Dividend versus Growth

A recent web article compared a total return from 1960 to 1999. A table showed the S&P 500 average annual total return was 12.5% (3.4% in dividends [27.9% of the total] and 9.1% in capital gains). Using the old Dividend-Bond Multiple Rule (via hypothetical market prices based on 120% dividend-bond yield multiples), the annual returns in the same period would have been 17.5% (9.7% in dividends (55.1% of the total) and 7.8% in capital gains. The table showed that investors would have had higher total return and better downside protection with dividends as part of their investing program.

Gradually, particularly among seasoned investment analysts and some academicians, Williams’ valuation theories gained credence. Arnold Bernhard, founder of “The Value-Line Investment Survey,” quoted Williams’ book, The Evaluation of Common Stocks:

“Williams postulates that the value of a stock is the sum of all its future dividends discounted by the present interest rates. . . . Because there is no generally accepted standard of value, the market prices of stocks fluctuate far more widely than their true values. The wide fluctuations have in the past imposed a heavy burden on the general economy and undermined the faith of many people in the free market economy. The need, therefore, exists for rational and disciplined standards of value that cannot lead to the wildness of 1929 or 1949 or the present.”

Arnold Bernhard also boldly stated, “In our own experience, during periods of inflation as well as at other times, in this country and abroad, it has been found that dividend-paying ability is the final determinant of the price of a common stock.  Over a period of years, whenever the dividend or the company’s ability to pay dividends, went up; so too did the price of the stock.  When the dividend-paying ability went down, so did the price of the stock, inflation or deflation.”

As an affirmation of Williams’ theories about intrinsic value and speculation, let’s look at the Great Recession of 2008-2009. From peak to trough, both price and earnings of the Dow Jones Industrial Average fell by just over 50%, while dividends fell by only about 15%.

In his 1959 book, Dividends, Earnings, and Stocks Prices, Myron Gordon pays tribute to Mr. Williams for his pioneering work in discovering methods of calculating the intrinsic value using the dividend.  Mr. Gordon would later win a Nobel Prize for his expansion of John Burr Williams’ groundbreaking work.  Many academics and investment professionals believe that Mr. Williams’ work also deserved a Nobel prize.
Williams extolled the virtues of a long-term view of the investment markets. He believed profitable investing focused on the long-term growth rate of dividends.  How right he was.  Since 1960, the annual price growth of the Dow Jones Industrials has averaged about 5.9%.  That figure is remarkably similar to the average annual growth rate of dividends of near 5.6%.  While these growth rates are very similar, they do not move in tandem.  Dividend growth over the years has been consistent, while stock price growth has been very volatile.  On average every two to three years they converge.

Market volatility can be frightening for, but long-term dividend investors should celebrate it. Large discrepancies between prices and dividends signal buying or selling.  In 1938, John Burr Williams predicted prices and dividends will always converge. Long-term investors who focus on dividends can avoid market ups and downs and even profit from it.

By claiming dividends, rather than earnings, were the determining factor in calculating intrinsic value, Williams knew he was reversing the normal rule that every new investor learns.  Williams said, “The apparent contradiction is easily answered, however, for we are discussing permanent investment, and not speculative trading; and dividends for years to come, not income for the moment only.”

John Burr Williams struck a bright line between being in the chicken business and being in the egg business.  He believed that buying and selling chickens was a commodity decision and thus, speculation.  On the other hand, investing in egg-laying chickens was completely different.  It was possible to calculate the present value of a chicken by estimating its total egg-laying potential during its lifetime and then discounting it to a present value.

 

 

John Burr Williams The Math Poet

John Burr Williams (JBW) was a security analyst who wanted to learn more about how to estimate fair value. After several years in the job market, he returned to Harvard to learn about economics, with the hope of finding causes for the 1929 stock market crash and the 1930s depression. His Ph.D. was secondary to the knowledge he sought. His quest of knowledge over an academic degree did not endear him to the faculty of Harvard. John suspected that Wall Street over-estimated stock values and that did not endear him to the Wall Street establishment either.

 

Williams determined the intrinsic value of a stock is worth the present value of all dividends ever to be paid upon it, no more, no less.

John did not say “earnings,” the favorite of Wall Street, or cash flow to determine intrinsic value. John earned another demerit from Wall Street.

John gained another demerit from academics when he challenged the “casino” of economists who thought prices were largely determined by expectations and counter-expectations of capital gains.

John changed the focus of the market to underlying components of asset value from directly forecasting stock prices. JBW emphasized future dividends and earnings over book values.

Williams’ formula for intrinsic value was.  

  

Value=D/ (I-G)

 

He presented a poem and story to make his point between dividend income and capital gains.

For most people, math is cut and dried, with only one answer and poetry is subject to interpretation and controversy. With John Burr Williams, the reverse was true. The controversy still surrounds JBW’s words he wrote in 1938.

 

Mathematicians believe it is not practical to calculate far into the future and there is always the question of what rates of return you use for dividend growth and interest rates. To the layman, all he wants to know is that the dividend amount going up and what is the yield.

 

Harry Markowitz disagreed with William’s book on risk. Williams wrote that holding a large number of stocks that produce maximum (income) returns is the “equivalent” to diversifying risk

From The Theory of Investment Value

By John Burr Williams

 

”Earnings are only a means to an end, and the means should not be mistaken for the end. Therefore, we say that a stock derives its value from dividends, not earnings. In short, a stock is worth only what you can get out of it. Even so, spoke the old farmer to his son:

 

 A cow for her milk,

A hen for her eggs,

And a stock by heck,

For her dividends

 

An orchard for fruit

Bees for their honey,

And stocks, besides,

For their dividends.

The old farmer knew where milk and honey came from, but he made no such mistake to tell his son to buy a cow for her curd or bees for their buzz.

The farmer is speaking of permanent investments, not speculative trading, and years of dividends for years to come (and possibly beyond your lifetime), not income (capital gains) for the moment.”

