Editor’s Note: Welcome back to “Pledge Week 2015.” We’re relaying some of the best resolutions for living richer in 2016. Yesterday, Mark showed you how to live rich right now by developing the personal “you”…
And if you can commit to making today’s important pledge, you’ll find yourself much better off… no matter what markets bring in the New Year.
From Mark Ford, founder, Palm Beach Research Group: I’ve spent a lot of time in the investment advisory business. Not on the financial planning or brokerage side, but as a consultant to publishers of investment books and newsletters.
I’ve also created, marketed, directed, and spoken at more than 100 investment seminars and conferences.
All that experience has taught me one important lesson: You can’t make money by looking for 10-to-1 returns.
If you want to get wealthy as an investor, you must have more reasonable expectations.
If you’re insistent on making financial decisions based on future guessing, you’ll find you’ll be right some of the time… and wrong some of the time.
But as Nassim Taleb persuasively argues in the book Antifragile, when most people get it wrong, they get it very wrong… wiping out any gains they may have made while getting it right.
As for finding the next Apple—well, the likelihood of that is slim. The data here are quite dispositive. The vast majority of individual investors (who try to beat the market by buying individual stocks) tend to underperform market averages by 80%.
So if you can’t reasonably expect to get rich reading The Wall Street Journal and subscribing to “Hot Stock of the Month Newsletter,” what can you do?
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You can model your investing behavior on the behaviors that’ve been proven time and time again to actually work.
I’m talking about asset allocation.
Asset allocation is the process by which you spread your wealth. You determine how much money you invest in stocks… versus bonds… versus real estate… versus gold, etc.
The way to wealth is through asset allocation—but not just stocks, bonds, and cash. You need to put your money into a wider group of assets… assets that’ll give you a full range of income and appreciation potential.
And when it comes to identifying what those assets should be, I can only tell you what I’ve done and how that’s worked out for me—so you can decide what’s best for you.
But—at the very least—if you’re at the short end of the stick in terms of asset diversification, here’s what I recommend: Make it a goal in 2016 to introduce some different asset classes and adopt a good risk-management strategy.
As for me, I currently invest in (and will continue investing in) eight asset classes:
It’s tough to put your money in bonds nowadays. The yields are low. Quality bonds are crazy expensive.
I once had about 60% of my net worth in bonds (when I had only three asset classes in my portfolio). Today, I have about 7% of my net investable wealth in bonds.
Why? Because I have so much of my wealth tied up in real estate and small businesses… which have grown considerably over the years. These investments have given me consistently higher returns—probably in the 15-20% range overall. And I stopped buying bonds. So as my bonds saw their maturity dates over the years, my holdings gradually dwindled.
But I do keep about 7% in bonds. That’s because I’d rather keep my “extra” money in super-safe investments. I like to “ladder” my bonds—i.e., buy them so every year of my retirement, I’ll have a certain number that are coming into maturity—and thus deliver a cash payout.
I have bonds laddered to expire from now until 2022, at least. That means I’ll have a bunch of money coming to me tax-free. It should be all I need—and if it is, I’ll be “good” until I’m 72.
But I plan to live till I’m 92. So I’ll have to either buy 20 more years’ worth of bonds, or roll those over in the early years of my next retirement if I don’t need them. So when the time is right again (we don’t yet know when that’ll be), I’ll be buying.
Which Palm Beach Research Group team member is pledging today?
I have trouble predicting the profits of companies I own—businesses I know as well as I know my children. So how can I presume to know the future earnings of someone else’s business?
And even if I could predict the earnings, how could I know how they’d be reflected in the share price?
Stock prices travel all over the place. I don’t know what will happen in 2016 (the only theory I’m certain of.) And I don’t trust my theories enough to bet on them too heavily.
So while I do believe in the stock market, I’m going to invest in it as cautiously as I ever have.
I look for four other traits in a stock story… or a stock picker… or a stock-picking system:
- I like to buy value. Over the long run, stock prices will—by and large—reflect earnings. Therefore, I like advisers—and advisory systems—that keep P/E ratios in mind.
