Home Ownership, Inflation and Banker Relations

          Owning your own home can be a very rewarding experience, especially during inflationary times. Usually, home prices adjust to reflect inflation. Back in the 1970's home prices appreciated at the rate of 12% + per year. Some people bought and sold within one year and doubled their money. My belief is that housing should not be viewed as an investment. Everyone needs housing of some sort and owning a home satisfies that requirement. There are costs to owning a home that must be considered : Mortgage interest, taxes, maintenance, lawn mowing, water and sewer, capital improvements like a new roof, and so on. If you are the type of person who cannot do many of these things and does not have the extra income for the expenses, then maybe you should consider renting. President George W Bush decided that every American should own their own home. He established policies that made it easy to get a home loan with little or no money down. Bad idea! Within a few years, people were defaulting on mortgages by the millions. The abandoned homes became a blight in many neighborhoods, bringing down property values for neighbors. If you are a person who wants to own a home, can afford the taxes and repairs, go for it, try not to use your house as your ATM by borrowing any equity from it. It's ok to have equity in your house. You will find that your house offers a reasonable hedge against inflation. Speaking of inflation, I suspect that it will pick-up slightly in the coming years. Stocks also offer some inflation protection if the dividend is increasing and the business is strong. Gold has traditionally been a hedge against inflation also. I like to hold a small amount of gold just as speculation-about 5% of my assets or less. I have always believed that the best strategy against inflation is to control my spending. Inflation only hurts the buyer in a transaction. Finally, about Bankers, if you are considering buying a house, it is important to have a banker in your corner. Establishing a good relationship with your local banker can make the process of financing much easier. What I look for in a financial institution, whether its a Credit Union, S&L, or Bank is that they will service your mortgage. Some banks sell the mortgages and the servicing of it to other companies, which means that you may have to send payments to the new owners, wherever they may be. So stick with a reputable banker and make his bank your PFI (primary financial institution).

Building A Foundation

     Just like building a home, a portfolio must have a solid foundation. This means selecting a few solid stocks that pay a decent dividend and have a sustainable business model. Look for companies that have been in business for 50 years or more and have a record of increasing their dividend for most of that time. Be careful to not choose companies that are cyclical in nature. Choose companies that can sustain sales in good times and bad. Some would call these defensive stocks because consumers will continue to use their products no matter what the economy is doing. People will always take the medicine needed to keep chronic illness at bay, homemakers will always buy soap and cleaning supplies, millions of cars on the road will need gasoline, online merchants will need delivery services like UPS and FedX. Modern life demands these products. I don't see our society suddenly rejecting cell phones and the internet. These things have become what we consider necessities. The foundation of your portfolio should be in large-cap stocks that provide some of these products and services. Their size is a guarantee that they will survive competition from smaller companies. Many large technology companies simply buy out serious challengers. The dividend is important because after several years of holding one of these foundation stocks, your yield could top 10,20 or even 30%. How could that be? Remember, your yield is based on the price you paid for the stock, not the current price. If your stock has appreciated and the dividend has been steadily increased each year, the annual dividend divided by the price you paid for the stock is your yield. Eventually, you will enjoy hefty yields on solid companies that resist downturns. In a bear market, usually all stocks suffer, but defensive stocks should hold up better. This is also an opportunity to buy more of your favorite foundation stocks at fire sale prices. Once you have a solid foundation, then the more speculative issues can be added to round out the total portfolio. My next post will talk about home ownership,inflation and relationships with financial professionals.

Go With The Flow

     To every thing there is a season and a time to every purpose unto heaven. These words were written two thousand years ago but they are still relevant today. Just like farmers follow the seasons for planting and harvesting their crops, stocks follow predictable cycles also. Just like the tides in the ocean, money flows from one asset class to another based on the political, monetary, and fiscal climate. For example, right now we are entering a phase where the Federal Reserve is increasing interest rates. What does this mean to the investor? A lot of things! First understand that when rates go up, bond prices go down. Why is this? Imagine you own a bond that pays a coupon of 3% Suddenly new issue bonds of the same quality are paying 4% Who would want your bond that pays less? How do you get rid of it? The buyer of your bond will pay you less than par for your bond, creating a capital loss for you. The lower price that he paid you boosts his yield to the going rate of 4%. Increasing rates creates a toxic climate for bond investors. That is why the stock market is experiencing large inflows of cash. Even though Donald Trump is taking credit for the market's rise, there is more to the story than he is letting on. Stocks can only go so far on political rhetoric. The tidal wave of money flowing into stocks is a natural occurrence. Valuations are near record highs. Money is desperately looking for a home. One thing that works near the end of long bull markets is stocks of small companies. These small and mid cap names can go long periods without much investor interest but now they are red hot. How long can they outperform? The easy answer is until money stops chasing their performance. My experience is that these trends usually last longer than you would think. Once people invest their money into the small and mid cap mutual funds, they tend to hold for too long. This is not an asset class to buy and forget about. At the first sign of trouble, reduce your exposure. When interest rates near a top, safer investments like cd's start to attract the tidal flow of money. My next post will talk about why every portfolio should have some "core" holdings of  large cap stocks.