 

Markowitz had two problems. Stocks producing maximum (income) returns is a one- dimensional focus on return. The other problem is that diversification doesn’t account for risk, which can be quite risky. Markowitz wants to diversify a portfolio with stocks that have low co-variances to each other. Harry also thought investors who invest in stocks they believed to offer the best odds of producing maximum (income) returns-without taking risk into consideration, are speculators not investors. Harry wanted everybody to think about risk  and return.

JBW wanted to use dividends as his base for returns; Markowitz wanted to use price relationships for his returns. JBW wanted certainty of return on his investment. Markowitz wanted changing price relationships for his hope for capital gains and appreciation.          

    The debate goes on and Harry appears to be winning — until the cows come home after the algorithms destroy each other.             

The Circus of Global Politics

Diners at the Bizzy Bee were debating world events and March madness when someone mentioned that the circus was coming to town.  Sally suggested they should all watch the world from the perspective of a three-ring circus.

Dempster jumped right in, suggesting animals for each ring: tigers in one ring (representing the Pacific Rim), bears in another (representing Russia) and lame ducks and ostriches for the center (symbolizing Washington).

Oscar said, “Remember what Pogo said many years ago? ‘We have met the enemy and they are us.’ By looking to the past, we can see the future. Human nature, a nation’s history and religion will usually provide a window into how people or a country will behave in the future.

Human nature does not change, so every few decades economic and political events tend repeat themselves.  Two reoccurring themes are debt bubbles and adversaries’ actions, based on perceived weak-nesses or arrogance and assumed behavior.

The March 19 issue of Investor’s Business Daily (IBD) included an article that outlined Russia’s history. The article included a piece about Marquis de Custine, of France, who went to Russia in the 1830s, expecting to love the autocratic czarism. What he saw repelled him. He returned to France and wrote about what he saw in the culture of Russia, much like the way Alexis de Tocqueville wrote about American culture. (See page 2 for their views of the two countries. The life and more quotes of de Tocqueville are on the website.) What both men saw in the 1830s is still true. De Custine said that Russia and America would lead the world.

The IBD piece noted, “Russia sees itself as the original guardian of Christian civilization, the nation that rushed to the rescue of Constantinople, then under Muslim siege, before its fall in 1204, while the West did nothing.” Defending Christianity has been the rationale for Russian invasions to its south including their 18th-century Ottoman land grab.

Putin is personally upset about the West winning the cold war and would like to avenge this perceived wrong. He is not likely to be concerned with photo ops and a bad economy. Rather, he is likely to act differently than Washington assumes and that could lead to unforeseen troubles. We need to remember Russia’s ruthless history and mission.

We think China may be sensing opportunities from weakness in the West. China is increasing its military power and showing it off around the Pacific.

In 2001, China signed the Shanghai Cooperation Organization (SCO) a military treaty with Russia.

The treaty, designed to fight regional terrorism in Muslim Central Asia (including China and parts of the former Soviet Union) has evolved into an alliance to keep U.S. interests out of the region.

China is a creditor nation and when its economy slows, can cause problems for the rest of the world.

The center ring has at least two performances in the same ring:  the White House and the Federal Reserve. The shows explain how the Fed unwinds its quantitative easing without causing major economic disruptions and a White House that has an appearance of weakness by cutting the military and not carrying out what it says it will do. The White House also expects world dictators to behave according to White House standards and assumptions.

The Fed needs a stable, growing economy to pull off their trick while the actions from Putin and China (in response to perceived weakness), are quite likely to cause economic and financial disruptions that hurt the Fed’s chances of an easy exit.

Washington assumes economic sanctions will force Putin to stop his escapades. That is possible but it is also possible that Putin will continue his military moves, leading to a series of events that hurts everyone.

Hetty said, “We may have many serious problems, but de Tocqueville was right that the United States can repair her faults. Energy can fix many of our problems and perhaps Putin is providing the wake-up call and incentive for America to get its political and financial house in order.”

Hetty added, “LNG and oil exports could help put the U.S. on an economic growth path and renew the world’s faith in America.” A little cheer went up from everyone at the table.

Sally realized that the world really is like a three-ring circus. She smiles, “It has a lot of thrills, chills, tears and laughter.”

However, when the show ends, people go home happy and the circus moves to the next town where they entertain a completely new audience.

 

John Bogle – The Man

John Bogle’s heritage is heavily Scottish. John’s maternal grandmother immigrated to America in the 1700s to work in farming.  Bogle’s great-grandfather, Philander Banister Armstrong, was John’s “spiritual progenitor”. Philander worked to reform the fire and life insurance industries. John’s family history may explain his thriftiness and two of his characteristics: “stubbornness of an idealist” and “the soul of a street fighter.”

Picture of Bogle

John Bogle was born on May 8, 1929 in Montclair, NJ to William Yates Bogle, Jr, (a WWII aviator) and Josephine Lorraine Hopkins. The Bogle family lost their inheritance in the Depression and they had to sell their home. His father became an alcoholic and his parents divorced.

Bogle attended Manasquan High School at the Jersey Shore. His excellent academic record enabled him to enroll the prestigious Blair Academy, where he excelled in math. John graduated from Blair Academy cum laude in 1947 and then enrolled at Princeton University to study economics and investment.  John was interested in the mutual fund industry – one subject that had not been analyzed before. Bogle’s senior thesis was “The Economic Role of the Investment Company”.

Bogle graduated from Princeton in 1951 and began evening and weekend classes at the University of Pennsylvania.

Walter L. Morgan, founder of Wellington Fund, read Bogle’s thesis and liked it enough to hire him in 1951. Bogle was promoted to assistant manager in 1955

John became chairman of Wellington but was fired for an unwise merger he approved. He considers the merger his biggest mistake and said, “The great thing about that mistake, which was shameful and inexcusable, a reflection of immaturity and confidence beyond what the facts justified, was that I learned a lot.”

In 1974, Bogle launched the Vanguard Company and a year later founded the Vanguard 500 Index Fund (referred to as Bogle’s Folly), the first indexed mutual fund available to the general public. In 1999, Fortune Magazine recognized Bogle’s success and named him “one of the four investment giants of the twentieth century”.

