyyou can achieve the same returns at a lot less cost by simply buying an index fund.
* Think long term. Obvious, right? Well, today"s market can bring some serious surprises to those who think they can simply buy and hold forever and capitalize on the growth of the American Way. The trick here is to buy individual companies that you think will not only be around when you retire, but will also be better than they are today. Try to visualize your company ten, twenty, or thirty years from now. And be prepared to bail out when things start to not look like you expected. There are a lot of GM shareholders and bondholders who wish they had done just that. The key word is "think."
* Get at least some dividends. Future appreciation is nice for retirement, but I believe that a bird in hand is worthwhile, especially if you can reinvest it in the stocks or funds held in your retirement accounts.
* Dollar cost average. If you keep reinvesting dividends and/or adding funds to your accounts consistently, you"ll buy more shares when prices are low, bringing your average cost down. For most people, it"s best to keep retirement contributionsand investmentsas consistent as possible.
* Use a portfolio strategy. Like the one outlined abovecreate a strong, steady "foundation" and add some opportunistic investments. The opportunistic investments can be used to stretch returns a bit, and they work better in retirement accounts because capital gains taxes are deferred or avoided altogether. That said, you should opportunistically invest only what you can afford to lose. Most of the 100 Best Stocks are suitable for foundation investments, and a few of the "aggressive growth" entries are good for opportunistic investments as well. Make some rules and stick by them.
So good luck, and we"ll come visit you at your beach house.
When and How to Use an Adviser.
To use a professional adviser, or not to use a professional adviser? That is the question almost all individual investors ask themselves at one time or another.
Individual investors are independent, self-starting, self-driven folks largely capable of accepting responsibility for their own decisions and actions. That"s good, and I a.s.sume that if you"re reading this book, you have at least some of that character. However, the world isn"t so simple, and your time isn"t so plentiful, and maybe business and investing stuff just isn"t your cup of tea, anyway. You don"t want to throw everything over the wall to a professional adviser (and pay the fees and lose control and all that) but you may want some help from time to time.
Just remember thisyou, you only, and ultimately you are responsible for your own finances, just like a pilot flying an airplane is ultimately responsible for what happens to that airplane and its pa.s.sengers. You are in charge. You are in charge whether or not you have someone else, like a broker or professional adviser, helping you out. You can (and should) think of advisers as more like a co-pilot, navigator, or air traffic controllerwho will give you information and suggestions and help you interpret the information and remind you of the rules when necessarybut ultimately you"re in charge.
Financial advisers come in many forms, and we won"t go into the details here. What"s important is to realize that no matter how much you outsource, you"re still at the helm. You need to develop a good, two-way relationship with the adviser where he or she can bring value and help you bring value to the investment decisions and investment strategy. An adviser shouldn"t tell you what to do, and shouldn"t just be the "yes man" for everything you want to do. A lively, point-counterpoint discussion of any financial move with an adviser is healthy; two heads are better than one. Remember, if two people think the exact same way, you don"t need one of them.
Don"t be snowed by fancy terminology and concepts. Investing is a complex subject, but if the explanation sounds more complex than the task itself, look out below. Find an adviser who speaks your language, that is, plain English. Smart, experienced people make things simple, not complex, for others.
Also be clear what you want and what you expect from an adviser. If you aren"t, he or she will give you the "standard" product, and it may be the same standard product given to the last client. Say that you want help constructing your portfolio and learning about, say, the tech and health care sectors, which you don"t know enough about. Ask your adviser to help you understand the headlines and what"s important about them for the banking industry. And so forth.
And of course, as Bernard Madoff has made so clear for so manymake sure you understand what your advisors are doing, if they"re managing anything on your behalf. There is nothing worse than thinking everything is okaywhen in fact it"s completely off in the weeds.
Bottom line, an investment adviser should be a great partner, someone you"d hire into your business if you were trying to create a partnership in the investing business. Look for common sense, look for advisers to help you most with the things you"re least comfortable with. Learn what they do (and have done) with other clients; if it sounds too good to be true, it probably is.
Here"s another bottom line: Your adviser should make you sleep better at night. If you"re waking up at 3 A.M. thinking about your investments, that"s bad. If you"re waking up at 3 A.M. thinking about your adviser, that"s worse. In both cases, they"re too risky for you.
Individual Stocks vs. Funds and ETFs.
As long as we"re sharing opinions on things like financial advisers and other help you can get with your investing, it makes sense to take a short detour into the world of managed investments. What are managed investments? Simply, they are individual investments where some intermediary buys and repackages individual investments, and sells you pieces of that package.
Intermediaries can be investment companies with professional managers choosing specific investments and otherwise looking after the portfolio. They can also be indexes, where groups of like stocks are acc.u.mulated into an index according to some sort of generally fixed formula. Either way, by buying into one of these intermediaries, you"re giving up picking individual investments in favor of a packaged and sometimes professionally managed approach.
