Should you invest in stocks?

Theintelligentinvestor.jpgThis past weekend I went to an investor fair sponsored by the Chicago North and West Chapters of BetterInvesting. These are the people who used to be known as the National Association of Investment Clubs. I write a quarterly column—Fund in Focus­­—for the magazine, and the occasional cover story. But like so many relationships these days, mine is virtual so it was nice to meet some of my fellow authors (and they are nearly all fellows, which is a bit disappointing).

They tend to be an engaged and savvy group. Maybe this is the product of self selection, because if you’re disinclined to put in the work a stock study requires, or regularly lose money, you probably wouldn’t stay with a stock investment group. But the people I met had a pretty good understanding of risk, had seen some investments lose a lot (and gain a lot), and generally asked thoughtful questions. No one seriously supported day trading, told me about the latest greatest penny stock, or was wearing a tin foil hat. I was heartened to see more than a few young people.

Buying individual stocks is not something I recommend to my clients. I strongly believe that the essence of investment planning is establishing and maintaining a core portfolio allocated among a wide variety of asset classes (e.g., large cap, international, natural resources, etc.). Depending on how much money you have to invest, how risk tolerant you are, and what options are offered in your accounts (and 401ks may be quite limited), you might choose a whole clutch of funds, or one target fund, or something in between. This is where most of your, and my, investments should be because most of us don’t have time to monitor investments day to day (and probably shouldn’t) and because it offers you a prudent combination of risk and reward. You’re never going to make 300% in a year or two on mutual funds, but you’re not going to lose every red cent, either. You can do both, or either, investing in individual shares of stock.

What I love about BetterInvesting and all the information, analysis tools, and opportunity to benefit by others’ thoughtful opinions is that there’s some basis for making judgments. Most people pick stocks because their brother-in-law told them about it, their kid likes the product, or their husband sat next to an executive of the company on a plane (which is why you cannot mention the name Ciena to me).  Or they’re told “buy what you know” or (shame on you Peter Lynch) go sit in a mall and watch what stores get the traffic. Which is a good way to end up with a whole portfolio of consumer cyclical stocks. And no, that’s not balanced or…wait, I’m foaming at the mouth.

I have seen the occasional client who thoughtfully bought and sold individual equities, and done quite well. But like the owners of apartment buildings, they’re often tired of the stress and want to reduce at least some holdings. Many people have inherited stocks, or fallen in love with a company, or are hoping to get back even on a loser, or reluctant to sell a winner because it might go higher. So BetterInvesting methods really shine not only in stock picking, but if you actually learn the methodology, in identifying when you should sell.

Which investor should you be? Probably, you should be what Benjamin Graham (Warren Buffett’s mentor) described as the defensive investor—seeking to maintain and grow a portfolio at a prudent rate, getting return while balancing risk. After all, most of us have enough trouble wading through and understanding the offerings in our 401k, although now at last the reasonably diversified target date funds are becoming the default.

But Graham also describes another kind of investor—the enterprising investor (which Warren Buffett surely is). As Graham so concisely puts it, The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear on his [sic] task. If you’re willing to put the time into study and monitoring, and have the intestinal fortitude to ride out terrible markets and make courageous choices, you might actually be that 2 or 3 in 100 who should consider some enterprising investing.

I like to divide portfolios (including mine) into “core” (asset allocated mutual funds) and “casino”—or maybe there’s a nicer name like adventure or enterprise. Keep that casino portion small (maybe 10%) of your total holdings, and ask yourself these questions:

  1. Could I stand it if I lost 50% of my investment’s worth? 100%?
  2. Would I sell everything in a bad market, hold on, or buy more? (Buy more is what an enterprising investor would do. A defensive investor would hold on.)
  3. Have I read a good core of basic books on investing? (Malkiel, Graham, Bernstein)
  4. Do I have rules for myself on what constitutes an acceptable stock to purchase, hold, and when to sell?
  5. Do I have time to continue to study, research, and monitor the portfolio?
  6. Can I trust myself to follow up regularly over years?
  7. Do I understand what conditions might make my investment go up or down? Buffett famously said he did not understand tech companies and so avoided the bubble in that sector by not buying them in the first place.
  8. Do I have a way to discuss ideas with other thoughtful investors (and I don’t mean a bunch of internet trolls or Jim Cramer)? Besides BetterInvesting and investment clubs, it might be worth checking out the American Association of Individual Investors (no personal experience) and groups such as the Bogleheads.
  9. Do I need this money in the next 5 years?
  10. Am I desperate for money? STOP, that was a trick! If you are, stock speculation is a sure way to make yourself even more desperate.

I don’t advise my clients on individual stocks, except to recommend they diversify into mutual funds if their individual stocks constitute too much of their total investments. I think it’s an art and a very personal interpretation, and ultimately you know the success of your judgment by your own results. Even in an investment club with people looking at the same data study, the opinions on worth will vary greatly. BetterInvesting has said for years that for any five stocks you pick after careful study and evaluation, three will do about what you expect, one will do far better, and one will tank. That’s been about right in my experience, but it can be a pretty nerve wracking ride. You always remember the ones that tanked, but you only talk about the ones that did well.

Only fall in love with things that love you back.

The Right Design for Your Financial Plans

Cover of "The Spirit Catches You and You ...

Cover via Amazon

One of the real delights of having a kid in college is the terrific books they bring home. Much as I lament the lack of survey courses, and the fact that students can get out of college almost completely ignorant of the Western Canon (don’t stone me), some profs manage to force them to read haunting, thoughtful pieces that will follow them through life.