Health concerns in the 1990s forced Bogle to relinquish his role as Vanguard CEO in 1996. He named John J. Brennan as his successor. That same year Bogle had a successful heart transplant, which enabled him to return to Vanguard, this time as senior chairman.

Bogle had a successful heart transplant in 1996 and returned to Vanguard as of senior chairman. Conflicts between Bogle and Brennan resulted in Bogle’s departure in 1999. Bogle started Bogle Financial Markets Research Center, a small research institute, unrelated to Vanguard.

Bogle is a member of the board of trustees at Blair Academy, an advisory board member of the Millstein Center for Corporate Governance and Performance at the Yale School of Management. Bogle received an honorary doctorate from Princeton University in 2005. Bogle also serves on the board of trustees of the National Constitution Center in Philadelphia, a museum dedicated to the U.S. Constitution

 

    The Clash of the Cultures: Investment vs. Speculation (2012) is John Bogle’s last book. In it he highlights how speculating (short-term) agency, mutual and hedge funds, have taken over from the investing long-term ownership culture. We will cover that in the other section.

 

Bogle’s Lessons of Investing

(What investors can do while the

financial system gets fixed)

 

  1. Remember reversion to the mean. The stock market reverts to fundamental returns over the long run.
  2. 2. Time is your friend; impulse is your enemy. Take advantage of compound interest.
  3. Buy right and hold tight.
  4. Have realistic expectations. You are not likely to get rich quickly.
  5. Forget the needle, buy the haystack. Buy the whole market and you can eliminate stock risk, style risk, and manager risk.
  6. Minimize the “croupier’s” take. Beating the stock market and the casino are both zero-sum games, before costs.
  7. There’s no escaping risk. I’ve long searched for high returns without risk; despite the many claims that such investments exist, however, I haven’t found it. And a money market may be the ultimate risk because it will likely lag inflation.
  8. Beware of fighting the last war. What worked in the recent past is not likely to work in the future.
  9. Hedgehog beats the fox. Foxes represent the financial institutions that charge far too much for their artful, complicated advice. The hedgehog, which when threatened, simply curls up into an impregnable spiny ball, represents the index fund with its “price-less” concept.
  10. Stay the course. The secret to investing is – there is no secret. When you own the entire stock market through a broad stock index fund with an appropriate allocation to an all bond-market index fund, you have the optimal investment strategy. Discipline is best summed up by staying the course.

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…Using Keynes’s idea, I divide stock market returns into two parts: (1) Investment Return (enterprises), consisting of the initial dividend on stocks plus their subsequent earnings growth, which together we call “intrinsic value” and (2) Speculative Return, the impact of changing price/earnings multiples on stock prices. 

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Bogle wrote a number of books: Bogle on Mutual Funds: New Perspectives for the Intelligent Investor,  (1993),  John Bogle on Investing: The First 50 Years (2000), Character Counts: The Creation and Building of The Vanguard Group ( 2002), The Battle for the Soul of Capitalism  (2005Reflections on Investment Illusions,  and The Clash of the Cultures), The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (2007), Enough : True Measures of Money, Business, and Life (2008), Don’t Count on it!:: Investment vs. Speculation (2012)

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“If you are considering purchasing shares in a firm, you have two broad expectations for that firm: (1) it will pay annual dividends and the amount of those dividends will grow over time; or (2) rather than paying dividends, it will retain earnings so as to build the business.

     While the second expectation suggests that dividends need not always be a critical determinant of the returns on stocks, even when a company does not pay a dividend, investors implicitly value the firm’s stock based on the presumption of future dividends.”  (John Burr Williams’ definition of investment value.)

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Twelve Pillars of Wisdom

 

  1. Investing is not as difficult as it looks

Successful investing involves doing just a few things right and avoiding serious mistakes.

  1. When all else fails, fall back on simplicity

Here is a solution: commit, over a period of a few years, half of your assets to a stock index fund and half to a bond index fund. Ignore interim fluctuations in their net asset values. Hold your positions for as long as you live, subject only to infrequent and marginal adjustments as your circumstance change. Occam’s razor—a thesis set forth 600 years ago and often affirmed by experience since then—should encourage you: when there are multiple solutions to a problem, choose the simplest one.

  1. Time marches on

Time dramatically enhances capital accumulation as the magic of compounding accelerates. At an annual rate of return of +10%, that additional capital accumulations on a $10,000 investment is $1,000 in the first year, $2400 by the tenth year, and $10,000 by the twenty-fifth year. At the end of 25 years, the total value of the initial $10,000 investment is $108,000, nearly tenfold increase in value. Give yourself the benefit of all the time you can possibly afford.

  1. Nothing ventured, nothing gained

It pays to take reasonable interim risks in the search for higher long-term rates of return. The magic of compounding accelerates sharply with even modest increases in annual rate of return. While an investment of $10,000, earning an annual rate of return of +10% grows to a value of $108,000 over 25 years, at +12% the final value is $170,000. The difference of $62,000 is more than six times the initial investment itself.

5.Diversify, Diversify, Diversify

By owning a broadly diversified portfolio of stocks and bonds, the only remaining risk is the market. This risk is reflected in the volatility of the total value of your portfolio and should take care of itself over time, as reinvested dividends and interest are compounded.

  1. The eternal triangle

Never forget that risk, return and cost are the three sides of the eternal triangle of investing. Remember also that the cost penalty may sharply erode the risk premium to which the investor is entitled.

  1. The powerful magnetism of the mean

In the world of investing, the mean is a powerful magnet that pulls financial market returns towards it, causing returns to deteriorate after they exceed historical norms by substantial margins and to improve after they fall short.

  1. Do not overestimate your ability to pick

superior mutual funds, nor underestimate your ability to pick superior bond money market funds. In selecting equity funds, no analysis of the past, no matter how painstaking, assures future superiority. Combing several low-cost equity funds to achieve diversification…so is the holding of a single low-cost index fund….

  1. You may have a stable principal value or a stable income stream, but you may not have both.
  2. Beware of “fighting the last war.” Too many investors are constantly making investments based

on long past or recent lessons. You should not ignore the past, but neither should you assume that a particular cyclical trend will last forever. None does.

