OK, newbies, beginners, and curious onlookers. We are now ready to build a portfolio for the ages (or at least the long term). The idea is to grow a portfolio from scratch with the least amount of risk and the most reward over those of you fortunate enough to have a long term horizon.
Keep in mind there is no free lunch, and there is risk with any and all investments, so check your risk appetite before doing anything. Once you've decided that you can live with some risk to gain some reward, then decide what road you want to travel on.
In this chapter of our series, we will look at the roads to choose from.
The Roads That Investors Can Choose
- The high risk / high reward road
This road is perhaps the most exciting, especially for the very young investors. Since everything is young to me, I will just settle on folks in their early 20s, just starting out, with a steady job and a bright future.
If you fall into this category you might want to toss caution to the wind and take some high flyers like Facebook (NASDAQ:FB), or Zynga (NASDAQ:ZNGA), or maybe even the next penny stock that might have a breakthrough product you feel like flinging $500 or so towards, for a few thousand shares. It might be exciting, but I would not pin any long-term hopes and dreams on this road.
- The value versus growth road
This road can confuse even the most savvy investors, because it is hard to pin down precisely when a stock goes from a value to a growth stock. Some stocks are both value and growth, like Apple (NASDAQ:AAPL), which has amazing fundamentals and a seemingly low PE ratio. That spells value; however, the stock has also risen rather high, rather fast, and now seems to have settled into a range with a dividend. That spells growth.
Think of Microsoft (NASDAQ:MSFT) as an example. At one time it was an amazing value with a super low PE ratio and had the world at its feet. No dividend, just an amazing product lineup, customers waiting for the next big thing from them and a stock price that rose over 20,000% from 1986 to 2006. That is a value stock.
Then it started to live off the fat of the land, was not breaking into new markets, still had an extraordinary balance sheet with $50 billion in cash on hand, and the share price was not moving. It gave its first dividend and split its stock back in 2003 and then placed a regular quarterly dividend not long after.
It has grown its dividend regularly, pays it out all the time, and still generates enormous amounts of cash. It is now a glamor stock.
Folks with a longer time horizon can build a portfolio filled with value stocks that offer tremendous potential, have low P/Es for the sector they are in, and are already making a great profit every quarter.
With a longer time horizon the investor can afford to have some stocks that might miss earnings estimates from one quarter to the next, but still has value, and it will not throw you off track completely because you can afford a few setbacks by plowing more money into savings and other stocks.
- The low risk / low reward road
You might be surprised to learn that this is perhaps the road MOST traveled simply because most folks are risk averse and want safety over anything else. This road obviously offers the least reward and in most cases will not even keep up with inflation.
The advantage is that you will always know exactly where every penny is, how much you will have on any given day, and in some investments, will be guaranteed by the US Government.
Bank savings accounts, most CDs, and Treasuries are the investments of choice on this road, and that does not make them bad at all. There are many variations of these that are sort of "in between" the risk reward metric, such as investment grade corporate bonds, many municipal bonds and money markets that offer a tick above savings accounts but are not FDIC insured.
Many folks opt to take a whole pile of money and hand it over to a big insurance company for an annuity that will just give you a fixed amount per month based on the actuarial tables that insurance companies use for just about every insurance product. A solid insurance company has made it possible for some folks to have a steady income for many, many years, without even thinking about the market.
The issue is that the insurance company will make profits, and you simply won't. Well maybe a trickle, but remember this is an insurance product, NOT an investment. The insurance company will gladly take a whole chunk of your savings and dole out a monthly "allowance" to you, if you agree to give up access to that chunk of money, of course. Do not misunderstand, there are millions of folks who buy these products and swear by them. I am just not one of them.
- The "some risk" with steady dividends road
This is the road that I travel and believe firmly it is the one road that when taken for the long term will offer an investor the best opportunity for a secure and fulfilling financial future.
The choice of equities on this road will consist of the biggest and best companies on the planet. They will pay a dividend that will vary between 2.5% and 6% for the most part, and the companies will have a wonderful history and track record of making regular payments.
The share price is not quite as important as is the overall yield that each stock returns to shareholders. over time, even a share price that falls modestly can still be an amazingly profitable investment via the total return consisting of regular dividend payments.
Take ExxonMobil (NYSE:XOM) or Johnson & Johnson (NYSE:JNJ) for example. Boring names. nothing exiting, and quite frankly real snoozers! They are not losers though. Over a 20-30 year period these two stocks have made regular people more money than most would think possible. For example, an investment in JNJ 20 years ago would have returned over 4,000% to shareholders. XOM also has a remarkable record.
Both of these stocks have many twentysomethings laughing at the folks who own them because they do not have the "bling." Apple has the bling. That's fine, but for a brand new portfolio that we will be working with, ExxonMobil and Johnson & Johnson will take center stage.
The road we are going to travel is the dividend growth road. Over time, I firmly believe that this road will get you where you want to go. You might not become filthy rich, but you can become wealthy beyond your current expectations.
Stay tuned for the next chapter in this series where we identify various stocks in each road, and then come up with the selection of core stocks for our new portfolio.