In merry old English pubs where ale was sold by the pint and quart, bartenders would often encourage rowdy customers to “mind your pints and quarts” – later shortened to “mind your p’s and q’s.” I’ve adopted a revised version of this ancient scolding to encourage members of the younger generations to do the same with their personal finances.
If the bear market of 2007-2009 or the flash crash of 2010 weren’t disturbing enough memories, this blog is meant to be a constant reminder of the unpredictability of the stock market. And it’s because of this unpredictability that I developed, over the years, my personal approach to investing – what I lovingly refer to as my PDQ Principles.
Short for “Patience”, “Diversification”, and “Quality”, these principles are most effective when employed as a package (more on this later).
Let me begin by elaborating a bit on each individual principle. These Tips from Pops posts are all about education, and my main goal here is to help take the mystery out of a subject that many find confusing. So, whenever I introduce a term you might not be familiar with, I’ll highlight that word (or words) in red. This lets you know that a definition will soon follow.
Ok – let’s get started!
Patience in investing simply means to buy something of quality and stick with it through market corrections. Yes, even through bear markets (unless you’re a hundred years old and counting). In short, don’t flush like a covey of quail every time the stock market experiences a dip.
A Correction is a short-term market downturn of 10% or more that usually lasts fewer than 60 days; while a Bear Market is a market downturn of 20% or more lasting more than 60 days.
In the investment world, diversification means buying a variety of stocks and/or bonds versus a single stock or bond. It’s all about reducing risk. The simplest example of this would be investing in an S&P 500 Index Fund comprised of many – well, 500 – different stocks, instead of buying the shares of a single company – like Facebook, AT&T or Microsoft. Speaking just for old Pops, the heart and soul of my investment package is mutual funds.
Mutual Fund: A regulated investment sold to the public. Mutual funds pool money from many investors, and that money is in turn used to purchase a broad array of securities (e.g. stocks, bonds, etc.) from different companies. It’s all about reducing risk through diversification.
Index: A tool used by many investors to compare how well their own investments are doing versus the index. Indexes are also good snapshots into how the economy is doing at a given point in time.
The Standard & Poor’s 500 Index: Often called the S&P 500, this is an American stock market index. It is based on the market capitalization (the number of outstanding shares of a company multiplied by its share price) of 500 large companies that have common stock listed on the New York Stock Exchange or the NASDAQ.
The S&P 500 Index Fund: An extremely low-cost mutual fund that does not attempt to beat the return of the stock market [as measured by Standard & Poor’s 500 Index]. Instead, it mirrors the S&P 500 Index by buying each of the S&P 500’s company stocks, in amounts equal to the weightings within the S&P 500 Index itself.
I love the diversification that mutual funds provide the small investor. I particularly love index funds because they are essentially unmanaged. After all, it doesn’t take much work to mirror an Index. This means low fees, which Pops is a big fan of! Managed funds require much more research during the selection process, and thus, charge higher fees. We’ll talk more about managed funds in the near future.
Choosing an unmanaged index fund over a managed fund essentially means you accept whatever the market yields (returns) in a given year, and not what a group of experts might earn for you through a carefully researched selection process. It should be noted that unmanaged index funds very often outperform those managed funds.
That’s why I “dare to be average” by building my stock investment portfolio around index funds. It ain’t perfect, but it sure as heck beat what I was doing before the mid-80s. And what was that, you ask? Well, that’s when young Pops was foolishly trying to outwit (earn more than) the market by attempting to “guess” its peaks and valleys. Because I’m not psychic, you can imagine how well that turned out. (It wasn’t pretty.)
Yield (Return): for those who stared out the window in math class, “return” is the interest or dividends gained from owning a particular investment, usually expressed as an annual percentage rate (e.g., a 7% yield) based on the investment’s cost (invest $100 and receive $7 per year back). The higher the risk associated with an investment, the greater the return or yield one should expect to receive.
Now let’s talk about the most elusive principle – Quality. Quality is often in the eyes of the beholder. One person might like skunks…while the other prefers cats. Me? I depend on the experts for guidance on this one. Preferably free guidance. I’m a big fan of Vanguard – a giant mutual fund company whose low-fee funds are ranked for quality (or lack thereof) by impartial third parties – like Lipper, Morningstar and Thomson Reuters Company.
In brief, Vanguard is the world’s largest provider of mutual funds. Noted for popularizing index funds and driving down costs in the mutual fund industry, Vanguard is owned by the funds themselves and, as a result, is owned by the investors in the funds.
Another great benefit of Vanguard: they provide a detailed return (yield) history on each of their funds and compare those results to target benchmarks. This shows investors how Vanguard funds are doing compared to other like-kind investments. That means the information is out there for the taking. It’s up to you to ferret it out and make your own judgment as to the Quality of your skunks or kitty cats.
PDQ Principles – A Package Deal
As I mentioned earlier, the PDQ Principles are most effective when employed as a package. Considering just one or two of the principles can result in less than stellar results. For example, a diversified portfolio of low-quality investments can result in loss of portfolio value. And without diversification, even a quality portfolio is vulnerable to asset concentration risks (e.g., an overload of energy stocks gets you in trouble when crude oil and natural gas prices go to hell, or too many Ford Motor Company bonds can find you in the junkyard if Ford has a big recall). Finally, if an investor lacks the patience to stay put during stock market corrections, even a quality, diversified portfolio can suffer when potential long-term winners are sold off too soon. I think you get my drift.
That’s it for now. Join me for the next few posts, where I’ll take a deep dive into each of my PDQ Principles. First up, Patience. Until next time, thanks for joining us here at YM&TT. We’re real glad to have you!