This post is the first of hopefully many questions and answers. Feel free to post questions on the Facebook page, send us private messages, emails, or post on the MoneyTalk
forum. Most likely, numerous other people have similar questions or
thoughts. We will gladly answer any questions privately. Then, if we
feel that the question will benefit everyone, we will post it
anonymously on the page along with our response.
The following is the first question posted on the MoneyTalk Forum. Robert Cook gave the following response:
Question:
What
percentage of household income do you think should be saved? Also, what
political policies could be put in place to increase national savings
and lower the debt?
Answer:
Regarding what percentage of household income should be saved, that
depends on each individual situation and circumstances, as all things
relevant should be considered. Age, income, family obligations, debt and
so forth are a few of the salient factors.
If the person is young and not in debt, then as much as possible
should be saved at an early age, as it's a great habit to acquire early
in life.
If possible, ~10% of gross income seems about right to me, although there should be no hard and fast rules.
And if the person is working where employer matching funds are
available, at the very minimum he should save enough to get the maximum
match. That amounts to fifty cent pre-tax dollars in cost to him for
each dollar saved and invested.
In any event, each time the individual's income increases, he
should establish the habit of saving a substantial part of that
increase. He won't miss having the income since it's all 'new found
money' to him at that time.
Regarding the national debt and increasing national savings, we
should first follow the golden rule of hole digging and stop making the
hole deeper.
If that were to happen, over time the debt would become more
manageable as future income gains would reduce the percentage of debt to
the total.
And we should teach ourselves that there is no free lunch, despite what the vote seeking politicians may say.
And that the private sector is the only real productive sector,
and not the public sector that is ruled by our self serving 'public
servants.'
Productivity (more output for the same input or the same output
for less input) is and always has been the single biggest factor that
makes us a wealthy nation. Period.
Wednesday, July 27, 2016
Financial Success: The Marshmellow Test, Time, and the Rule of 72
This is my second post in a series on financial
planning. In my first post, I talked about
investing in yourself, which you are all doing by taking an interest in this
page. Today’s post will cover saving, time, and compounding, which Einstein
called the 8th wonder of the world.
Saving is a fundamental prerequisite for successful investing. By
saving and investing early and regularly, one can reap huge rewards down the
road. Saving isn’t about making a lot of money. It is about the willingness to
sacrifice or delay certain immediate gratification now for long term
results. This applies not only to investing but being successful in all life’s
endeavors. Consider this test which was
conducted in the late 1960’s by Walter Mischel, a psychologist at Stanford
University.
Professor Mischel called this experiment “The Marshmallow Experiment.” In his experiment, he placed children between the ages of four and six in a room with no distractions. He then offered them a treat of their choices such as a marshmallow or Oreo. He told the children he would be back in 15 minutes with another treat of their choice if they waited and did not eat their treat until he returned. The sample size was 653 children. At the end of the test, the majority ate the marshmallow within the 15 minutes. Roughly a third waited for the second reward. These results, nonetheless, are not the most interesting part of the test. The most interesting part of the experiment came from the data collected after reconnecting years later with these test.participants. Mischel, along with some help, was able to collect data on 185 of the original test participants. Ninety-four of them provided their S.A.T scores. Professor Mischel found that the people who deferred the immediate treat scored on average 210 points higher on the S.A.T than those who ate the treat in the original experiment. He also found correlations to obesity, response to stress and career success as a whole.
Professor Mischel called this experiment “The Marshmallow Experiment.” In his experiment, he placed children between the ages of four and six in a room with no distractions. He then offered them a treat of their choices such as a marshmallow or Oreo. He told the children he would be back in 15 minutes with another treat of their choice if they waited and did not eat their treat until he returned. The sample size was 653 children. At the end of the test, the majority ate the marshmallow within the 15 minutes. Roughly a third waited for the second reward. These results, nonetheless, are not the most interesting part of the test. The most interesting part of the experiment came from the data collected after reconnecting years later with these test.participants. Mischel, along with some help, was able to collect data on 185 of the original test participants. Ninety-four of them provided their S.A.T scores. Professor Mischel found that the people who deferred the immediate treat scored on average 210 points higher on the S.A.T than those who ate the treat in the original experiment. He also found correlations to obesity, response to stress and career success as a whole.
Early this month, Robert Cook, who
was a successful CEO and investor and a person that I consider one of my mentors,
shared this article.
The article revealed that most Americans are filled with regret when it comes
to financial matters:
Fully three
in four, in fact, admit they harbor financial regrets, according to a survey of more than 1,000 adults by Bankrate.com.
