I’m reading a great book right now called, Winning the Loser's Game: Timeless Strategies for Successful Investing” by Charles Ellis. Without necessarily using the words, he reminds us that sound investment strategy is largely based on income investing. There’s no doubt that growth stocks are what make Wall Street sexy but income stocks are what make Wall Street money.
Warren Buffett and is billions of dollars isn’t sitting at his desk watching stock tickers and he isn’t watching for a 2 cent spread between the bid and ask price of an equity and quickly throwing a couple billion towards it hoping to capitalize on it. George Soros, Bill Gross, and Carlos Slim aren’t doing that either. (I’m sure they have some staffers that ticker watch but none of the big, legendary investors list day trading as their capital appreciation method of choice.)
If you were a football coach and you could emulate the actions of Steve Spagnuolo or Tony Dungy, which would you pick? Steve Spagnuolo is the coach of the St. Louis Rams and since 2009 his record is a not so impressive 8-24. Tony Dungy is the recently retired coach of the Indianapolis Colts who had an incredible record of 85-27 while he coached the Colts.
If these two coaches were investors, who would you emulate? At the risk of offending people, the day trading crowd have records much like Steve Spagnuolo while the income investors are the Tony Dungys of the investing world. Just look at the returns. Retirement portfolios are built around income investing while somewhere between 80% to 90% of all day traders lose money over long periods according to some studies.
In his book, Charles Ellis speaks sharply against the idea that anybody can beat the market. A sustained performance record that sharply outpaces the market is both statistically as well as practically and realistically impossible. The pros can’t do it because they are the market and can’t beat themselves and the smaller fish in the pond can’t do it because they don’t have the resources to find, analyze, and react to rapidly flowing information.
It’s not possible but people try it anyway. Why? Because it’s thrilling. A recent CNN article titled, “Why you Should Quit Trying to Beat the Market” talked about some of the same things. Let me give you my realistic strategy on how to actually make money in the investment markets. It satisfies my human need for thrill and sex appeal while also satisfying a bigger need to actually make money in the market.
Ingredient 1: Fixed income
Every portfolio needs a little bit of fixed income. To be honest, as a 36 year old, I don’t need as much as I have but in a shaky market, I can’t pop enough Zantac to calm my stomach when the VIX is in the mid 30s, I’m seeing 300 point swings in the S&P and I’m watching my stocks move every which way. I have too much fixed income because the market is volatile and because I haven’t formed all of my good habits yet. Fixed income allows me to compartmentalize my funds and investment with the idea that some funds just aren’t touchable unless something big happens to one of those names. How many amateur investors see their capital as sitting in one pot?
Ingredient 2: Income Stocks
This is the core of my portfolio because this, along with my fixed income keep me in strict compliance with a rule I always keep in the forefront: I’m a seller, not a buyer. I collect money rather than spending it. My money is for sale because when I sell my money it gets returned to me much more regularly than when I go out buying. Selling my money comes back to me in the form of dividends/interest payments and options premium revenue.
My income stocks are picked first for the fundamentals of the company, then their yield, and finally their potential for capital appreciation. If I use my income stocks to generate yield and covered call revenue, the capital appreciation becomes far less important. Low beta is fine with me because the call options need much less management and to be honest, I can get reliable sustained returns over time from these sources far easier and with far less stock picking mojo than relying on capital appreciation.
You may argue that I’m treating my stocks like bonds but where am I going to find investment grade bonds with yields at junk bond levels when the yield and call revenue is combined? Since I’m planning to hold these stocks for a long time, I’ll see some capital appreciation anyway but that’s icing on the cake.
Ingredient 3: Growth stocks
I’m young so I have plenty of room for growth stocks in my portfolio but I don’t want the value of my money dictated by short term market performance so I keep my growth exposure to a minimum. But, I like the sexy side of ticker trading as much as the next guy so much of my growth exposure comes in the form of longer dated call options and on a small scale, positions in leveraged ETFs that I trade based on the charts.
If I’m confident in my stock picking ability, I’m fine owning the longer dated call options for capital appreciation and the leveraged ETFs come from money that I can afford to lose although I normally don’t. It’s important, though, to say that don’t hit a homerun on my trading and either do all of those people on Stocktwits or other sites. They tell you that they do but it isn’t happening. I do OK and in most years I’ve stayed around market performance but it’s not getting what my income producers are doing for me.
I will say this: I make far more money as a seller of my money instead of trying to buy investments. I know that the hard core investors will take issue with my terminology of buying and selling my money but I’m more interested in making money than I am in using the right words.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.