  1. You rarely, if ever, know something the market does not. The financial markets reflect the knowledge, the hopes, the fears and even the greed of investors everywhere. It is usually unwise to act on insights that you think are your own, but are in fact shared by millions of others.
  2. Think long term

Stocks may remain overvalued, or undervalued, for years. Patience and consistency are valuable assets for the intelligent investor. The best rule is: stay the course.

 

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The central task of a lifetime is to allocate financial resources so to balance the different market risks among three basic classes of liquid assets: (1) Common stocks, which carry the greatest short-term volatility and uncertainty, but—based on the underlying fundamentals of corporate earnings, dividends, and dividend growth—promise the highest expected returns over the long term; bonds, which normally provide lower returns than stocks and, depending on the length of maturity, carry significant risk of principal fluctuation but remarkable stability of income; and money market reserves (or cash), which usually engender minimal risk to capital and thus the lowest returns but, given their short- term nature, create an inevitable risk of income volatility.

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Mark’s Saunder’s Workshop Journal

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Regarding mutual funds, John Bogle wrote, “The principal giant (of an industry) upon whose shoulders I have stood in writing this book is Benjamin Graham…. My objective is to provide the same sort of framework for investing in mutual funds as Benjamin Graham provided for investing in individual stocks and bonds.”

Bogle promoted the idea of low cost index funds as a good way for investors, who seldom “beat the market,” to grow their assets. Investors can’t control their greed and fear so they jump in and out of the market at the wrong times. Institutions didn’t beat the markets because they were charging unreasonably high fees for the services and they busy trying to gather assets, rather than follow Ben Graham’s value principles that managed the emotionalism of “Mr. Market” (Graham’s name for the market).

Ben Graham’s shared his thoughts about developing a simple set of rules later in life with a university. The school said they weren’t interested because they couldn’t make as much money using simple rules. They weren’t following Bogle’s rules about-high fees and complexity.

The other fundamental investment giant is John Burr Williams, who believed in compounding and future incomes for dividend or interest. Williams would be appalled at the waste by corporate management, which is also a Bogle crusade.

 

Three Ways to Invest

 

  • The value methods of Ben Graham and John Burr Williams (from the 1930s) (investment based view)

 

  • Modern Portfolio Theory-for risk adverse investors (from the 1950s) (investor based view)

 

  • Low cost Index funds that Bogle pioneered (in 1976). This is an investor bad habit based view.

 

Bogle was influenced by the Efficient Market Theory of Eugene Fama, the Random Walk Theory of Burton Malkiel and Paul Samuelson, his economics professor. The two theories researched price movements and made a case for owning passive index funds over actively managed funds.

Index funds still have portfolio turnover. The important points are low fees, reasonable turnover and managers owning the fund. Look for those three points when choosing a fund.

  1. Why are investors supposed to “beat the market?”
  2. Benjamin Graham said, “The majority of investors should be satisfied with the reasonably good return obtainable from a defensive portfolio.”

 

Q: In these Twelve Pillars, where is it that investor risk tolerance is important?

A: Most important is the risk (amount of value) level in the market. Good market value increases the chances and amounts of gain. No value (distribution like today) increases chances of losses and lessens chance for much gain.

There are two ways to measure value that have proven themselves over at least the last 130 years-dividend yield and a price/earnings ratio (P-E).

 

Summary and Comments on the 12 Pillars

  • Keep it simple-and understandable (Pillar 2).
  • Compounding- increasing dollars and/or shares is the objective, not percentages or ignoring risks and feeling comfortable (Pillar 3).

Notes: An important part of compounding is limiting losses, not beating the market (Pillar 3).

  • Compounding requires regularly reinvested interest, dividends and capital gains, rather than unrealized appreciation or depreciation of asset values (Pillar 3).
  • Great and Good Value are the way to build profits; little or no value are the way to hurting returns (Pillar 4).
  • Only market risk remains. Manage it with value measures or be prepared to lose when there are

major corrections (Pillar 5).

  • Should implies it may never happen. When markets are highly over-valued or manipulated (i.e., the Fed’s low rates), investors are likely to face a major price correction that can significantly hurt their compounding efforts (Pillar 5).
  • Risk premiums on stocks and bonds can change over decades (Pillar 6).

 

    Balanced funds include stocks and bonds. Bogle’s Vanguard includes the Wellington Fund and was picked by Money magazine as the only fund you need if you had to make a choice. VWELX is an example of a fund for a simple investment plan. It has reasonable long-term returns with reasonable portfolio turnover.

 

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The Less Stressed Investor

In this issue, we present checklists for new and old investors to help them review their financial and investing game plans to make sure they are not overlooking or forgetting things that make extra profits or lessen losses. Better investors are healthy, have good clear minds and control their emotions and have less stress.

Good investing starts with common everyday concepts. Common sense, discipline and a plan can get investors started. As one better understands the influences on investment prices, they gains confidence and can address more adventurous investing.

We want to show readers how investing is closer to everyday life than many people think.

 

General Concepts

  • It is not what you make, it’s what you save. Pay yourself first!
  • Compound interest is the eighth wonder of the world; use it to your advantage!
  • The System is the solution-have a financial plan.
  • Buy straw hats in December- don’t pay retail, buy good values.

 

  • Know when to hold them, know when to fold them – you have to sell stocks to see capital gains.
  • Life is not fair; it is what you make of it.
  • Control your destiny or somebody else will.
  • Look to the past for events or fads that could affect future changes.
  • Know what you can change and accept/ adapt to what you can’t.
  • Just do it!

 

You have likely heard many of these quotes before and investors have used them to gain comfort with investing and minimize stress.

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Areas of investing

 The Investor

 The Investment

 The Investing environment

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Each area has its own considerations and skill sets. Let’s address each area separately.

 

The Investor

    The investor is the emotional part of the investment equation. This is the area where a person can determine how much time, money and effort he is willing to put into his financial and investing plan for retirement and other financial needs.

