<< Previous   of   Next >>

ADVERTISEMENT

CONTACT SCBJ John Wolcott, Editor jwolcott@scbj.com Dave Clark, Assistant Editor dclark@scbj.com

Good investments may be boring but profitable

By Dale Terwedo
Terwedo Financial Services LLC

Have you ever noticed how some of the most effective ideas seem relatively boring? Let’s take the sports analogy of baseball. I know many who think it is boring and there is little action. Others, however, enjoy the strategy and gamesmanship of the managerial staff and the athletes.

No, it doesn’t have the action of soccer or hockey, but there is more scoring. Imagine for a minute that the only hits that counted were home runs. Imagine that singles, doubles and triples are considered outs. Much of the strategy would be gone as well; no stealing bases, hit-and-run or double plays.

Many treat their investment plans in a similar fashion, finding it more exciting to find that “right” stock that will be a “HOME RUN” than to diversify the portfolio. The difficult part of this strategy is that the losses can be great. You don’t normally hear about other’s failures, just their successes. Therefore, you could have a built-in bias for this strategy.

I have met many people who have been over-concentrated in a particular stock only to find the volatility to be difficult to accept. After all, who would have predicted the financial sector to have had such a tremendous fall during the past 12 months?

According to Yahoo Finance, at the time this column was written on June 4, the last 12 months have seen the following companies have incredible erosion of value: American International Group (AIG) was $35.72 (52-week range $34.53 - $ 72.91); Bank of America (BAC), $32.99 (range $32.90 – $52.96); CitiGroup (C), $21.08 (range $17.99 - $54.49); Countrywide (CFC), $5.35 (range $3.95 – $39.45); and WA Mutual (WM), $8.68 (range $8.60 - $44.37).

These results are during a time that the S&P 500 was at $1,377.20, with a range for the previous 52 weeks of $1,256.98 - $1,576.09. Note: the S&P 500 has a significant portion in the same financials listed above. Being an index you cannot invest directly into it. The individual securities may have been more exciting but the boring strategy of the index may tell the story more effectively.

Compounding is another very effective and powerful concept but requires consistency which can be considered boring. Consider a person at 25 who invests $5,000 each year for 40 years. At 65, the total $195,000 investment would grow to $470,127 at only 4 percent interest, compounded. Averaging 8 percent would total $1.3 million and at 12 percent the return on investments would become $3.8 million.

This demonstrates the power of compounding at various rates, assuming the deposits are made at the beginning of the year and are made consistently at the same annual amount. Also, this does not address any tax benefits of programs such as IRA or other savings plans that could increase investment growth. See your advisor for programs that fit your family needs. This is a concept that we should employ but it is really critical to teach our kids. If the deposits are made at the end of the year you will basically lose a year of compounding.

Volatility is important to consider. An investment that loses 10 percent takes approximately a 12 percent gain to break even, while an investment that loses 25 percent requires a 33 percent gain to break even. If you realize that a 50 percent loss requires a 100 percent gain to break even, then consider: what is more likely in any portfolio going forward, a gain of 12 percent, 33 percent or 100 percent? Keeping negative volatility to a manageable level is very important to the long-term investment opportunities.

As parents, my wife and I struggle with the balance between helping our kids excel, providing them with more opportunity than we had and still having to work for their benefits in life. We try to instill a level of gratitude necessary to be considerate of others and have a desire to give back to the community.

These investment concepts are not new but they are still valid and the need to discuss them occurs regularly. These thoughts are meant to encourage your active participation in your investments, with the help of your advisors. Let’s also help the next generation understand these principles as well.