A Father's Investment Advice To His Son

Includes: C, CNI, KHC, KO, MCD, MDLZ, MO, PM
by: Larry Smith

My oldest son graduated from college a couple years ago and has spent the last couple years paying off some student loans and getting established in the work world. He is now at a point where is looking to begin investing for retirement. He has called me a couple times to ask my advice about brokerages, IRAs, funds etc. We have talked a little about strategy, but I wanted to take some time to share with him what I have learned from my 40-years of investing. I will publish it here so perhaps others can also benefit from it.

There Are No Shortcuts - Do not be deceived by those promising big profits or easy no effort secrets to millions. Those that offer secret formulas or get rich quick plans are only interested in their profits, not yours. Successful investing is not easy and your profits will not come quick. Investing involves work, discipline and time. Put in the work to research and study, stay disciplined and allow time to work for you. That formula will lead to success. Your greatest investing edge is your age. The miracle of compound interest will help lead you to extraordinary gains over time.

There are many examples of how starting early gives an investor a great advantage. The following example is a common one, but does a great job of showing how starting early and the miracle of compounding make a huge difference.

Twenty-five year old Madison invests $2,000 annually over 10 years in her company's 401(k), with an average growth of 10 percent. When she retires, at the age of 65, her investment would have grown to $556,197.

Cooper, age 34 invests $2,000 annually over 30 years into his 401(k). At age 65, Cooper who has invested three times as much as Madison will have $328,988 in his retirement account.

As you can see, Madison's extra 10-years of compound interest provide her an extra $225,000 for retirement than Cooper will have.

Although the above example is simplistic and markets do not go up 10% a year, the important takeaway is that the earlier you start, the more you will have at the finish line. You have taken the first step in starting early, but there is more you must do.

Have a Plan and the Discipline to Stick to It - There are many ways to make money in the stock market, you can succeed investing in growth stocks, value stocks, dividend growth stocks, mutual funds, index funds, options, emerging markets, or commodities. However, if you want to succeed over time, you must have a plan and the discipline to stick to that plan. Constantly changing strategies or having no strategy is a recipe for losses. Develop a plan that works for you; understand what amount of risk you are willing to have while still sleeping at night, know your investment time horizon, and know how much time you are willing to spend researching investment options. Knowing the answer to those questions will help you develop your plan. If you have little stomach for risk and, do not have time for research, than index funds may work for you. There is nothing wrong with that option or any other investment option. If you choose to invest in individual stocks, you must be willing to do the research and take the time to monitor your investments to succeed.

If you invest in individual stocks, I suggest you consider dividend paying stocks. Numerous studies have shown, over time, dividend paying companies outperform non-dividend paying stocks. One study conducted by Ned Davis Research compared results between dividend paying stocks from 1972 to 2008 against stocks that did not pay dividends. His study showed that stocks that pay a dividend and annually increase that dividend returned 8.6% per year. Stocks that did not pay a dividend returned 0.2% a year. The S&P during that period returned 5.9%. There was also a study by Wharton finance professor, Jeremy Siegel, who looked at stock market returns from 1871 through 2003, a 132 year period, and found 97% of the total after inflation gains from stocks came from dividends, and only 3% came from capital gains.

Whatever plan you develop, if you stick with it, you will succeed.

There Will Be Bumps in the Road - Do Not Get Discouraged - The investing world is never as great as it may seem and it is never as bad as it may seem. The history of the stock market has been a series of bull markets and bear markets. Every frightening bear market has been followed by a rally and bull market, just as every jubilant bull market has been followed by a decline and bear market. However, over time, the stock market has slowly, but surely, inched higher. Keep your eye on your long term goal and do not be scared away from maintaining your plan. Stick to your plan through thick and thin and you will be rewarded.

In 2008 and 2009 the stock market and my portfolio lost more than I ever thought it would. However, I stuck to my plan and by doing so have been greatly rewarded. In 2008 and 2009 I bought shares in McDonald's (NYSE:MCD) for $52.24 and $55.26. I bought shares in Canadian National Railway (NYSE:CNI) for $46.48 and shares in Coca-Cola (NYSE:KO) for $57.32 (pre-split). I also continued to contribute every two-week to the index funds I have at work. The shares I bought during those years have been some of the best shares I have ever bought.

Never let fear scare you out of investing and never let jubilation alter your plan, because neither fear nor jubilation will last.

Minimize Fees and Taxes - Building wealth is a difficult process, it can be even more difficult if you pay high fees or have the tax man take from your gains. Whatever plan you develop, keep your fees low. There is no reason to purchase a load fund as there are always no-load funds that are just as good. The lower you keep your fees, the more you keep for yourself. Over time, even an additional 2% in fees can add up. John Bogle of Vanguard Funds often uses this example to show how fees can rob from your gains.