Some people are happy just to have certificate of deposits (CDs); some want their money to grow more in mutual funds or with a money manager; still, others like to do their own research.

The better you understand yourself, the better financial decisions you can make. Consider the following bullet points:

 

Know Yourself

 

  • Understand/know your interests, strengths and weaknesses.

 

  • Set goals (big and small) and reevaluate them throughout your life.

 

  • Teach yourself to adapt to change – watch for opportunities.

 

  • Disciple yourself and have a life plan.

 

  • Open your mind to see opportunities.

 

  • Imagine things from different perspectives for understanding.

 

  • Learn to enjoy life.

Know You Investor Self

 

  • Know your greed and fear levels and control them

 

  • Know the financial risks you are willing to take

 

  • Know the risks you are not willing to take

 

  • Know your investment goals

 

  • Know your timeframe needed to meet your investment goals.

 

Goal Planning

 

Define your goals and objectives. Make your plan using short and longer timeframes with easy to difficult goals.

 

Review and evaluate your goals and progress in meeting your goals and objectives.

 

Change or adjust your goals as needed.

 

Determine your goals by what you enjoy doing and by what you want out of life.

 

Develop Your Plan

 

Match your risk levels, time frame and investment goals to the investment products you understand and are comfortable with.

 

Make your plan flexible enough to change with market and personal financial conditions,

 

Start working your PLAN!!

 

Review the results of your plan and make any adjustments needed.

 

Know Your Investments

 

Only buy what you understand

 

Be comfortable with what you buy. Stress can cloud your thinking

 

Know how your investments should perform in different market conditions.

 

Know the benefits of diversification and use them in your plan.

 

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 Remember to control your emotions or somebody else will – and that can

be hazardous to your wealth!

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Investments

 

People invest to generate income and hopefully, future profits when they sell (a.k.a. speculation). Common examples are stocks, bonds, CDs, real estate, future contracts, currencies, commodities, and anything else Wall Street and others can sell.

“Experts” (Wall Street, appraisers, colleges, individuals, advisors, newsletters and charlatans) use a variety of methods to evaluate investments.

Consumers can find financial performance reports to calculate a value (or range of values) for their investment. A bond pays a specific amount over a specific time, a stock pays dividends and generates sales and earnings; real estate collects rents.

Stock (equity ownership) investments can produce sales, earnings, cash flow, dividends and risk of default but they do not produce prices.  The investor buyer and the investing environment determine an investment’s value.

Investments perform at different levels that can affect price. Some levels are consistency and quality of earnings, dividend payment record, likelihood of interest and principal being paid and condition of the asset.

There is a third type of investment that goes along with income and hope for capital gains; it is the store of value. Gold, silver, art are examples of store of value assets. They don’t generate any income and can have wide price fluctuations. They are alternative “currencies” to fiat currency when it is not accepted in uncertain times.

Most investments compete with each other on a yield basis. Bonds and CDs pay interest rates and stocks pay dividends and earnings yield. Real estate offers a cash flow yield. Compounding money is the objective of many investors.

There are investments to fill any investor’s or speculator’s objective. The investor needs to know which asset best fits his goals and comfort levels.         

 

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The Investing Environment

The investing environment is when investors, investments, real world activities, history and theory collide to create prices.

Real estate values are determined by local conditions, rate of return on investments and borrowing costs. Other asset classes are typically influenced by supply and demand for that asset, potential rate of return and borrowing costs. Commodity prices are factors of supply and demand and financing costs.

Stocks and bonds are available in small units, which makes it possible for more people to own and benefit from income and potential profits. Let’s look at stocks and bonds.

 

Determining Prices

The foundation for valuing stocks and bonds begins in 1903 with books and academic research. These books include:

 

  • Bonds-The Principles of Bond Investment by Lawrence Chamberlin, 1911

 

  • Stocks Fundamental Security Analysis by Benjamin Graham, 1934
  • The Theory of Investment Value by John Burr Williams, 1938
  • Stocks Technical Analysis-the Dow Theory originated by Charles H. Dow (published in The ABC of Stock Speculation by S. A. Nelson, 1903

 

  • Common Stocks as Long Term Investments by Edgar Lawrence Smith, 1924. Smith “proved” that common stocks have consistently been extremely attractive as long-term investments. Allegedly, this book contributed to the roaring twenties market rally.
  • Modern Portfolio Theory by Harry Markowitz, 1950s and Efficient Market Theory by Eugene Fama, 1960s explain MPT and EMT theories that manage risk/rewards in markets that Fama concluded were too efficient to predict prices.

 

These theories were based on mathematical formulas and academic research that Wall Street used to justify investment risks for return on assets that could be measured and managed by rebalancing asset allocations groups. Individual stock prices aren’t considered for risk/reward. Computer programs and borrowed money (leverage) have become increasingly popular.

 

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MPT is now the Prudent Investor Rule superseding the Prudent Man Rule of 1830. Fiduciaries no longer seem to have to be concerned with return OF assets or Compounding benefits with MPT. The Rule also tells the Prudent Man how to think.

 

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When investors have strong confidence in their formulas, they often borrow a lot of money leaving no margin of error.

Throughout the 1900s, theories and formulas have measured price movements and have created value ranges. When prices rise above the top range average, they become over-valued and eventually fall. The reverse is true on the downside.

Below are a few of the basics that cause price changes regardless of what the formulas, governments or opinion makers say. As these basics go to extremes or shift in a long lasting correlation, prices will change daily and over time.

 

Basic economic facts:

Compound Interest • Supply and Demand •

Competition • Marketing

 

Basic Human nature:

Greed • Fear • Jealousy • Envy • Hope

 

Basic Market Movers:

Expectations • Perceptions • Illusions

 

 INFO FOR BOX VVV

In time, excesses correct, which forces change, creates risks, uncertainty

and unexpected opportunities.

END OF BOX INFO

 

 

Economic Environments

The economy is where the influences converge. Economic indicators gauge the health and direction of the economy. The stock market is a leading indicator of the economy; it leads the economy up or down by six to nine months.

