The Easy Way to Invest

Long term investing is really the best and easiest way to invest. You just keep putting money into the market as you get it, and over time you discover that it has turned into a rather decent amount. You can buy a good no-load mutual fund or try your skill at selecting individual companies to invest in. And then you just wait, counting on the fact that the long term trend of U.S. stock market has been up from the beginning.

The History of Long Term Investing

The New York Stock Exchange was founded on March 8, 1817, so it is close to 200 years old, and shares have been going up ever since. There is a reason for this, which is that shares appreciate when companies are productive and make money, and generally that is what happens. Generally. On average.

Of course, stock prices didn’t go up in a straight line. There was the Panic of 1819, the Panic of 1837, the Panic of 1857, the Panic of 1873, the Panic of 1893 and so on right through the Great Depression and up to the Great Recession of 2008.

The Problems With Long Term Investing

You see, there are two problems with long term investing.

First, it’s long term. That would be all right but, as a rule, people don’t have all that much time to invest. As Keynes famously said, “In the long run we are all dead.”

Second, it isn’t straight up. So even if you have a fairly lengthy horizon – 10 or 30 years, maybe to retirement – you might buy in at the top and wait for many years just to get even.

What an investor needs is some way to know, “This is a pretty good time to get in” and also, “This is a pretty good time to get out.” Doing that is called “market timing,” and Bumblebee Investing is dedicated to coming up with those market times.

Trading the Market Indices

Let’s look at how Bumblebee tries to do that.

The way I use the term, “investing” (as opposed to “trading”) means putting up money or other assets with the idea that it will be used to create a product that can be sold and generate a return to you, the investor, as a reward for putting the money up in the first place. Why you deserve a reward is that you took the chance – risk – that you would lose some or all of the money you invested.

The reward you get is money. The money you get is in the form of dividends and of the increased value of your shares if and when you decide to sell them. Where do dividends come from? From profits. What makes your shares more valuable in the future? The profits that are not distributed as dividends but are reinvested – profitably – by the firm.

Stock analysts try to determine what a company’s shares are worth so as to know whether the price they are currently trading at is a “good buy” or otherwise. Though the analysis can be very complicated, what the analysts are always trying to figure out is simply how profitable is company XYZ now and in the future. If you know what a company is earning now and what it would earn at any time in the future, there is nothing else necessary so far as investing is concerned.

At Bumblebee Investing I am not particularly interested in the present and future profits of individual companies. That is really hard to figure out for any one company, let alone hundreds and thousands of them, and there are people who are much better at it than I am. Fortunately, it is possible to invest without analyzing any one company. Instead, we can invest in all of them at the same time.

The way you do that is by buying shares of a mutual fund that follows the market up an down, or by investing in an index Exchange Traded Fund (ETF) for the S&P 500 Index, the Dow Jones Industrial Average, or the Nasdaq Composite Index, or by trading the corresponding index futures.

Market Timing

And it turns out that investing this way makes market timing much easier.

What happens with a major stock index is that the uncertainties associated with individual tend to cancel out, leaving you with a representation of the direction of the overall market. And while it is quite difficult to correctly evaluate individual companies, the direction of the whole market can be predicted with some accuracy.

This is because individual companies operate inside of the general economy. If the economy is good, companies (as a whole) make profits. If the economy is bad, companies make much less profit or even go out of business. Therefore, the stock indices will follow the economy.

It is often noted that the stock market commonly signals recessions by turning down. This is because the market is sensitive to the state of the economy. But the market, because of the various psychological factors of traders, lags behind the economy a little. It is always waiting for confirmation.

Many years of very short term trading have convinced me that profits are made by not waiting for confirmations. So while the market waits for confirmation in the economy, the Bumblebee Investor gets out near the top and in near the bottom on the basis of early signs. If the call is wrong, well, you just reverse your position with a small loss — sometimes that happens, but it’s just part of the game. The small losses are offset by the much bigger profits when you are right.

As investors, we all want to beat the market, but most people have a hard time doing it, let alone doing it consistently. In this 3-Step guide, we explore some simple techniques that will give your portfolio the edge in 2012. Following these 3 simple rules, we will take control of your portfolio and position it to beat the market.

So what do smart investors do differently than the rest?

Investors who consistently outperform the market are actively engaged in the management of their portfolios. It is not enough to build a portfolio and walk away from it; rather, it requires constant review and fine tuning. The reason lies in the flow of new information.

