Great Stocks At Great Prices Are Entirely Irrelevant To Great Investing

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Includes: BRK.A
by: Investment Pancake
Summary

You only need to know one thing, easily demonstrated on one spreadsheet.

Outperforming the market is trivial and simple to do.

Own income growth assets, reinvest the income, and please, please, please: Stay. Out. Of. Your. Own. Way.

You don't have to pick exceptional stocks in order to be a wildly exceptional investor. You don't need to know every single last thing about the companies you invest in. You don't need to buy brilliant stocks at great prices. All you need to do are just three things:

(1) pick out a reasonably diversified portfolio of businesses with fairly predictable dividends that grow at a fairly predictable rate;

(2) spend less than you earn and reinvest the savings; and

(3) don't do truly stupid things, such as trading.

I will now illustrate for you the only thing, and I do mean literally, THE ONLY THING, you need to in order to be fabulously successful at investing.

Imagine you are starting out with a portfolio of $100,000. You work a job that pays you $50,000 a year, and your salary rises by 3% a year, keeping pace with inflation. You are thrifty, and spend $30,000 a year, and your expenses rise with inflation every year. Let's assume you pick a diversified portfolio of blue chip stocks with very reliable dividends. Not hard to find them - you can pull the holdings for every dividend ETF that exists right off the fund sponsors' homepages. You can consult the list of dividend contenders, challengers and champions compiled and published for free by the late David Fish (a brilliant and generous SeekingAlpha author whose work has improved the lives of countless grateful individual investors, including this author). David Fish's DRIP Investing Tool. Suppose the dividend yield on this portfolio you create is 3% (which is pretty reasonable). And suppose that the dividend growth rate is 7% a year (hardly an extreme assumption). And let's suppose that after 20 years, you retire with no source of income besides your portfolio.

Now suppose that you invest your $100,000 portfolio into this portfolio, and the only thing you do, and I literally mean THE ONLY THING YOU DO, is you reinvest your savings straight back into your portfolio. You do not read annual reports. You do not pay attention to stock prices. You don't read lunatic authors on SeekingAlpha with mysterious breakfast item pen names. You simply reinvest your savings into a portfolio of stalwart dividend paying companies that reliably raise dividends, and then you go do something else with your day. What happens?

See for yourself.

Yes, you will be a multimillionaire twice over by the time you retire in 20 years. Yes, by then you will have invested a cumulative sum equal to more than ten times your original portfolio investment of $100,000. Yes, by then your portfolio income will outstrip your spending by a healthy margin. Yes, in 27 years your annual dividend income will exceed the amount of your original portfolio investment. But that's not the big news here. Remember, we are all about generating portfolio Alpha.

The big news for you is that little number in the yellow box to the lower left. It is your annual rate of return, which happens to be 13% a year. I want you to really focus on this number for a moment, and then I want you to ask yourself who the greatest investor in the history of the stock market is (hint: he drinks Coke and lives in Omaha, Nebraska). What is the long-term rate of return he has earned for his investors since 1995?

According to the dividend growth calculator on Dividendchannel.com, DRIP Calculator, the answer is 11.24% - handily beating the S&P500's 8.81% return over the same time period.

Outperforming the stock market is kid's stuff. Blowing past Berkshire Hathaway is mindlessly simple. So what I am telling you is that you don't need extraordinary skill at picking great companies to invest in, at brilliantly timed prices. If you want to outperform the greatest investor in history, what you need to do is pick companies with predictably and steadily rising dividends (easily found online with limited research required), you need control your spending, reinvest your dividends like a religious fanatic, and by all means, above all, stay the hell out of your own way. Don't trade, or be silly with your money. Anything you do that does not relate precisely and exclusively to the math illustrated on the attached spreadsheet can only harm you, and cannot logically help you... so (obviously) don't do it. Good heavens, don't even THINK about trying to time the market. In fact, don't even bother trying to time your investments to get the best prices for any company you own. Over 31 years, in this example, you're looking at a total investment return of 4943% on your original $100,000 investment. In the grand scheme of things, do you think it even matters if you overpaid by 20% on any single one of the trades you'll place over 31 years? Hint: it doesn't.

If you want, make a copy of this spreadsheet for yourself. Plug in your own numbers, your own assumptions, and then every time you are about to make an investment decision, ask yourself: "how does this decision relate to this spreadsheet?" If you can't answer that question, don't do whatever you were just considering doing.

The Only Investment Activity That Matters.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: This might sound like investment advice, but it actually isn't. The reason why is because I am not an investment advisor. I couldn't advice you if I wanted to. This article expresses my own views about what I like to do when I invest, but I don't know you, I don't know your situation, I don't know what strategy or investments make any sense for you whatsoever. This article is designed to be a thought provoking piece of literature (if you can even call it "literature"), and that is all. I can't vouch for one single thing I've said here, or attest to the accuracy of any of the referenced online resources and tools. Do your own thinking. Do your own research. That's why you are here on SA, after all.