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  • Stocks Versus Bonds - Defining your Long Run
    Stocks and Bonds 

    Yes, of course stocks have higher returns than bonds in the long run. Over a lifetime, there is no question. Stockholders demand a higher return from the corporation in exchange for no claim on the assets if the company goes bankrupt. During a 100 year span, it is fairly certain that stocks will beat bonds by several percentage points.
     
    While this is all true in the long run, what does it mean for the average person investing for retirement? Not much. Like we have seen in the past 10 years, and like Japan has seen for the last 30 years, stock markets can have poor returns for decades. When asked whether stocks or bonds would return more, Buffett replied "Who knows?" People say that stocks have to be better than bonds, but I've pointed out just the opposite: That all depends on the starting price."
     
    From the investors's perspective, this means not to attach oneself to any particular dogma. Buy and hold may not be as good as advertised, but market timing is very hard. Treat your retirement as if your life depended on it with no option for bankruptcy, by contributing more to your retirement than you think you will need. Overinvest in your retirement, because you cannot count on adequate returns.
     
    Remember that the combination of low interest rates and years of bond outperformance mean that fixed income should underperform in the future. Worried investors must understand that future returns may be lower than average. This means recognizing that stocks may return only 2-3% more than inflation over the next 20 years. Bonds may provide 0-1% real returns.
     
    Investment Action Plan
    What is your plan in case this happens? You need to max out your 401k to the best of your ability, and open an IRA. If you know nothing about investing, consider putting stocks at 50-60% of your portfolio with equal parts international (NYSEARCA:EFA) and domestic (NYSEARCA:VTI), and spreading out the funds among large (NYSEARCA:RSP), mid (NYSEARCA:MDY) and small caps (NYSEARCA:IWM). Put the rest in bonds (NYSEARCA:AGG) with a sprinkling of other asset classes, including real estate (NYSEARCA:RWR) and commodities (NYSEARCA:DBC).
     
    Understand that a secure retirement means possibly giving up spending income now, and putting that money towards retirement. 30 years of leisure at the end of your life is not a God-given right, it is a privilege that must be earned through a lifetime of prudent action.
    Oct 13 1:20 PM | Link | Comment!
  • A Mini Berkshire Hathaway - Markel
    We begin a series this week about corporations similar to Berkshire Hathaway. There are several companies that use either insurance float or free cash flow to invest in other well run firms. While Berkshire is limited in investments today due to its massive market cap, plenty of smaller businesses take the same course.
     
    The first firm in the series is Markel Corp (NYSE:MKL). This family-run insurance business attempts to break even in their underwriting business, and have 18% annual book-value increases from investments.
     
    In their investments, they seek 4 main qualities:
    • a profitable business with good returns on capital
    • talented and honest management
    • reinvest in the company to grow
    • fairly priced stock
    The Chief Investment Officer, Thomas Gayner, has stated that the perfect balance of the above 4 factors is impossible, but that the most important of the variables is integrity. He refuses to invest in a company where he doubts the trustworthiness of the managers.
     
    Like Buffett, Markel uses a value investment style. In Gayner's own words, "I often find opportunity in companies where a compression of valuation has already taken place. GE is an example. Six years ago, it was at 40x earnings. Its earnings have continued to go up, but now the shares trade closer to 15x earnings. The stock six years ago was just overpriced." Several years ago, Markel acquired Terra Nova, which also had a significant investment portfolio. They sold all of the securities the next day because they did not mesh with the Markel value philosophy.
     
    Markel also looks to invest in durable companies with a barriers to competition, where they are comfortable that it will remain a premium firm in the next 20-30 years. This leads them to companies like Anheiser-Busch, Disney, Costco and Marriott. Can you imagine one of those businesses not being at the top of their industry in 2030?
     
    Outlook
    They have had a lot of cash on hand the last few years, and remain conservative because as 2008 showed us, leverage can be a quick way to hurt a good business and even a solid investment thesis. However, don't let the financial crisis make you too conservative, or else you will miss future opportunities in the market. Opportunities will always be around, because investors make the same mistakes repeatedly, regardless of the lessons during the crisis.
     
    Gayner is worried about inflation, but doesn't know when it will come. He has his fixed income holdings in short term securities, regarding long term bonds as the worst possible investment at the moment, as he expects an interest rate spike at some point. With stocks, make sure you own firms that can raise their prices along with inflation (Kraft is an example - KFT).
     
    Oct 08 1:28 PM | Link | Comment!
  • 5 Investment Managers You Should Learn From
    Legions of investment gurus beckon us to follow, but is anyone really worth our time and money? The most popular investor in the world is Warren Buffett, but is he really our best example?  Why not emulate other spectacularly successful investment managers? Does he deserve his oracle status? While you may not agree with all the differing styles, let's examine him alongside other legendary investors:
     

    Warren Buffett
    He has been turned into the icon of the American Dream. With his humble demeanor and aw-shucks attitude, he buys quality business for less than they're worth, where the market dominance of the firm creates a "margin of safety" in the stock. His problem is that many of his investments are in declining industries, where he could have sold the businesses and reinvested in better firms (see Dairy Queen).