Of course, like any value proposition, you"re giving up something in the interest of gaining something else. The "something else" you"re trying to gain by using the packaged approach is usually a combination of the following: * TimeYou don"t have the time to research individual stocks or to research individual stocks for 100 percent of your portfolio.
* ExpertiseIn the case of managed funds, you"re getting a trained, experienced, investment professional. Some also prefer to hire others to do the work to take the emotion out of investing decisions.
* DiversificationBy definition, both managed and index funds spread your investments so that you don"t have too much wrapped up in a single company; this is generally good unless they diversify away any chance of outperforming the markets. Funds and ETFs also allow you to play in markets otherwise difficult to play in for lack of knowledge or time; e.g. Asian stocks, European currencies, etc.
* ConvenienceIt takes work to build and manage an investment portfolio. With funds you can move in and out of the markets with a single transaction; the administrative work is taken care of.
Of course, with any value proposition comes a downside, and the downsides of fund and index investing are often underappreciated by prospective clients: * FeesNot surprisingly, funds, and especially managed funds, charge money for the packaging and services they provide. Actively managed funds can take a half to over 2 percent of your a.s.set value each year, whether they do well or not. If you understand compounding, you know that the difference between a 6 percent return and a 4 percent net return over time is huge. Index funds and ETFs are better in this regard, usually charging 0.10 to 0.50 percent, but it still puts a drag on your outcomes.
* Tax efficiencyWhen ordinary mutual funds sell shares, any gains flow through to you (unless you hold them in a tax-free or tax-deferred retirement account). You cannot control when this happens, and many "active" funds may roll their portfolios frequently, producing adverse tax consequences. Also, you need to watch when you enter the fundyou should buy in after capital gains are paid out, not before, or else you"ll be paying for someone else"s gains. Index funds and ETFs are far less likely to produce "unwanted" gains, for they tie their investments to the indexes, which don"t change much.
* ControlWith funds of any sort, you lose control, and as we said at the outset, there are few things more painful than having someone else lose your money for you. Particularly with managed funds, it is almost impossible to know what they are really doing with your money except in hindsight. We would support any initiative requiring funds to give you a more real-time accounting for what they do with your funds.
* Tendency toward mediocrityOne of the biggest criticisms of funds over time is the tendency for managers to follow each other and to follow standard business-school investing and risk-management formulas. The result you tend to get in practice is a herd instinct, known in the trade as an "inst.i.tutional imperative." You can see this in many fundspick almost any fund and the top ten holdings are GE, Microsoft, Exxon Mobilyou get the idea. Worseand this is the biggie from our perspectivewhen you buy a fund and especially an index fund, you"re getting all the companies in the industrythe mediocre players, the weak handsnot just the best ones.
So we suggest using funds where it makes sense to get some exposure to an industry or a segment of the market otherwise difficult to access or outside your expertise. Use funds to round out a portfolio or build a foundation or rotational portfolio, and to save yourself the time and bandwidth to focus more closely on other more "opportunistic" investments.
Part II.
THE 100 BEST STOCKS YOU CAN BUY.
The 100 Best Stocks You Can Buy.
Index of Stocks by Category.
CONSERVATIVE GROWTH.
3M Company.
Ticker symbol: MMM (NYSE) S&P rating: AA Value Line financial strength rating: A++ Current yield: 2.4%.
Company Profile.
The 3M Company, originally known as the Minnesota Mining and Manufacturing Co., is a $24 billion diversified manufacturing technology company with leading positions in industrial, consumer and office, health care, safety, electronics, telecommunications, and other markets. The company has operations in more than sixty countries and serves customers in nearly 200 countries. The company has such a broad reach that it is often looked to as a leading indicator for the general health of the world economy; it has proven its mettle in this regard both in the 200809 downturn and in the recovery commencing in 2010.
3M"s operations are divided into six segments, approximate revenue percentages in parentheses: The Industrial and Transportation segment (31 percent) produces industrial tapes, a wide variety of abrasives, adhesives, specialty materials, filtration products, and products for the separation of fluids and gases. They supply markets such as paper and packaging, food and beverage, electronics, automotive (OEM), and the automotive aftermarket.
The Health Care segment (19 percent) serves markets that include medical clinics and hospitals, pharmaceuticals, dental and orthodontic pract.i.tioners, and health information systems. Products and services include medical and surgical supplies, skin health and infection prevention products, drug delivery systems, dental and orthodontic products, health information systems, and anti-microbial solutions.
The Safety, Security, and Protection Services segment (12 percent) serves a broad range of markets that increase the safety, security, and productivity of workers, facilities, and systems. Major product offerings include personal protection, safety and security products, energy control products, building cleaning and protection products, track and trace solutions, and roofing granules for asphalt shingles.