- I prefer companies that have profit schemes I can understand. You can’t know enough about another person’s business to predict its outcome. But if you can at least understand how he plans to sell his product—and if you have some similar experience in your own business life that you can compare his selling scheme to—you have a better chance of avoiding flakes, fakes, and fast faders. (The reason I bought very few Internet stocks is I could never make sense of their marketing plans. For the most part, they violated everything I’d learned about selling.)
- I’m skeptical of good stock stories. Being a marketing man myself, I’m a sucker for a good tale. But I know—from the inside out—a good stock story usually says more about the storyteller than it does about the stock itself.
- I’m prepared to be wrong. No matter how sound my investment seems, I’ll never know enough about the stock—including the market’s reaction to it at any given time—to be sure the price will go where I want it to go.
For that reason, I favor trailing stop losses. In my portfolio, I do have some stocks from very substantial, very solid companies—stocks that are part of the Legacy Portfolio. I intend to hold these forever. But to get a higher-than-average yield from the market, you have to pick stocks that have lower market caps and are more likely to grow.
And since this approach involves more risk, you need to mitigate that risk by setting—and keeping—trailing stop losses (which is exactly what we’re doing with our Junior Legacy Portfolio stock picks in 2016).
To further reduce my risk, I break my ongoing stock investing into several parts.
Together, they comprise about 10% of my net investable wealth.
- Sixty-five percent of the stocks I own are “Legacy”-type stocks—super-big, super-safe, dividend-giving long-term businesses.
- Ten percent of my stocks are invested in “Performance”-type stocks—a selection of stocks that attempt to beat the market.
- Twenty percent of my stocks are invested in stock options—selling puts the way we do in Palm Beach Current Income.
- And 5% of my stock portfolio is in a combination of strategies I consider to be somewhat risky. (Keep in mind: This is a very small percentage of my net investable wealth overall. So the actual number in these speculations is actually just one-half of 1%. And that small percentage is not a single stock, but a portfolio of several dozen stocks. I hope this shows you how one can distrust stocks yet have a strategy to profit from them… through proper asset allocation and a good risk-reduction philosophy.)
Around 2005—when it became impossible for me to find real estate deals I could get for a gross rent multiple (GRM—something similar to a stock’s P/E ratio) of 8 times yearly rents or below—I started accumulating cash.
By 2010—when I went back into the market—the cash portion of my net wealth was nearing 10%.
That left me with lots of cash at a time when real estate prices were dirt-cheap. I haven’t been buying since, and my cash is quickly accumulating again. I intend to leave this be until the real estate market provides better buying opportunities.
Gold (and other precious metals) (3%)
Years ago, I got into gold because of Agora Founder Bill Bonner. He frightened the hell out of me with one of his great essays about the end of America. So I bought a bunch of gold when it was priced at about $400. It’s gone way up and come back down since then. But at 3%, it’s still about 50% more than I need in terms of how I might ever want to spend my gold.
I don’t plan to buy more or sell any. And I’m quite comfortable with these holdings. (It’s also fun to go count every now and again.)
Life insurance and annuities (4%)
Generally, I don’t like any kind of investment based on life insurance—annuities included. But I’ve found two exceptions… both of which PBRG has spent dozens of hours and resources covering and explaining.
One is a SPIA (single premium immediate annuity)… the annuity with the lowest fees.
The second is dividend-paying whole life insurance… set up the “Income for Life” way (from a mutual insurance company with a special little contract rider that minimizes fees up to 70%—and supercharges the cash value of the account).
I get the greatest pleasure from my collections of investment-grade art, first-edition books, rare cognacs, vintage cars, etc. But I can’t pretend they can equal, in terms of purely financial rewards, some of my other investments.
The main drawback of collectibles is they don’t produce income. And I love income.
But the benefits—besides a lifetime of pleasure—are that they’re tangible, portable, and nonreportable.
Real estate (28%)
Real estate was once my first—and worst—single investment. But it’s since become my favorite asset class… even though it ranks second in creating wealth for me.