The Basics

First, let’s understand some basics about the flow of information. The market is a pricing tool, which takes into account all available information every second of every business day. As new information is received, the market digests the information and makes a decision as to how much each company is worth, given the newfound knowledge. As the market goes through cycles, each time reassessing what companies are worth, prices adjust to the appropriate level. This constant fine-tuning by the market allows it to allocate more capital to the companies that will give investors the highest returns, and less to those companies that are expected to underperform. These instantaneous cycles that shift funds between companies, make the market both diversified and efficient, and enables it to get a healthy return.

How can you beat that?

Sure, the market sounds intimidating – and it is – but there is one fact that gives investors a fighting chance. The market holds all invested money, which is more money than could possibly be allocated to just those companies that are doing well. Some of the money will inevitably remain with the companies which will underperform, and because of this, the gains will be offset by losses either partially or completely. If this wasn’t the case, it would be next to impossible to beat the market.

Investors who consistently outperform the market recognize the relationship between the flow of information and price, and constantly review their portfolios to make sure they are allocating capital to the stocks with the highest potential return on investment. Further, they are able to concentrate their investments into the securities that will outperform the market, whereas the market must allocate capital to all companies – the good ones and the bad ones.

To beat the market, investors need to be able to identify those stocks that will provide the best returns. However, any analysis is bound to be wrong for the simple fact that it is an estimate of things to come, and most of us are not in the business of predicting the future. Using this analysis, the investor will make a decision as to whether to invest in a company, and if so, how much. When an analysis is wrong, it may often be the difference between outperforming the market and falling short.

To beat the market, it is not enough for us to analyze companies. Incorporate these three simple rules into your investment strategy to give your portfolio an edge.

The Steps

Keeping a comfortable Margin of Safety is crucial to wise investing.

The First rule is to maintain a Margin of Safety. The concept is simple with an example: If the analysis estimates XYZ stock is worth $10 and you decide to maintain a 10% Margin of Safety, then you should invest in the XYZ stock at a price no higher than 90% (100% – Margin of Safety) of the price determined in the analysis. In the example I gave, this means 90% of $10, or $9. By applying a Margin of Safety to our analysis, we are allowing for error in the analysis. If an analysis has more uncertainty, a higher Margin of Safety should be used.

The Second rule is to Dollar Cost Average. This sounds complicated, but is not. In fact, if you have a 401k or an IRA, you are probably already applying the technique and didn’t know it. Dollar Cost Averaging is a concept based on a simple fact that successfully timing the market is almost impossible to do. One study showed that in order to produce successful returns, an investor would have to time the market right approximately 80% of the time. Dollar Cost Averaging allows us to invest our money at a fair price by contributing a fixed amount of money over time instead of trying to time the market. Learn more about Dollar Cost Averaging here.

The Third and final rule is to keep those commission costs low. The more times you make trades, the more fees you have to pay. For example, to invest $100, you may be required to pay a $7 commission on the trade. This fee is what a company will charge you to cover their costs and to execute the trade. For an investor to recover this cost, the stock would have to gain over 7%, and that’s just to break even. To breakeven and beat the market, this position might have to earn 15% or more! So, how can we lower our commissions? It’s simple, invest larger amounts, and invest less frequently. If you are scratching your head right now, don’t worry.  If you think that this rule is somewhat contradicting to our Dollar Cost Averaging rule above, you are correct. What we can take away from this observation is that it is important to strike a balance between the two rules where you are comfortable.

Investors who consistently outperform the market are not doing anything secret, they are simply investing their money in smart ways – they are “Intelligent Investors.” By applying these three simple rules to your investment strategy, you should be able to give your portfolio an edge.

Earlier this week I was speaking to one of the guys at work about true DRIPs and how they can be a great way to build a position in a company, especially when you are just starting out and when your portfolio is on the smaller side. I wrote about DRIPs and SPPs in an earlier post, but my co-worker had some additional questions about synthetic DRIPs and when (or if) to use any DRIPs at all.

True DRIPs (also called real, classic or authentic DRIPs) are dividend reinvestment plans provided by a company to current shareholders as a way to directly buy additional shares. These DRIPs are handled through a transfer agent such as Computershare or Canada Stock Transfer, with no need to deal with a brokerage. Rather than pay out the dividends in cash in the form of a cheque sent to your house or deposited into your bank account, the company provides additional shares (which includes whole and fractions of shares) which they add directly to your account. For example, if your quarterly dividend is $100 and the current share price is $40, you would receive 2.5 shares. On the next dividend payout even the fractions of shares generate more dividends, thus compounding the growth. Many companies offer a discount off the current market price when purchases are made through a true DRIP, which helps your position grow even faster.

