The Four Pillars of Investing

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The 4 Pillars of Investing: Don’t End Up as Stock Market Road Kill

by Louis Basenese, Advisory Panelist, Investment U
Associate Investment Director, The Oxford Club
Wednesday, June 25, 2008: Issue # 812

Next time someone casually asks, “What do you do?” I’m going to tell them I’m a high school chemistry teacher… or a volunteer fireman… or maybe a spy. Because every time I say, “I’m in finance. I invest and write about the stock market,” I find myself stuck in another conversation bloviating about where oil’s heading… whether the Fed will raise or cut… if China’s finally undervalued… and if we’re in a recession or not.. Arguing over what Peter Lynch appropriately deemed “background noise” – events that ultimately have no bearing on our long-term investing goals.

But that’s the thing. When the markets act up, everyone (and I’m guilty of it sometimes, too) refuses to pick their chin up and refamiliarize themselves with the 4 pillars of investing. Instead they stare at their feet, at the economic landscape right beneath them. They worry incessantly about it. Worst of all, they want, and try, to figure out precisely what will happen next – so they can trade and profit from it.

You know, I want a Herculean body on a Krispy Kreme diet. But that’s not going to happen. And neither is predicting the very next move of the stock market, oil, interest rates, or foreign currencies. Even our most thought out forecasts, theories and/or hunches are bound to be wrong more than they are right – and our portfolios will suffer from it…

Peter Lynch On Predicting the Economy

In other words, Peter Lynch clearly understood that all the worrying and questioning is a complete waste of 99.99% of our time, saying, “If you spend 13 minutes per year trying to predict the economy, you have wasted 10 minutes.”

So as hard as it may be right now, we need to stop worrying about what’s going to happen tomorrow, next week, even next year. If we’re truly after long-lasting investment success, we only need to answer the big questions – the important ones that we can take action on no matter what’s happening in the markets – like:

How can I get the highest return with the least amount of risk?
How can I protect both profits and principal?
What can I do to guarantee my investment portfolio will be worth more in the future?

At first blush, you might think the answers to such questions are similarly elusive. But they’re not…

The 4 Pillars of Investing

Since we can all benefit from a quick refresher course now and again, let’s get reacquainted with our 4 pillars of investing today…

Pillar 1: Stick to an Asset Allocation Model

Successful investing boils down to combating uncertainty. And the only way to consistently beat uncertainty is to asset allocate. No other investment strategy can boast the same. That’s why it earned a Nobel Prize. And that’s why we made it the foundation of our investment philosophy here at The Oxford Club, Investment U’s premium service. To make it easy to implement, we even created The Oxford Asset Allocation Model.

Following this model and rebalancing annually ensures our portfolios will be well diversified and positioned to profit in any market condition. And yes, investing success can be this straightforward.

Pillar 2: Adhere to a Sell Discipline

Everyone knows you should cut your losses early, and let your profits run. Well, the only way to consistently do both is to use a trailing stop. That’s we why created The Oxford Safety Switch – a customary 25% trailing stop on all of our recommendations. It defines an exit strategy for all our positions right from the start… and makes sure we have the gumption to stick to it.

Pillar 3: Understand Position-Sizing

Knowing how much to invest in each and every situation is crucial to building long-term wealth. Position-sizing ensures that even if a number of our investments turn sour, we’ll never lose our shirts again. As a guideline, we recommend investing no more than 4% of your equity portfolio in any particular stock. If you want to be conservative, invest less. If you want to be aggressive, invest more – but not too much more.

Pillar 4: Always Look to Minimize Investment Expenses and Taxes

There’s nothing we can do to affect a stock’s performance once we own it. But there is a way for us to guarantee our portfolio will be worth more 5, 10, 20 years from now. All we have to do is cut our expenses… and stiff-arm the taxman (legally, of course). On the expense side, that means avoiding investments that carry front-end loads, back-end loads, 12b-1 fees, or surrender fees. On the tax side, it means reducing what the IRS is entitled to take. We can do that by avoiding actively managed funds in non-retirement accounts, owning high-yielding investments in tax- deferred accounts and buying high quality investments (high-quality = less turnover = less capital gains taxes).

Investors – Don’t Let The Market Cloud Your Judgement

As Peter Lynch also observed, “It [the market] does get nasty at times, but it shouldn’t cloud investors’ judgments about thinking long term. The key organ here is your stomach. Everyone has the brainpower, but not everyone has the stomach for it.”

So instead of worrying, it’s time for a gut-check. And if you’re following our 4 Pillars of Investing on how to build wealth, break out the Tums – or spring for the Prilosec OTC if you’re a real stress ball – and endure it. The pillars (and our portfolios) will do more than just endure everything the market throws at us.

Good investing,

Louis Basenese

Louis Basenese, The Oxford Club’s Associate Investment Director and a regular contributor to Investment U, was a former equity specialist at one of the world’s largest investment banks. Louis recently gave us Weak Dollar Rising: 10 More Reasons Not to Bet Against the Greenback.

Today’s Investment U Crib Sheet: A “Prescription” for Healthy Dividends
by Floyd Brown

When most investors approach pharmaceutical stocks, they usually spend time dreaming about new therapies, treatments or an experimental compound that they pray will become the next mega-blockbuster drug.

I prefer to dream about cash flow and compound interest on stock dividends. Making a pill for a nickel and selling it for $4 is a business you can sink your teeth into.

In a troubled economy, investors head to safe havens, where dependable profits provide downside protection. Pharma stocks often filled that role, but not in 2008. Big drug companies have taken a beating and are hitting historical lows.

Recently, Merck (NYSE: MRK) hit a two-year low and Bristol-Myers Squibb (NYSE: BMY) hit lows of $19 – erasing six years of gains. The world’s biggest drug stock, Pfizer (NYSE: PFE), bottomed out at its lowest price in nearly 11 years.
American drug companies aren’t the only ones being slammed. European drug makers GlaxoSmithKline (NYSE: GSK) and Sanofi-Aventis (NYSE: SNY) are also way down this year.

The overall perception on Wall Street is that pharmas carry too much risk. In the next few years, U.S. drug makers will lose patent protection on many current blockbusters, including Pfizer’s Lipitor, Merck’s Singulair and Bristol Myers’ Plavix.

But Wall Street has over-punished these firms. Their cash flow and dividends are underappreciated, and that’s exactly what we like to see…

Undervalued Dividends at Excellent Prices

While shares of drug companies have traded downward, profits have held strong. Price-to-earnings ratios have traveled to generational lows. You could make a bundle at current prices. And if you need another reason, these firms have been raising dividends along the road.

As the market beats up their stocks, it can be profitable for you to hold shares of these dividend-paying firms while waiting for the shares to catch up. The compounding effect will make you richer even if the shares were to stay flat for years, an outcome I consider unlikely.