More on Strategies

     As I've stated before, my main strategy is "theme" investing. This is where I forecast trends then buy stocks of  companies which should benefit if my thesis is correct. But what if I am wrong about both the trend and my investments? It is always a good idea to hedge your bets with some other strategies. Think of your total portfolio as separate buckets of money where the buckets are different strategies. This will provide you with diversification among industries, company size and style, (growth vrs value). It's important for the strategy to fit the times. At this time, overall stock multiples as expressed by the P/E ratio are near record highs. My thought is that record low interest rates justified these lofty valuations. However, interest rates are on the rise and expected to go higher. This means that at some point lots of money will leave the market in favor of lower risk alternatives such as CD's (certificates of deposit), bank accounts, and money market accounts. I don't know what level of rates will cause this migration but I know it will happen. That's why I like a strategy that avoids the high valuation stocks. There is an old strategy called the "Dogs of the Dow" portfolio. This is where the highest dividend payers in the Dow Industrials index are bought at the first of the year and held until the first of the next year. Usually the high dividend is a result of the stock price declining over the past year or longer. If the dividend had not been cut or reduced, the yield soars. Companies are reluctant to reduce or cut the dividend because that may be the only reason the stock doesn't decline more. Typically, these dogs have low P/E ratios (valuation) because investor demand is low. I like high yields combined with low valuations. I am not recommending this strategy or any of its variants, which are many, to my readers.  I just think it is important to know about it and research it further to see if it is right for one of your "buckets" at this time. In my next post, I will talk further about fat dividend yields and my thoughts about saving for retirement.

Why I Do This

     Before I publish any more posts on how to profit in stocks, I thought it would be appropriate this Valentines  Day to explain why I bother with this blog. First of all I do it for my daughter because she asked me to. Secondly I do it because I enjoy it. It takes less than 1 hour to make a post. If my daughter can learn some of these concepts that I have learned over the last 40 years, then it was a success. I have made this info public so anyone with a desire to learn more about investing can read my short and to-the-point lessons at will. I am not an expert at investing. I have never worked in the industry and now I am too old anyway. It has always amazed me that money management is not taught in junior high and high schools. I have recently heard of some progressive private schools offering this subject but they are the exception. When a young person leaves school and goes to work making money, they are not prepared to invest any savings. Our school systems are doing a great disservice to our young. It is especially important today because the traditional pensions my generation earned are becoming more and more rare. Instead, self funded retirement plans are the norm today. Not only is the employee forced to fund his own retirement, he must invest the funds so they will be there for him at his retirement. In addition, the social security benefits that I enjoy today may not be there for future generations. The contributions made today to social security by the working folks are being used to fund my benefits. Bottom line: The deck is stacked against every generation born after the Baby Boomers. What to do about it? Get wise about investing! Use this blog as a start but not an end. Read about financial matters anywhere you can, your future may depend on it.

The Short Sale

     There is a way to profit from a stock if you know that it is going to fall in price by using a technique called a short sale. The premise is simple, borrow shares and sell them. If you are right and the stock falls, you simply buy back the shares and replace them to the rightful owner. The difference between the sale price and the purchase price is profit. BUT what if you are wrong and the stock goes up instead of down? Your losses are only limited by how high the stock can go. How high can it go? Unlimited! While you suffer from losses while the stock rises, you have to pay the lender any dividends that come due and the brokerage firm where you borrowed the shares gives you what is called a margin call. That means that you have to put-up more assets as collateral in case the sold shares keep appreciating. Can you see why I don't sell short? Its best to let the pros play this game. Instead I will keep with my "buy long" strategy, where I buy shares and hope and pray they go up. My next post will be about some strategies I know about and what I think about them.

Forecasting and Stock Strategies

     Forecasting market movements is a fools game. Nobody knows what the stock market will do in the next 12 months. This doesn't keep every so-called expert from trying though. Instead of predicting what the market averages will do, I just want to try to predict what stocks are likely to do well if the market does continue its steady assent. If the market does poorly, then I just wait until it reverses while cherry-picking bargains amid the rubble. It always pays to have a buy list in case stocks do go on sale. How do I assemble my list? First I read financial publications like Barrons and The Wall Street Journal for ideas. I don't believe everything I read but I appreciate the information. Look at the political environment, the direction of interest rates and changing trends in technology and consumer behavior. Think through the implications of these changes. What industries are likely to benefit from these changes. This is VERY important: write down your thoughts and keep a record of them, you may be exactly correct but forget everything. Next, after determining what industries (sectors) will benefit under your assumptions, search for the best and most undervalued companies in that sector. Watch them for a period of time before buying them. If they are still falling and you buy too early, you have caught a "falling knife" and will suffer. Basic forecasting is not rocket science, for example, interest rates have recently bottomed at the lowest levels in decades. They are bound to go up as long as the economy is improving. Is this a sure thing? No, but it is as close as it gets to one. What benefits from higher rates? Banks and companies that invest large amounts of cash obviously. What drives rates up? Inflation and a hot economy. What benefits from inflation? Gold and fixed assets like real estate. You get the picture, its common sense. I call my assumptions for the future Themes. One of my current Themes is my expectation of increased defense spending. There are about a dozen of large defense contractors who will benefit under this scenario. A google search will reveal them. My concern is to not pay too much for them. You might have guessed that I am very cost conscious when buying. I can be called a Value investor as opposed to a Growth investor. A Growth investor will pay a higher multiple for a stock because his basic premise is that a stock in motion is likely to stay in motion. The Value investor likes "fallen angels" or stocks that have stumbled but are fixable over time. Also by paying attention to valuation (P/E ratios), and buying low P/E stocks, a level of protection is built-in if the market tanks. Think "less distance to fall". There are an unlimited number of strategies to pursue stocks. You are only limited by your imagination. Next I will discuss a strategy that I have never tried and never want to because it is too risky. Just because you don't use it doesn't mean you shouldn't know about it. It is called Selling Short.