Recently, dearest daughter brought home The Spirit Catches You and You Fall Down. a study of the terrible collision between Western medicine and a Hmong refugee family over the treatment of their severely epileptic child. Anne Fadiman, the author, knows a thing or two about writing—she won a National Book Critics Circle Award  for the book, and she probably imbibed literature with her pablum, her father being Clifton Fadiman, the famous editor and author of the Lifetime Reading Plan. (Footnote: we used his wonderful book as a guide while homeschooling, so DD did get some smidgen of aforesaid Canon).

Spirit is so thought provoking and spellbinding that not only did it keep me up nights but two weeks after finishing it I’m still thinking about it every day. I’m not giving away anything to say that it’s all a horrific train wreck. If you’ve ever had experience with serious illness, you will find yourself identifying mightily with the Hmong family, and if you’ve ever dealt with annoying clients or even a recalcitrant child, you’ll feel for the doctors, too.

One of the most interesting questions the book raises is oh-so-relevant for financial planning—is perfect compliance with a plan necessary? or is there some lesser change that would work nearly as well? Is the correct answer always the one justified by numbers (and science) or are our beliefs and feelings (aka behavioral finance) just as compelling and important? Is there any middle way?

No, yes, no, yes, yes. We financial planners like the certainty and precision of numbers, so much so that we even believe them ourselves. If our projections say your money will last your lifetime, and you can spend exactly $84,237 per year (pick a number), we breathe a sigh of relief, print out the report, have a reassuring client meeting, and off you go. But change the assumptions, the conditions, or the faith of the people involved, and maybe the medicine doesn’t work quite so precisely. It’s critically important to recognize that the best prescription is dependent on certain conditions, but must be tweaked for individual circumstances, personality, and life situation.

Of course, the best plan won’t work if you don’t carry it out. But as Lia’s doctors found out, the plan won’t work if your beliefs, abilities, and commitment disrupt it. I see this so often when people come to me with some robo-advice that proves they can never retire or afford college for their children. Faced with the model that says they must save umpteen thousand dollars, they get terrified and give up (and don’t take the medicine). But even less than perfect action can be life-saving. If you have only managed to save $20,000, or $10,000, or $5,000 (instead of $250,000) for college, more power to you! Believe me, you won’t be sorry to have it.

Other perennial questions—should I pay off the house or invest the money? Should I take the lump sum or the pension?—depend as much on what will bring you peace of mind as on what the numbers might indicate. These are questions that must be sorted through with an advisor who tries to get to know you, not just someone who will crunch numbers.

If you leave an advisor’s office (including mine) with a plan for investments and it turns out to require changes that you put off, and put off, and put off…then maybe the plan, while excellent, is simply not the right design for you. Moving in the right direction is better than doing nothing at all, and revisions should be made until you feel confident that you can proceed.

One of the horrible truths the book demonstrates is that not speaking the language can result in devastating  and costly consequences. In financial planning, too, advisors and the industry can speak a foreign and fatally confusing language. Witness the firestorm over fiduciary, which is a difficult word meaning only that the advisor must act in the client’s best interest. Why on earth would this be controversial, and why would the brokerage industry be conducting a bombing campaign to scare the individual investor into believing that this is somehow an evil requirement cooked up by the Obama administration? Because their bull (er, ox) might be gored and they might not be able to make usurious profits on the backs of people whose lack of industry comprehension they exploit. Or the confusion over fee-based (brokerage jargon that means we’ll collect a commission and charge you) vs. fee-only (which means we’ll charge you by the hour or based on assets managed). Fee-based is a subterfuge to confuse you and make you think you’re getting a better, and honest, deal. The brokerage industry is counting on the fact that most people won’t understand the difference, and that they’ll look like they’re wearing the white hats, too. They’re not.

If you don’t understand what an advisor is saying, how that advisor is being paid, why they are recommending what they are, and how they arrived at those conclusions, don’t stop until you do. Even the best doctors make mistakes, and learn from them, but patient, and client, input can have better outcomes if the plan fits well. And sometimes the questioning can produce a thoughtful change in tactics, one which might save the future.

How to choose a financial adviser

Simple, but not easy. Anyone and their brother can call themselves a financial adviser, advisor, planner, investment specialist, wealth manager, etc. And let me tell you that you would be shocked by the brouhaha in financial trade journals over whether or not advisors should have to be compelled (!!) to adhere to a fiduciary standard. A fiduciary standard simply means that the advisor is legally obligated to put YOUR best interests first, rather than, say, the product that pays him the best commission, wins him the free vacation contest, or allows him to meet his sales quota and keep his job.  People who are not fiduciaries are SALESPEOPLE and, uh, maybe what they’re peddling to you is somewhere in the realm of possibly being remotely suitable for you. If you hear any of the following terms, hold onto your shirt and wallet and run: non-traded REITs, master limited partnerships, most annuities, whole life, hedge funds—wait, the list is getting a little long.


But don’t take my word for it. Gregory Karp, who writes a column called Spending Smart for the Chicago Tribune, recently had an excellent article about how to choose an advisor. You can read it for yourself.  I couldn’t have said it better myself, and I welcome anyone who wants to quiz me on any or all of his criteria. I particularly like that he highlighted the difference between fee-based (you’re talking to a broker/salesperson who is getting a fee AND commissions), and fee-only (you’re paying solely for advice, which should be free of owing any commissions or referral fees to anyone).


My only complaint about the article is that the Trib tends to bury consumer financial articles in the business section, where the people that need to see it often don’t. If only we could get this information into the features section, next to the gardening, decorating, recipes, and parenting advice.