Their
biggest regret: not saving for retirement early enough (nearly one in five
Americans put this in the No. 1 spot). What’s more, among those 65 and up, 27%
said this was the biggest regret, compared with 17% of those aged 30 to 49.
Learning to sacrifice certain luxuries now and
save pays huge dividends. If a person saves $500 per month starting at age 23,
assuming a 7% return on investment, they will have $1,486,659 at the age of 65
despite only saving $246,000. On the other hand, if that same person waits
until 35 to start saving the same amount, he or she will only have $612,438 at
the age of 65. The person who starts at 35 will have to save over double ($1100)
per month to have the same amount of money at retirement.
How is this possible? Compounding. As stated previously,
Einstein called compounding the eighth wonder of the world. It is the Rule of
72 at work. The Rule of 72 is a simple rule with which every investor should be very familiar. This
general rule tells investors how often their money will double. If you take the
number 72 divided by the average rate of return on investment (interest rate),
you will get the number of years required for your money to double. For
example, if an investor earns and average annual rate of return of 8%, it will
take nine years for your initial investment to double.
Mr. Cook stated the following about the compounding
and the Rule of 72:
Accordingly, knowing enough not to panic when markets drop ~10% or so every few years is one fundamental aspect of personal investing success. And knowing how the rule of 72 can help you accumulate lots of assets down the road is also a fundamental aspect of long term oriented successful individual investing.
When Warren Buffet was asked for the single most powerful factor behind his investing success, he responded, “Compound interest.” It is what has made him a billionaire.
Summing Up:
Start saving early and often, buy solid blue chip companies that pay dividends, stay to course, and allow compound interest to work wonders.
Tuesday, July 26, 2016
Graham's Intelligent Investor is easy to recommend
***I initially wrote this for another purpose. But I reprinted it here after Matt told me he has copies for the (in person) KP Investment Club members of such books as The Intelligent Investor, A Random Walk Down Wall Street, and more investing classics.***
Twice this year I’ve recommended the “Intelligent Investor” to people who have asked for suggested investing reading. Author Ben Graham taught the famous Warren Buffet and he makes investing make all the sense in the world.
The only value I can hope to add is in the area of investing. I probably know nothing of value about speculating. Regarding investing, I focus on the notion that the money that is invested must not be needed for many years, and that we investors plan to at all costs stop ourselves from panicking and selling when things get scary. So when the money that is invested in the stock market is saved throughout your 20’s, investing it means not computing its availability to be accessed for pretty much any purposes. Any plans to reliably “flip” sums of money or double and triple it in only a few years are a strategies I know nothing about and that although Graham maybe does, he certainly doesn’t spend any time on it in the book except to caution strongly against it.
He says learning about investing when you have a lot of time to make mistakes with very little money at stake will train you for the decades in the future when you’ve saved enough to truly use what you’ve learned to take care of your financial self. So this book, and hopefully everything I share about investing, is every bit about the “long game” of working hard, saving, minding your fees and expenses, and taking care of your savings.
A big part of investing is understanding the fundamentals of economics and business. Equally big is understanding how we act and how that affects our investing results, what I think of as "behavioral finance." Hopefully I'll soon get to a book from that field, maybe Marshmallow Test, by Walter Mischel, or Thinking Fast and Slow, by Daniel Kahneman.
I'll soon share many more details about Graham's book.
And I'll also review Burton Malkiel's Random Walk Down Wall Street immediately afterwards before hopefully getting to the books mentioned above.
Twice this year I’ve recommended the “Intelligent Investor” to people who have asked for suggested investing reading. Author Ben Graham taught the famous Warren Buffet and he makes investing make all the sense in the world.
The specific things I would take from this book first if I were young and just starting out include the following:
Think hard about and make sure you understand what Graham means when he contrasts investing with speculating.
The only value I can hope to add is in the area of investing. I probably know nothing of value about speculating. Regarding investing, I focus on the notion that the money that is invested must not be needed for many years, and that we investors plan to at all costs stop ourselves from panicking and selling when things get scary. So when the money that is invested in the stock market is saved throughout your 20’s, investing it means not computing its availability to be accessed for pretty much any purposes. Any plans to reliably “flip” sums of money or double and triple it in only a few years are a strategies I know nothing about and that although Graham maybe does, he certainly doesn’t spend any time on it in the book except to caution strongly against it.
Also consider his advice to the “young doctor.”
He says learning about investing when you have a lot of time to make mistakes with very little money at stake will train you for the decades in the future when you’ve saved enough to truly use what you’ve learned to take care of your financial self. So this book, and hopefully everything I share about investing, is every bit about the “long game” of working hard, saving, minding your fees and expenses, and taking care of your savings.