“Mr. Market” eventually reflects economic growth and direction but may be distracted by the games speculators play when there is extra money and credit is flowing.

A few areas that can change economic relationships for years, or even decades include government fiscal policies, taxes and regulations that have a major impact on the growth of the economy. If government wants to grow the economy, they can cut taxes, pass legislation encouraging growth and cut regulations.

When a government has a political agenda as a greater priority, the economy may stagnate or grow depending on the issues.

In 1913, Congress created the Federal Reserve (Fed) to do its bidding by managing the country’s money and credit. Congress no longer wanted to be responsible for a political football. In addition to managing the currency, Congress mandated the Fed to manage employment, which can create conflicting policies.

The Fed can increase or decrease money supply and credit as it sees fit. The Fed’s actions are not always in tune with the economic cycle and can cause unintended consequences in the stock, bond and other markets. Providing more money than the economy needs means extra money for speculative ventures. Too little money and credit can slow economic growth.

 

The economic cycle is centuries old. Typically, the cycle moves from boom to bust to boom again in five to seven years. Depending upon events that cause excesses or disruptions, the timeframe of the cycle is longer or shorter.

  • Natural disasters, weather or climate changes can cause major disruptions to an area of the economy for years or decades. Some changes may benefit one area while others hurt.
  • Geo-political events may cause worldwide changes and disruptions that can last for decades or centuries.
  • Investor/consumer psychology can change as events occur or as established trends begin to shift. The change in mood can cause markets or the economy to reverse direction.

 

The investing environment has the most influence on price movements.  The markets can only grow as fast as the economy; any gain higher than economic gain is likely to disappear in the long term. Political and geo-political changes may dramatically change your life and finances. Watch for changes and try to understand their consequences to your life.

 

     In this article, we covered many areas to acquaint you with the basics of investing. We want you to consider what factors may affect your situation and we believe that a good plan will help you avoid losses and have less stress.

     Happy investing!

 

 

 

 

 

Edson Gould

Edson Gould was born in 1902 in Newark and died in 1985 in West Reading PA.

Once he graduated from Lehigh University in 1922, he started to work on Wall Street for Moody’s and spent most of the rest of his life researching. He wanted to be an engineer but he became obsessed with finding the one factor beyond economic and monetary conditions that sparked the market.

Edson’s journey lead to forecasts right so frequently that the mere rumor of a change of would cause discernible market reactions. Everybody wanted to know what Gould had to say, but nobody wanted to believe or study his underlying reasons for his forecasts. When he died in 1985, history soon forgot him and his techniques. A quiet and simple man with reasonable simple methods (less profitable for academics and Wall Street) can easily be left to the pages of history.

INFO FOR BOX VVV

       “There are three factors that determine…the level of the stock market and the trend thereof. You can list them as economic, monetary and what I call psychological. Now, the monetary factors are always early, but they’re very important. They give you the early warning of a change. The economic factors are always late….And the so-called psychological factors that I use are concurrent.” Edson Gould

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Gould has been called the dean of technical analysis and the most accurate forecaster ever but he, and his methods, have gone by the wayside-just like the concepts of Charles Dow and his Theory.

Gould’s Senti-meter, calculated on the Dow Industrials dividends, and Dow’s concepts and theory create a great set of indicators for and investor to use for a successful investment program.

Gould was the first to suggest that fundamentals and monetary conditions alone couldn’t explain stock market behavior. Edson read the book “The Crowd” by Gustave Le Bon (see page 4) and after re-reading it he “came to the realization that the action of the stock market is nothing more nor less than a manifestation of mass crowd psychology in action”

      Edson created The Senti-meter to measure crowd psychology. It is described on page 2. The indicator shows how much investors are willing to spend for $1.00 of dividends. Kenneth Fisher has called the Price/Dividend Ratio “the single most powerful indicator of long term stock direction I’ve seen. It’s so simple, but inexplicably powerful”

 

Decennial Pattern

 

Edgar Lawrence Smith pioneered the Decennial Pattern in 1939. Gould used the Decennial Pattern as a cornerstone of his technical analysis.  Larry William in his book The Right Stock at The Right Time, wrote, that after studying Gould’s analysis of “the 10-year pattern for stock prices” he had “been handed, figuratively speaking, the keys to the kingdom of stock market forecasting.” The pattern is shown on page 3.

 

The Utility Barometer

 

In 1974, Edson Gould wrote an article that said he thought utilities were an early stock market indicator. He said they peaked and bottomed before the other indices by a few months.

Gould presented times when the utilities did lead the market down and up by a few weeks or more.

 

The “Gould Standard”

 

An investor should consider only sound companies with consistently strong earnings, they are the “Gould standard.” Avoid poorly managed companies, which regularly miss Wall Street expectations, they are hunks of lead.

Gould said to focus your holdings on proven winners – companies where investor psychology will always tip back in your favor – is the one of the best ways to remove uncertainty and emotion from your portfolio.

Psychology Extras

Henry Howard Harper wrote The Human Element in Stock Market Transactions in 1926. Since 1924, the Dow Industrials had risen 88%. The introduction reads, “Harper’s human behavior material gives us insights into handicapping prejudices that ruin our stock market theories and sound resolutions.”  Since then, securities laws have been enacted to make some actions illegal but somehow human nature tries to find ways around them.

We present a few selected stories for your consideration.

 

There is but one way to beat the stock market; there are many ways of being beaten by it

 

The sagacious financiers admit that the only sure way to make money trading in the stock market is to get in and out at opportune times and to stay out most of the time. Against this are numerous ways of losing money. One method is quite popular among a class of traders who, although too clever and conservative to buy stocks at “top” prices, do not have the patience to wait for “bottom” prices. When values begin to crumble after the top has been reached in a bull market there must be a set of “carriers” (or support), onto which stocks can be dumped on the way down. The market does not collapse like a ten-story house of cards; it generally goes down gradually for a while, one or two flights at a time and finds steadying thrusts every now and then, which sustain it for brief periods.

