The conventional wisdom seems to be that the primary vehicles individuals use to save for the long-term are mutual funds. But are mutual funds always the best and only route? Sure, there are some fantastic fund managers out there, but, often, a large mutual fund can become a victim of its own size – sometimes with a team that spends too much time marketing it’s brand and raising more funds than trying to make money for it’s investors. So why not create your own stock portfolio?
Stocks return higher than cash & bonds over time
Research conducted by Raymond James Investment Management shows that from 1926 – 2017 the compound annual return from small cap stocks = 12.1% & large cap stocks = 9.9%, while government bonds & treasury bills have only returned 5.5% & 3.6% respectively over the same time. Therefore, creating a diversified large cap stock portfolio in 1980 with $10 000 USD would would mean that your $10 000 USD would have grown to= $328 786 USD today. The fees charged by fund managers would reduce these returns by 1.5% – 2% on average, per annum. Assuming the same 10 000 USD example in 1980, having the same portfolio held within a mutual fund would mean you would end up with $166 645 today (a $162 141 difference).
But isn’t it too risky to buy stocks directly?
This depends on how you perceive risk. If you think of risk in terms of how a stock moves up and down frequently – sure, they are quite risky. But frequent up and down movements should be ignored in favour of taking the long-term view of owning a stock. The real risk you should worry about is in relation to a company’s business model and the risk that it might go bankrupt. Large corporate bankruptcies are incredibly rare. Enron & Lehman Brothers failed because their business models were flawed & the former was committing accounting fraud. It had nothing to do with their short-term price movements.
How do I know if a company is good?
Good companies will always have a competitive advantage, or “moat” (think of how the moat around a castle protects it from outside invaders). An economic castle is built around 2 factors: 1. Producing a unique product or service 2. Being a cost leader (making your product cheaper than your competitors can). A company exhibiting a combination of the 2 will likely sell more goods than it’s competitors, and be more profitable. The more profitable a company is over time, the more the stock price will increase in future.
Great companies also exhibit substantial bargaining power. A great company will have enough leverage with it’s customer base to charge higher prices than competitors without losing customers, or will have enough leverage to negotiate lower prices with its suppliers. Think of how Apple is able to charge higher prices relative to competitors for iPhones because of the power it has over it’s customers due to the fact they value the brand so much.
How do I spot a bad company?
Spotting an outright fraud is incredibly difficult, and would require pretty decent accounting skills. Spotting a bad company is a lot easier. A basic indicator would be a company who’s management spends more time and money on their hobbies than on their work. A South African company called Steinhoff came under investigation recently for accounting fraud, and it’s stock price collapsed. It was public knowledge that the CEO was passionate about horse racing, to the extent that it consumed considerable time and money on the hobby. It was later revealed that he was having also having an affair. All this leads a human being to become distracted, takes focus away from profits and leads to poor corporate behavior. Warren Buffet is one of the best business managers in the world. All he does is work, and does not have much time or spend money on anything else.
Also, you’re a consumer. If you buy a product that you think is terrible, go and look at the stock price of the company that manufactures it. If it has a higher value compared to it’s competitors with better products, logically you would buy the shares of one of it’s competitors and anticipate that it will eat away at it’s competitors market share.
How do I generate ideas for companies to invest in?
You’re a human being. Human beings consume products and create profits, so go out and see what other human beings are doing. If you’re in an Asian country and you see that most of the McDonald’s restaurants are clean & filled with customers compared to their competitors, who’s restaurants are dirty and empty, then it might be a good idea to buy McDonald’s stock.
Also, try and find industry ideas. For example, if you know that the rate of cyber attacks on corporations are increasing, and will likely continue to increase in the future, then it would lead you to believe that cyber security companies will see demand for their services increase in the future. If you go an look up a few cyber security companies and find that they are relatively cheap compared to traditional software firms, then perhaps it would be a good idea to buy shares in cyber security firms. See what people are doing, how companies and industries compare, and find the gap.
What if the worst happens & one of the companies in my portfolio goes bust?
Again, not many people can spot a pending bankruptcy or a blatant accounting fraud. As a rule of thumb, diversify your portfolio by not owning too many companies operating in the same industry or who do business in the same markets. Also, try not to invest more that 5% of your total portfolio into a single stock. That way you will enjoy the benefits of the success of the business sufficiently, and if the company is somehow exposed for accounting fraud or goes bankrupt, and becomes worthless, you’ll only lose 5% of your portfolio instead of the whole lot.
How can I invest in stocks myself?
There are a multitude of account platforms and services that allow you to buy stocks from anywhere in the world, at a very low cost. Some great services are: TD Ameritrade, Interactive Brokers, Charles Schwab and a multitude of others. You’ll be able to purchase shares on most market centers globally and find all the other tools you need.
For more information on building a personal share portfolio, contact us here http://tpim.co/contact-us/