I've been studying hidden wealth lately in my personal files. Last night, another "secret millionaire" came across my radar - a man named Jack MacDonald who built a $188 million fortune by investing in stocks as a hobby - and it got me thinking about simple long-term compounding really is if you have the basic structure right, start young enough, and don't take foolish risks.
The catch is, unless you can tell when a stock is overvalued, it's probably a smarter idea to invest in an index fund. In fact, you don't even have to own stocks to get rich, although they are the best performing long-term asset class and you're putting yourself at an unnecessary handicap if you opt to exclude them from your potential list of holdings. There are plenty of people in the world who have made a lot of money by investing in real estate or some other comparable activity; if that's your bailiwick, more power to you (personally, I'm not one who enjoys using debt, making the return on equity calculation more difficult, though I'm more than willing to examine real estate projects when investing my own money).
If you are reading this and you still haven't started the process of making your money work for you, begin today. Find an investment that makes sense to you, that is low risk, and that throws of cash in the form of dividends, interest, or rents. The momentum from doing something, from starting, is often enough to get you excited. It's addicting to see fresh money come in like clockwork, showing up even if you were vacationing with family, playing around with a hobby, or going about your life.
For those of you dedicated to a buy and hold investment strategy for your portfolio, minimizing cost and taking advantage of deferred taxes, it's important to know that certain types of companies and stocks are better suited to your needs than others. As a general rule, this can make a big different to the amount of money you ultimately end up amassing, so take a few moments to study the list ...
The S&P 500 Dividend Aristocrats Index Can Be a Great Source of Portfolio Ideas for Conservative Investors
If you are looking for a list of high quality dividend stocks to consider adding to your portfolio, one neat trick is to pull the S&P 500 Dividend Aristocrat Index component list and examine it for ideas. To be included in this stock market index, each company must have increased its dividend for a minimum of the last 25 years in a row. It takes a special kind of business, and a shareholder friendly culture, for a corporation to increase the amount of money it sends out to shareholders year after year for a quarter-of-a-century!
Another bonus is that the index funds based on this strategy completely disregard the market capitalization of the businesses, instead equally weighting each component. Personally, I'm a bigger fan of that approach for various reasons but not everyone agrees.
S&P makes this data easily available on its Dividend Aristocrat website, where you can download a spreadsheet of the stocks that make up the index. It's a great place to start if you're shopping for blue chip stocks.
In a lot of meaningful ways, a water or electric utility share of common stock is economically similar in behavior to a bond. Though it is lower down the capitalization chain, and would certainly do worse if the business ever found itself in bankruptcy court, a utility generates surplus cash at a guaranteed rate of profit set by the regulators overseeing the particular area and industry, then pays out most of that cash in the form of dividends. Large projects are often financed with new stock or bond issuance, rather than from retained earnings.
In this sense, the dividend yield of a utility is of the utmost importance. We are in a world of artificially low Treasury bond yields, with the 30-year Treasury bond offering 3.82%. If you were looking at a utility stock that offered a 3% dividend yield, and had a very low, stable growth rate, you're going to be in for a shock when interest rates rise. Were the Treasury bond yield to return to a normal 5% to 6% per annum, the dividend yield of the stock would likely adjust to the same level, meaning a drop in stock price of between 30% and 50%. This is only rational. If you could get the "safest" bond in the world, backed by the taxing power of the nation with the greatest aggregate net assets, and earn $6 for every $100 you invested, why would you buy a lowly utility common stock issue that offered you $3 for that same $100? The opportunity cost shift caused by a rise in Treasury bond yields means utility stocks must fall. (Or, alternatively, experience a rapid and miraculous rise in profitability.)
It comes down to utility stocks, as a class, having a low dividend-adjusted PEG ratio under most circumstances. The earnings "coupon", if you think of it in bond terms, doesn't grow fast enough to undo a lot of the damage higher rates or inflation can create over a shorter period of time; say five years or so.
I've had people write me, upset that their company's profits have grown 300% to 400% over 12 to 15 years, yet the stock price has fallen. When I look at their information, they paid 50x, 70x, 100x earnings for their stake back in the dot-com boom! To teach them the fallacy here, I often explain to them that buying a stock is not much different from buying an ice cream stand in your hometown in a certain sense. I tell the following story, and ask them the subsequent questions.
Imagine I wanted to sell you an ice cream stand in your hometown. It generates $100,000 a year in profits.
What is a fair price?
Would you pay me $7,000,000 for it?
Why would you do the same thing for a small piece of ownership? That's all a share of common stock is. If the ice cream business were split into 100,000 pieces, or "shares", and you owned 10,000 of them, you'd own 10,000/100,000th, or 10% of the business. Why would you be any more, or less, logical about the price you paid for a single one of those pieces than you would the entire enterprise?
Even if everything went right, and 10 years later, the ice cream stand now makes $400,000 per year, are you going to be surprised when the world has come to its senses and you can only sell it for $4,000,000? Yes, profits are 4x higher, but the valuation multiple is much more reasonable. You can't fool people indefinitely; they eventually come to their senses.
It is totally understandable that you can lose almost half your investment, despite watching you earnings quadruple, if your initial purchase price was too high relative to subsequent profits. The cost basis must be a fair one.
More than a decade ago, I explained this in an article called Price is Paramount. Nothing has changed. This is one of the most fundamental ideas of investing. It's relevant in stocks, bonds, real estate, private businesses, oil rights, copyright royalties, or even arable farmland.
I've taught you what the Dow Jones Industrial Average is, and which 30 companies make up the index, in the past. One really useful tool you might want to keep in your back pocket comes from investment research firm ValueLine. They provide free, detailed stock reports on the thirty companies in the DJIA that show you tremendous amounts of detailed, well-organized historical data, including earnings, dividends, debt, shares outstanding, returns on capital, and more.
At the moment, all thirty of these regularly updated reports are made available on this page. The reports look like this:
One would think that with the potential losses caused by penny stocks being so evident, investors would run from them. But they don't. Time and time again they put their hard earned money into tiny corporations with very thinly traded market capitalizations, little to no business operations, and skeletal management teams hoping for the capital market equivalents of a lottery ticket. Why do they do this? There are four psychological forces at play that tempt otherwise intelligent people to behave so foolishly ...
It seems that so many new investors are enamored with penny stocks and finding penny stocks to buy that no matter how many times I address them, there is constantly a new influx of questions about how to find them or whether they are dangerous. Before you go down that road, here are three important considerations you should at least address prior to adding a penny stock to your portfolio ...
Want to lose money? Be unable to sell your position quickly if the need arises? Collect no dividends? Then investing in penny stocks might be for you. In almost all cases, buying these shares is a very foolish thing to do if you want to grow your net worth. Here are some of the reasons penny stocks should be on your "avoid" list if you are trying to be a conservative investor ...
One of the basic skills every new investor should make a point to learn is how to calculate the rate of return on their stocks, bonds, mutual funds, real estate, and other assets. It's so simple that practically every junior high student in the country could do it. Do yourself a favor and read the article, grab a calculator, and run a few practice formulas yourself.