Tuesday, April 10, 2012

How We Invest

Investing is such a broad subject.  How does one invest?  In what?  When?  I asked all of these questions.  Then my brother suggested I read “The Intelligent Investor” by Benjamin Graham.  This is the quintessential book on investing.  The amazing thing, it was written in 1949 and applies as much today as it did then!  I learned a lot from this book; the most important being that I don’t have the time to invest in individual stocks!  Unless you have time to study balance sheets, management, accounting rules, as well as other market factors, then you shouldn’t be investing in a company.   That’s why mutual funds were invented!

Loosely following the teachings of Benjamin Graham, I’ve invested in index funds. While Graham teaches a portfolio of stocks and bonds, I substitute gold for bonds.  Here is a sample, depending on market conditions, of what my portfolio might look like: 
  • Vanguard Dividend Appreciation Index Fund (30%)
  • Vanguard 500 Index Fund (20%)
  • Vanguard Small-Cap Growth Index Fund (10%)
  • Vanguard Mid-Cap Index Fund (10%)
  • Vanguard International Growth Fund (10%)
  • Precious metals (e.g. gold, silver, etc) (10-20%)
I love dividend funds!  Any company that will pay me a dividend to own their stock, and increase that dividendis a company I like to own!  There is a great stat about dividend stocks:  If you invested $1 in US stocks in 1900 and kept the dividends for yourself, 100 years later that stock would be worth $198.  That’s not too bad for a buck.  However, if you invested that same dollar in US stocks and reinvested your dividends, that stock would be worth over $16,000!  The moral of the story is to invest in dividend paying stocks, and reinvest those dividends!

I invest in the 500 index fund because it follows the S&P 500 (aka – the broader market).  It’s instant diversification! I get to invest in companies that span all sectors (health care, energy, financial, etc). 

Small and mid-cap index funds allow me to gain exposure to smaller to mid-size companies that have the ability to grow quickly.  I can pick out the IBM’s, the McDonald’s, the ExxonMobile’s but I’m not familiar with smaller companies at all.  These funds allow me to invest in those smaller companies.

The International fund allows me to invest in those emerging markets that I’m not aware of as well as those companies in developed countries outside of the US. 

Except for the International fund, these are all index funds; Funds that are put together to match the components of a market index such as the S&P 500, the Dow Jones Industrials, the Dow Jones Utilities, the Russell 2000, etc.  Investopedia explains index funds this way: "Indexing" is a passive form of fund management that has been successful in outperforming most actively managed mutual funds. 

A huge benefit of investing in index funds is that they tend to be the benchmark with which fund managers are judged; whether or not the fund manager was able to beat the S&P, for example.  Another benefit is the low expense ratio of index funds.  Mutual funds cost money to run: the cost of research, the cost of trading, the fund manager’s salary, etc.  Because the index defines what stocks the fund can hold, fees are kept to a minimum. 

Aside from the funds listed above, I think it’s also a good idea to have some money in precious metals such as gold.  Gold helps you hedge against inflation.  If you listen to the podcasts and radio shows I listen to, we could be in for some serious inflation over the next few years.  While an argument could be made that that inflation will stay in check, the fact that gold can help you hedge against inflation cannot.  I used to believe that gold was a horrible investment but considering the money printing policy of governments today, we’re considering adjusting our portfolio so that we have between 10-20% of our money in gold. 

While this investment style works for me, it may not for you.  I don’t know your risk tolerance, your investment style, or your suitability to invest so this is not a personal financial advice.  I’m simply explaining how we invest and that it might be something you’d like to familiarize yourself with.  

How do you invest?

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