I put real estate on top of the list for many reasons: It’s real… it’s tangible… it’s (sometimes) lovely to look at… it gives pride of ownership… and it’s the kind of investment you can leverage with safety (if you follow some basic rules). And you can make money from it… without spending much time.
I’ve learned a lot about real estate investing over the past 30 years. My current portfolio reflects that. It’s comprised of income-producing residential units, income-producing commercial units, land banking (agricultural tracts, islands, and vacant lots), and investments (both direct and through limited partnerships) in residential developments, resorts, hotels, and office buildings—both in the U.S. and overseas.
Direct investments in entrepreneurial businesses (40%)
This asset class represents the largest part of my wealth. What you might never guess is—of all the money I’ve invested in all the assets listed above—I’ve put the least into entrepreneurial businesses.
My total investment in this class was probably less than 2% of my current net worth. But it’s grown to where it is today. That’s why I’m such a fan of this category.
In hindsight… and looking forward…
Looking at this past year to date (as I write this), the S&P 500 has barely budged, losing just 0.1% for the year. At its highest point, on May 21, the S&P 500 was up 3.9%. And at its lowest, August 25, it was down 8.9%.
The major stories of the year include the drop in oil prices and the impact of China’s stock market on the rest of the world.
Oil (Brent crude) started the year at $55.38 per barrel. That was already down 52% from its 2014 high of $115.19. The weakness has continued throughout 2015 on oversupply concerns. With prices now around $40, oil’s down another 28% for the year.
The primary impact of lower oil prices has been weakness in energy stocks. For example, XLE, the energy sector ETF, is down 21% for the year… versus 0% for the S&P 500.
This year also saw the biggest drop in the Shanghai Composite Index since 2007-2008. Chinese stocks hit a high in mid-June before starting to sell off. The sell-off culminated on August 24… when the Shanghai Composite index fell over 8% in one day.
Fear gripped the market. The VIX Index—commonly known as the “fear index”—shot up over 200%… a signal the market was really nervous. The FTSE 100 (London Stock Exchange), DAX (German Stock Exchange), and the Dow Jones industrial average all hit new lows.
Another major sell-off was not in the cards, however, as major markets have rebounded since then. In fact, August 25 marked the low for both the Dow Jones industrial average and the S&P 500.
Here’s where U.S. equities stand now: The S&P 500 is down 0.1%… small caps are down 4.6%… and micro caps are off 5.5%. Overseas markets have struggled as well: Developed markets are down 2.6%. And emerging markets have been hurt the worst… down 16.8% for the year.
Switching gears, bonds have performed in a similar fashion to stocks. Generally, when stocks do poorly, you expect bonds to perform well and vice versa. But just as stocks have gone nowhere this year, so have bonds. Barclay’s U.S. Aggregate Bond Index, the most widely used fixed income benchmark, is up just 0.7%.
Right now, the markets are in a state of uncertainty. As for where they’re headed: I don’t have an answer for you. And as you know, I’m not one to speculate.
What I do know is we’ve spent 2015 treading water. And we might continue to do so in 2016. Will we experience volatility? Most certainly. That’s the nature of the markets.
Lock-solid safety and peace of mind
Regardless of what happens, I feel 100% safe with my current diversification setup. That’s the beauty—and the power—of intelligent asset allocation.
When certain assets take a hit, other assets rise to compensate. And the vast majority of them continue to kick off more and more income.
If you’re not following the Palm Beach Research Group principles of asset allocation and risk management, you’d be wise to make changes before the New Year.
As for my own investing portfolio, I’ll continue to update you in Creating Wealth, as well as through a brand-new series we’re introducing in the Wealth Builders Club in 2016.
It’s a very special series on the type of safe, conservative, income-oriented investing I believe in… the kind of investing that will make one quite comfortable in a relatively short amount of time. Stay tuned for more…
Reeves’ Note: Mark believes anyone—with the proper mindset and the right plan—can become a millionaire in seven years or less. He details the exact way to do it in the Wealth Builders Club.