    He learned investing from Ben Graham, who first wrote about this margin of safety. But over time, Warren evolved from buying decent companies for dirt cheap to buying great firms for a fair price. Fortunately for him, he is now the buyer of choice for closely-held businesses, which gives him the right of first refusal for deals inaccessible to most managers. Unfortunately, missteps like selling index puts near the market highs have slightly tarnished his sterling reputation.
     
    Other than heading a large firm and his status the world's richest man for a time, what makes him so endearing? The public swoons over his image as a humble, down-to-earth man making simple buys that the average investor believes they can imitate. His main strategy, on its face, is quite simple, but 20% returns over 50+ years is by no accounts easy.  Some examples in Buffett's portfolio include KO, COP and PG.
     
     
    David Swensen
    Next to Buffett, Swensen has one of the best reputations today. He has managed the Yale endowment since 1985, garnering compounded returns of 14.5% even after a 25% drop in the last fiscal year. He advocates passive buy and hold allocations in a retail investor's portfolio, going so far as to recommend his own lazy portfolio:
     
    - 30% in Vanguard Total Stock Market Index (VTSMX)
    - 20% in Vanguard REIT Index (VGSIX)
    - 20% in Vanguard Total International Stock (VGTSX) or (15% in VDMIX and 5% in VEIEX)
    - 15% in Vanguard Inflation Protected Securities (VIPSX)
    - 15% in Vanguard Short Term Treasury Index (VFISX)
     
    However, his success at Yale doesn't lie in passive buy and hold. He is famous for moving beyond normal stock and bond allocations into alternative investments, including hedge funds, private equity, timber, commodities, etc. He may still buy and hold his investments, but he has access to the best alpha-producing managers in the world, and takes full advantage of their availability.
     
    He argues that average investors should not try to pick investments, as they are hopelessly outclassed by institutions with the best analytics, talent and strategies.
     
     
    George Soros
    In short, his strategy is to ride massive global trends, and then capitalize on his belief in Reflexivity. Reflexivity is the concept that faulty belief systems create unsustainable trends. When the belief pervades the great majority of market participants, a low risk trade can be made in the opposite direction of the trend.

    He is interesting in that his great desire is to be remembered not as an investor, but as a philosopher and philanthropist, donating funds to encourage democracy in eastern Europe, and proclaiming his theory of Reflexivity.
     
    He is most famous for "breaking" the Bank of England, betting against the pound because of a faulty policy. His other most notable accomplishment is founding (with Jim Rogers) and managing the Quantum fund to average returns of 30% from 1970-2000. His strategies are much harder to imitate than Buffett's, as he bets on currencies, stocks and bonds all over the world, requiring a diverse economic acumen far beyond any normal investment manager.  Like Rogers, he can be expected to advocate commodities, Asia, and higher long term interest rates, so example plays might be DBC, FXI, EEM and TBT.
     
     
    William O'Neill
    He is the founder of Investor's Business Daily, and one of the first to marry fundamental and technical analysis into the same stockpicking strategy. He advocates buying newer stocks with high earnings growth and low debt, but only if they have leading price action during a bull market. His most valuable lesson is the maxim of cutting your losses at no more than 7-8%. He writes detailed selling rules for all possible scenarios because he learned firsthand that it's not the winnings that make a great investor, but knowing how to take a loss.
     
    In order to be successful with his strategy, one must keep a watch list of suitable stocks, waiting for a stock to reach a buy point. This point is supposed to be the least risky price at which to buy. O'Neill's strategy is popular because it presents the possibility for large returns while limiting losses.  Example stocks in his recommendation portfolio include such stocks as BIDU and AAPL. 
     
     
    Richard Dennis
    It is very understandable if you have not heard his name before. Dennis traded his account from a few hundred dollars to $200mm. He is famous for creating the "Turtle Traders," a group of trend-following traders that he taught from scratch to become successful investment managers. He would trade any asset classes, but created rigid technical buy and sell rules that he followed religiously, trading breakouts in the direction of the current market trend. While his technical strategy was fairly simple, it required discipline that was very difficult for most people. He himself suffered large losses when he diverged from his strategy.
     
    Are you willing to backtest strategies and follow the proven ones even when they underperform the market, in exchange for fantastic returns in the long run? Learn from Richard Dennis.
     
     
    Conclusion
    Regardless of style, you can learn from each of the above investors. Each is a master of their own style, a style that fits their personality and strengths completely. Buffett could never follow Richard Dennis, and Swensen could not be a George Soros. If you find an investment style you are comfortable with, stick with it at all costs.
     
    A word of caution, though. How much of your life are you willing to devote to investments? If you are not willing to live and breath the markets, don't even think about global macro. If your emotions get the best of you, stay away from Richard Dennis. The easiest to follow would be Swensen, who as a master asset allocator does not trade individual assets, but instead works to diversify and find the best managers.
     
    Do you think it is possible to emulate the masters, or is it purely luck that has made them successful? Are there any other managers that you believe are better than those above? Can any average person become a great investor?

    Disclosure:  Long BIDU and AAPL through a mutual fund.
    Oct 05 10:04 AM | Link | Comment!
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