For instance, a stock paying $5 per share annually, has been hoisted by degrees from $75 to $150 a share. When it descends to $140 a few wise

traders who have been impatiently waiting for a the

reaction, will buy it because it looks cheap at $140 after having sold at $150; then at $130 another lot of traders who are a little wiser and more patient than

The first lot, buy because it looks much cheaper that it did even at $140; and so on down. The stock finds these temporary supports until eventually, it drops back to $75, or perhaps even lower. At that time, it is accumulated by a few shrewd investors and bargain hunters who’s attention has been attracted to the market by front page newspaper headlines, which announce that the stock market is in a state of complete prostration.

Those investors then go on about their business and pay no attention to the market until the price has recovered to appoint where the stock, returning $5 a share is no longer “paying its board.” Then, they sell out at a good profit and stay out while the speculators carry it on up as far as they like.

When the stock was at the bottom price, those who bought it on a scale from $140 down were either so overloaded or pessimistic—probably both—that they were unable to buy more and thus reduce their average to a reasonable cost.

 

Excerpts from The Pernicious

Influence of the Ticker Tape

 

    The individual who trades or invests in stocks will do well to keep away from the stock ticker; for the victim of “tickeritis” is no more capable of reasonable, self-composed action than one who is in the delirium of typhoid fever.

The gyroscopic action of prices recorded on the ticker-tape produces a sort of mental intoxication, which foreshortens the vision by involuntary submissiveness to momentary influences. It also produces on some minds an effect somewhat like  one might feel after standing for a considerable time, intently watching Niagara Falls. Dozens of people without any suicidal intentions, have been drawn into the current and dashed on the rocks below. Every day, thousands are influenced by the stock ticker to commit the most foolish blunders.

As a camera fails to record a true picture if placed too close in juxtaposition to the object, so in studying the ticker tape one is restricted close-up view of conditions, resulting in a distorted gauge of values. The figure recorded often misleads and confuses the attentive observer. In fact, it frequently happens that the price fluctuations result from a wave of hysteria among a coterie of traders and has but little analogy to the true value of the stocks.

To illustrate this point more explicitly, the stock of almost any conservatively capitalized and well managed concern paying $6 in annual dividends has an investment value from $85 to $100/share; but in the ups and downs of the market, the stock gets buffeted about on the exchange in response to the varying sentiments of traders, sometimes selling as low as $50, and at other times as high as $150, without any change whatever in the company’s earnings prospects, or its management. It does not follow that who keeps in touch with the stock market by telephone, or through daily papers, will find his path free from thorns and snares. But, he will at least have a more open perspective than one who submits to the influence of the ticker.

Any intelligent trader may reason out exactly what he ought to do under specific conditions; but in the quickly shifting and uncertain process of determining values, he loses his mental poise. Experience proves that anyone whose reasoning faculties become confounded is apt to be affected by some form of hysteria and will frequently do the opposite of what he would do under normal conditions.

The most unreliable financial writers are the market “tipsters,” who write daily letters of advice to an army of subscribers and claim to have positive knowledge of what certain stocks or groups of stocks are going to do marketwise. They often profess to have definite “inside information,” which any subscriber may receive at a stated price, ranging anywhere from $10/month and up. These false financial prophets, who lead a horde of blind followers, should not be confused with reputable bureaus and statistical experts who base their opinions and their advice to clients on a logical analysis of general conditions.

Henry Fielding wrote an essay to prove that a man can write more informingly on topics of which he has some knowledge than on matters that he knows nothing about. He also believed that mankind is more agreeably entertained by example than by law. Therefore, it is not the purpose of this discourse to teach anyone anything, unless of course, something may be gained by example or suggestion.

There are four subjects on which advice, is generally wasted: politics, stock speculation, religion, and love. In these matters adults rarely follow the advice of others and when they do (if they profit by it) they take all the credit themselves. If they lose, they always blame the advisor. These are the universal laws of human nature.

Still, hundreds of thousands of people continue to play at gambling tables and hundreds of thousands speculate in stocks. Since trading in stocks has the appearance of being an easy way of making money, it is one of the most alluring pursuits of modern times. This very fact, although legalized, is susceptible of becoming one of the most dangerous habits known. It is dangerous for the confirmed addict because he is apt to lose and it distracts his attention from his business in daytime and frequently destroys his rest at night.

 

 

INFO FOR BOX VVV

There are four subjects on which advice, however good, is generally wasted:  politics, stock speculation, religion, and love; for in these matters adults rarely follow the advice of others.

END OF BOX INFO

Since it would be folly to advise people not to embark in commercial pursuits because statistics show that upwards of ninety per cent of business ventures result in failure, it would also be useless to caution people to not trade in stocks because it is a hazardous undertaking in which a peculiar sort of sagacity and self control are the only safeguards against certain disaster.

Prosperity in the stock market seems to encourage optimism, rashness and impatience in about the same degree that adversity discourages enterprise and aspiration. But there is far greater danger in excessive optimism than in excessive pessimism, because optimists are inclined to back their hopeful views by indiscriminate purchases of stock at high prices. Pessimists are seldom disposed to back their views at all.

This leads us to conclude that in stock trading, all speculators, whether experienced or inexperienced, are subject to inscrutable laws of psychology which Nature herself seems to have designed for the discomfort of those who play at the wheel of fortune.

 

INFO FOE BOX VVV

Gamesters and swindlers may play at Wall Street, but the game itself is as straight and legitimate as any business pursuit. As a matter of fact, it is one of the fairest and most open games ever played; a game in which every participant, man or woman, rich or poor, old or young, has an equal chance….

END OF BOX INFO

 

 

Many businessmen who should have learned from experience, still take the business situation as a guide to their stock market operations, although stock exchange history shows that the market turns up long before a period of business depression (recession) has run its course and likewise turns down six months or more before prosperity comes to a cause.

It is never safe to buy good stocks at figures well below their intrinsic worth. The element of gambling does not enter the picture until the market price has risen above the investment value. If the owner refuses to sell, or buys more (as the speculator usually does) he is gambling on the uncertain event that some individual or clique is going to pay him more than the stock is worth.