Synthetic DRIPs work much the same way, with a few notable exceptions: they are sponsored by the individual brokerage you deal with and they can only provide whole shares. In this case any cash remaining from a dividend after purchasing whole shares will be returned to your account to do with as you please. Using the same example from above, if your quarterly dividend was $100 and the current share price was $40, you would receive 2 shares (totaling $80) and the remaining $20 would be placed in your account. Though your total number of shares will grow a little slower with a synthetic DRIP, it does have some advantages that true DRIPs do not. Because synthetic DRIPs are held with a brokerage, you can drip them inside a TFSA or RRSP, sheltered (or at least deferred) from taxes. Be sure to ask your brokerage whether they honour any DRIP discounts as well, as some will give you the same discount off the market price for your synthetic DRIP as offered through the true DRIP.

There can be some fees associated with DRIPs, and you need to be aware of these before you start. In Canada almost every true DRIP is free once you’re set up. However, to enroll most companies require at least 1 share to be registered in your name, and the cost for this tends to range from $30-$50. On the flip side, most discount brokerages in Canada will do a synthetic DRIP for free. You simply need to phone in as ask them to DRIP your shares of Whatever Corp and they take care of the rest. The list of companies that brokerages offer DRIPs for can vary widely however, so you may wish to take this into consideration when choosing where to hold your accounts.

If you wish to true DRIP a US company it adds a whole new challenge. According to the US Securities and Exchange Commission any foreigner purchasing stocks must do so through a US bank or a foreign bank that has a branch located in the US. Don’t confuse this with a Canadian account that trades in US dollars. The account needs to actually be either physically in the US (opened at a US branch even if you do your banking online up here in Canada), or more conveniently for many of us, through an online US bank. Synthetic DRIPs for US companies can be handled in Canadian based accounts, but currency conversion fees will eat into your dividends, and this will happen on each DRIP transaction. If this seems too complicated you may decide simply to invest the dividends somewhere else.

The question of whether or not to bother with DRIPs is up to the individual investor, both in how much effort you want to put in, as well as how strongly you feel about your holdings. I’m a big fan of DRIPs (gotta love the set-it and forget-it style of investing!), but they may not be right for everyone.

There is a fair amount of work involved in true DRIPs, especially in setting them up. Application and anti-money laundering paperwork needs to be filled out and submitted for each company you plan to DRIP. True DRIPs are held in taxable accounts as well. Though they are taxed favorably in Canada (usually much lower than your marginal tax rate), if you have the room in a TFSA or RRSP you could shelter them there. This is exactly what I do – build my position as quickly as possible through true drips, then transfer them into my TFSA in order to shelter all future growth, and start a synthetic DRIP from there.

As I mentioned above, using a synthetic drip is much less hassle. Simply call up your brokerage and tell them you would like to drip every stock in your account. Assuming a synthetic drip is possible through your brokerage, and that the dividend amount is at least enough to buy 1 whole share, they will start the drip and you can sit back an watch the new shares roll in each quarter. There is really very little involved with synthetic DRIPs.

I was trying to come up with a reason why an investor would not want to DRIP their shares of a specific company, and I could only really see one: If you would like to do something else with the dividends, such as invest in a different company or product. The dividends are, of course yours to do with as you please and you could choose to use that money to invest in whatever else you like. You can even withdraw the cash to spend instead of investing (keeping in mind any penalties and tax considerations depending on the account you hold them in.) This is exactly what we Drippers will do when we retire – use the dividends as income.

My plan basically involves buying strong, solid companies that I’ll hold and build my position with for many years, hopefully into retirement. That means I’d rather use each dividend as efficiently as possible to buy more shares of the same company. Assuming I’ve chosen the right companies and they still fit within my investment plans, I’m going to want as many shares as possible and dripping (either true or synthetic) helps the whole process move along faster. For me dripping is a no-brainer, and quite a bit of fun to watch as my number of shares increases each quarter.

What about you? Do you DRIP every stock, pick and choose, or just let the cash roll in?

Happy Dripping!

If you’ve already read tons of stock market reading materials, I’m sure you’ve already come across of the recommendation to diversify your portfolio. Invested in 10 to 20 great companies so that you’ll have a margin of safety. What do they mean by that?

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If you’re invested in 20 companies, and one of them would screw up, you still have 19 left. That way, you protect your capital. It’s even written in the bible that you should diversify, because you can never tell what can happen. Great strategy, aye?