"What seems inconsequential over the short term becomes profoundly important over the long term. Let's assume we have a market return of 8 percent, and you reinvest all of your earnings. At the end of 50 years, the dollar you invested is worth $46.90. Now, let's assume we take 2.5 percent in fees out of the 8 percent return. Your return drops to 5.5 percent. At the end of 50 years that dollar grows to $14.54."

Lower fees equal greater returns.

Depending on your goal, the majority of your investments should be in a tax deferred IRA or Roth IRA. In addition, your employer may offer tax deferred opportunities like 401K's, if they do and if they match your contribution you must take advantage of it. You simply cannot beat a matching contribution; it is an immediate 100% return.

Never Stop Learning - The more you know about investing the better your investing decision making will be. Read as much as you can and be willing to read books/articles from those that may have different goals or investment plans than you have. I do not invest in precious metals, commodities, or options, yet I have read books on every one of those topics. The more you know, the more you will understand how the market works and the more the pieces will fit together. The bond market can affect the stock market, as can commodities and other asset classes.

Also, take time to read books from or about the master investors. I have read numerous books about Warren Buffet and books written by Peter Lynch, Marty Zweig, Jim Rogers, John Bogle Jeremy Siegel, Jim Cramer and many others. I have learned something from every one of them.

It was Jeremy Siegel's book, "The Future for Investors" that showed me the benefit of dividends. Had I not read that book I may have stayed the aimless investor I was. Expand your knowledge and learn as much as you can. You too may discover an investing strategy that works for you

Ignore the Noise and Listen to Your Own Voice - There will be co-workers, friends, television analysts, newspaper writers and magazine authors who will think it is their job to tell you what to do. All these people will be no more right or wrong over time than you will. It is your money and your future, take responsibility for it and follow your voice.

My grandfather, who lived through the depression, had all his savings in bank CDs. When he learned I owned some stock, he told me I was nuts and that the only investment a person should have is bank CD's. The market is too risky he said. I loved my grandfather, but if I had listened to him I would not have anywhere near the savings I now have. Find your own way, it will give you all that much more satisfaction when you reach your goal.

In March 2009 I bought a great deal of Citigroup (NYSE:C) for $1.29. I was confident it would not go much lower as the Government had a big position in it and surely the Government was not going to let it go to zero. I mention the trade to several people I know who also trade stocks, they all said I was nuts and was taking a big risk. Their words made me uneasy; I do not like taking risk so I sold the shares for little gain. I should have listened to my own voice and held the shares, because it would now be a four bagger.

If you have done the homework and our confident of your thesis, do not let others change your opinion without a good counter thesis of their own.

You Will Make Mistakes - Learn From Them - There is not an investor alive who has not made a mistake, the market is full of unknowns and no one can anticipate everything. There is no shame in making a mistake, the only shame would be not learning from it.

A couple years ago I reviewed my investment history going back to my earliest trades and discovered I had a history of trading too much and not giving investments time to flourish. One such investment was Altria (NYSE:MO). I purchased Altria in October 2006 for $78.78 and then sold the shares in January 2007 for $85.67. My reasoning for buying the shares was correct, once Altria split into three separate companies, each company on its own, would prosper more than the current combined company was prospering. I sold before my investment thesis had a chance to be proved right. That was a mistake, had I held, I would now own MO, Philip Morris International (NYSE:PM), Kraft (KRFT) and Mondelez (NASDAQ:MDLZ). On stock price alone I would have had a double and the dividends received would be huge. That was not the only example, but it was the most glaring. After seeing that, I made a vow that I would buy and hold companies until the business itself started to decline. For the most part, I have stuck with that vow and my returns have greatly improved. I saw my mistake and I learned from it. Take time to assess your plan and your results, if you see mistakes, learn from them.

The Most Important Lesson of All - In the movie Wall Street, Charlie Sheen's character Bud Fox, a Wall Street broker, who is engaging in insider trading to obtain fast profits has a confrontation with his father who is not impressed with Bud's new life. During the verbal argument, Bud tells his father "What I see is an old man who is jealous of his son who is more successful than he ever was." Bud's father responds "You don't measure a man by the size of his wallet." Those words are true. We all want more money and we all want to be successful, but success is more than big bank accounts. It is hard work, integrity, honesty, taking care of your family and empathy for others. I wish you the best of success as an investor; I wish you more success being a good person.

Disclosure: I am long KO, MCD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.