 

Speculators are Slaves of Sentiment

When the whole country becomes pervaded with an epidemic of bullishness the action of speculators is always directed by sentiment rather than judgment; and a market that is swept along be excited emotions is always dangerous…dangerous to go short and dangerous to be long of Hysterical “bulls” care nothing whatever about the earnings or dividend returns on a stock: the only note to which

they attune their actions is the optimistic slogan, “It’s going up!” And the higher it goes the more they buy, and the more their ranks are swelled by new recruits. A herd of stampeding cattle (cows no less than bulls) will rush blindly into a river, or butt their brains out against stone walls, trees or other obstructions; they also stampede every critter that happens along their path. Anyone who has ever witnessed a panic in a theater or auditorium, or in the stock market, need not to be told that under such circumstances men are only a little more sane than cattle.

Speaking of sentiment, it is remarkable to the extent the combined business and financial structures of the country are moved by this giant power. Like the biblical wind that blows, man hears the sound but knows not from where it comes or where it goes, sentiment springs up from comparatively insignificant or unknown sources. After playing havoc, it vanishes as suddenly and mysteriously as it came.

In a bear market, a train wreck, or the death of some financier, or an earthquake in Europe, will put the market off to the aggregate extent of hundreds of millions. However, one of the greatest bull markets in history found its chief impetus in the most universally devastating war the world has ever known.

 

In Conclusion

To sum up the situation, those who would make money speculating in the stock market should first understand that it requires as much caution and business acumen as any other money-making enterprise. It also helps to have some knowledge of the psychological handicaps. It also helps to be able to control one’s impulses, emotions and ambitions under the most heroic tests of human endurance.

All speculations, even the most conservative investments, have some slight element of risk. All lines of business are more or less a gamble; marriage is a gamble; political preferment is a gamble; in fact nearly everything in life, including our very existence is an uncertainly. However, people are not discouraged from entering into these ventures. Those who look only for certainties have far to search and little to find in this world.

 

 

Human nature influences all three areas of investments: the investor, the investment and the investing environment.

The three books below can help you get familiar with your emotions in the computer age.

In his book, Tape Reading and Market Tactics, (1931) Humphrey B. Neill suggests that a way to control your emotions is to have “an investment philosophy that considers fundamentals, technical action and market psychology.”

There are no good ways to curb your emotions but a solution to controlling them is to focus on the process and not the outcome, according to The Little Book of Behavioral Investing (2010) by James Montier

 In his book, Trading for a Living (1993), Alexander Elder suggests that if your emotions are causing losses and you want to control them, call Alcoholics Anonymous for their 12 steps to overcoming addictions.

 

 

 

                          

 

 

 

 

 

 

Investing and Farming

Like farming, when a farmer plants his crop, the investor is buying stocks. Like the farmer who watches his crop and waits for a harvest, the investor watches his stocks from day to day. Neither one knows how good the harvest will be because they are both subject to conditions beyond their control. The farmer must contend with Mother Nature and the investor has to contend with Mr. Market, who can be as fickle as the weather.

     Both the investor and the farmer should be humble and respectful of Mr. Market and Mother Nature because they can override anything a person or a group of people do. Both the investor and the farmer need to look out for various conditions can affect their crops and see how they can maximize their harvest any condition.

Both crops need to be nourished. Markets are hungry for corporate earnings growth, increased sums of money and credit at low interest rates. Markets and the economy normally rise with expanding amounts of money supply and credit.   

     Typically, an increase starts in a recession and continues until the economy and markets begin to overheat. When money and credits contract and interest rates rise too high, it resembles the beginning of a drought and the harvest/profits disappear. Know when to harvest early.

The farmer must contend with hail and wind; the investor has to contend with greed and fear – within both himself and the markets. Fear creates buying opportunities and greed creates selling opportunities. Both can create losses.

     The investor needs to control greed and fear or his harvest will be destroyed. Preserve values and profits by knowing how to control greed and fear to preserve values and profits.

To realize good harvests, learn about compounding, emotional influences, interest rates (and earnings yields), money supply and credit. Use them to your advantage.

Ten Ways to Lose Money in Wall Street

Ten Ways to Lose Money in Wall Street

By the Market Cynic

      After many hours of toil and deep thought, I have compiled a dependable guide for stock traders: Ten Ways to Lose Money in Wall Street.

I won’t attempt to explain or qualify these precepts, because my readers will doubtless follow them regardless of any advice, from any source, to the contrary.

 Put your trust in board-room gossip.

  1. Believe everything you hear, especially tips.
  2. If you don’t know, guess.
  3. Follow the public.
  4. Be impatient.
  5. Greedily hang on for the top eighth.
  6. Trade on margins.
  7. Hold to your own opinion, right or wrong.
  8. Never stay out of the market.
  9. Accept small profits and large losses.

(source: Tape Reading & Market Tactics by Humphrey B. Neill, 1931)

 

The opinions of past U.S. Presidents on the Federal Reserve

 

If congress has the right under the Constitution to issue paper money, it was given them to use themselves, not to be delegated to individuals or corporations. –Andrew Jackson

The Government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the Government and the buying power of consumers. By the adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity. –Abraham Lincoln

 Issue of currency should be lodged with the government and be protected from domination by Wall Street. We are opposed to…provisions [which] would place our currency and credit system in private hands. – Theodore Roosevelt

 Despite these warnings, Woodrow Wilson signed the 1913 Federal Reserve Act. A few years later he wrote: I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most  completely controlled and dominated Governments in the civilized world no longer a  Government by free opinion, no longer a Government by conviction and the vote of the majority, but a Government by the opinion and duress of a small group of dominant men. -Woodrow Wilson

Years later, reflecting on the major banks’ control in Washington, President Franklin Roosevelt paid this indirect praise to his distant predecessor President Andrew Jackson, who had “killed” the 2nd Bank of the US (an earlier type of the Federal Reserve System). After Jackson’s administration the bankers’ influence was gradually restored and increased, culminating in the passage of the Federal Reserve Act of 1913. Roosevelt knew this history.

(Source: Unknown)

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