But why am I discouraging you from diversifying?

Warren Buffett once said, “Wide diversification is only required if investors do not understand what they are doing.”

I’m sure for most of you who read this for the first time would feel a bomb explode in your heart. That’s okay. We all had our days. As for me, I was never guilty of diversifying, BUT…But was guilty of being ignorant. As I’ve said, we ALL had our days.

In this post, I’ll share with you why I never diversified, and never looked back.

1K, 10K, 100K or 1M doesn’t make a difference.

I’d like you to think of the day when you were investing for the very first time. Maybe some of you have an initial capital of 25K, while most have 5K. With that in mind, I’d like to ask you two questions, specially to those who are doing EIP:

How many companies did you buy when you started out?
How and why did you come up with that choice?

If I have to answer those questions: I invested in three companies, and I know they are the best of the best, that’s why I invested in them.

Most people do this:

They only have 5K so they invest only in the best companies out there. Let’s say, those were SMPH and MBT. Suddenly, when they already had 100K, their portfolio multiplied quicker than a gremlin on a rainy day.

This is my belief: SMPH and MBT are great companies when you had your 5K, and still remains great when you had your 100K. And would probably still be great when you will have your 1 million. When I earned 133% in one year, ALI was the only company in my portfolio.

Choose one: Invest your 500K in 10 crappy companies or in 2 of 3 blue chips? Warren Buffett, again once said, “You only have to make a few good choices in order to get rich.”

Save yourself from all the headache.

This varies from one person to another. In my whole investment career, I’ve only had at most 5 companies at a time in my portfolio. Why? Because if I go higher, I won’t be able to monitor them properly.

When I say monitor, I’m not referring to just looking at its current price, target price, trend, etc. That’s only half-baked monitoring, and won’t do for me. I read news, target profit, future projects, reported earnings, current challenges, etc (COL Financial provides these items everyday).

For those of you who can pull this off with 10+ companies in your portfolio, then I salute you! Maybe for some of you, this is the reason why you resorted in subscribing in the truly rich club. So that someone will just prompt you to either buy, sell or hold. Maybe. Just maybe.

Minimize, if not totally remove your risk.

You may not believe it, but yes, you can minimize your risk by not diversifying.
Imagine these companies in your portfolio:

JFC: Chinese business facing challenges.
CEB: Downgrading on negative airline industry outlook.
AP: More challenges seen in 2013.
EDC: More challenges ahead.
FGEN: Hydro plant to disappoint this year.
SMDC: Bloom to replace SMDC in PSEi
SCC: landslide could potentially disrupt mining operations.

While these companies face these challenges, they remain good companies with great long-term fundamentals. But can your fear handle it? When these news broke out, share prices dropped faster than you can say I’m going to sell!

Had you chosen your companies very carefully, you could have spared yourself with all the heart attacks.

Quality versus quantity.

This has been a never-ending debate, thus this topic does not need any more explanation. It’s a personal choice that I go for quality companies over quantity.

Why invest in SMDC if there’s SMPH or ALI?
Why invest in EW, SECB, PBB if there’s BPI, BDO and MBT?

In every sector, there’s always the bigger shark that just eats the rest for snack.

You never go wrong with quality. Besides, most beginners that I know go only for quantity because a stock is matunog. Can’t blame them, it’s easy to go with the crowd than against it. On second thought, it’s not that hard, isn’t it?

Lesson from my mother.

If I were to name my greatest mentor, it would be my mother. I learned not to diversify from her. Did you know that she only invested in one company? That would be her employer. Talk about confidence.

You see, my mom works in the finance department of a giant that have been in the business for more than 100 years. Being part of the finance dept, she had access to budgets, earnings, target profit and future projects. She knew what her employer can pull off. That gave her confidence.

She was able to do many things (which I will not mention in this post), and was able to help other people outside our circle because of that one investment.

Conclusion.

Clearly, a non-diversified portfolio can also give you great benefits. And in my book, it has better benefits than a diversified portfolio. Since one has both advantages and disadvantages over the other, neither is superior. It still depends on your own strategy, goals and emotions.

What did I miss?

For those of you who don’t have a diversified portfolio like me, I’d like to know how you’re doing. Were there times that you’re influenced by the mob and jumped to another stock? How many companies do you have today?

If you have a diversified portfolio, are you doing it for the sake of “safety”. Is it worth it?
Do you have companies in your portfolio that you wish to dispose? What’s preventing you from doing it?

Did I fail to mention other benefits that a non-diversified portfolio might have?