A big part of investing is understanding the fundamentals of economics and business. Equally big is understanding how we act and how that affects our investing results, what I think of as "behavioral finance." Hopefully I'll soon get to a book from that field, maybe Marshmallow Test, by Walter Mischel, or Thinking Fast and Slow, by Daniel Kahneman.
I'll soon share many more details about Graham's book.
And I'll also review Burton Malkiel's Random Walk Down Wall Street immediately afterwards before hopefully getting to the books mentioned above.
Monday, July 25, 2016
Invest. Don't be sold to.
Matt has shared a great reading list that included Michael Batnick, author of the Irrelevant Investor blog who is also great to follow on Twitter (@michaelbatnick).
Batnick recently shared his suggested reading list, which is great and has a bunch of great quotes from some of the best ever investors.
Batnick's posts often surprise me initially but soon, after thinking about them, make great sense. Like today's, which points out that in a given year, 73% of investors' funds that flow from one fund to another flow into new funds with no track record! During the past decade, over 57,000 funds have been created so financial firms can sell them to individual investors.
Well buyer beware. I would think that even though "performance chasing" is real and often detrimental to performance, the one "screen" that would dominate among buyers of mutual funds would be that it at least have some history! And Morningstar, the creator of the report that is the source of the 73% statistic, seems to share my amazement at the figure. From the report's introduction section:
More from the report:
But as illogical as the idea is, to Morningstar and me, of new funds with no track records getting most of investors' "flows," I do get it. Products are made by producers to sell to consumers, or in this case investors. So common sense dictates that the sellers of these products will be successful persuading even this large a percentage of people to buy even such products as investment funds with no track records.
In theory I understand Batnick's prescription for investors who don't want to be sold what's best for the seller: get a good financial advisor to save you from playing this loser's game. But as he pointed out earlier in his post, the "bad advisors (my words)" are the intermediaries who influence the 73% now. So I think it would be hard to decide ahead of time first which financial advisor isn't just selling me junk and disregarding my interests, and second whether this advisor, even if he has my best interests in mind, will be worth what I'll pay him anyway.
I'll repeat here over and over that not paying people, or diligently limiting what you pay them, to help you invest is very effective in reaching your financial goals. So I suppose that's a bias of mine. The opportunity to be sold from an array of 57,000+ new funds these past 12 years is something I'm glad I missed.
Batnick recently shared his suggested reading list, which is great and has a bunch of great quotes from some of the best ever investors.
Batnick's posts often surprise me initially but soon, after thinking about them, make great sense. Like today's, which points out that in a given year, 73% of investors' funds that flow from one fund to another flow into new funds with no track record! During the past decade, over 57,000 funds have been created so financial firms can sell them to individual investors.
 |
| From the Morningstar report Batnick refers to. Link to download here. |
Well buyer beware. I would think that even though "performance chasing" is real and often detrimental to performance, the one "screen" that would dominate among buyers of mutual funds would be that it at least have some history! And Morningstar, the creator of the report that is the source of the 73% statistic, seems to share my amazement at the figure. From the report's introduction section:
More from the report:
But as illogical as the idea is, to Morningstar and me, of new funds with no track records getting most of investors' "flows," I do get it. Products are made by producers to sell to consumers, or in this case investors. So common sense dictates that the sellers of these products will be successful persuading even this large a percentage of people to buy even such products as investment funds with no track records.
In theory I understand Batnick's prescription for investors who don't want to be sold what's best for the seller: get a good financial advisor to save you from playing this loser's game. But as he pointed out earlier in his post, the "bad advisors (my words)" are the intermediaries who influence the 73% now. So I think it would be hard to decide ahead of time first which financial advisor isn't just selling me junk and disregarding my interests, and second whether this advisor, even if he has my best interests in mind, will be worth what I'll pay him anyway.
I'll repeat here over and over that not paying people, or diligently limiting what you pay them, to help you invest is very effective in reaching your financial goals. So I suppose that's a bias of mine. The opportunity to be sold from an array of 57,000+ new funds these past 12 years is something I'm glad I missed.
Sunday, July 24, 2016
PE
Matt just put out a post about metrics. The work on that led me to write this about the important PE ratio.
The price to earnings multiple tells us how much we would pay for each dollar of earnings. If all else is equal, the lower the multiple, the cheaper the stock. There are many versions of the PE, from the trailing twelve month (TTM) PE, to the forward earnings PE, to Shiller's cyclically adjusted price to earnings (CAPE) ratio. Here are instances when I find PE's especially useful (not an exhaustive list):
The price to earnings multiple tells us how much we would pay for each dollar of earnings. If all else is equal, the lower the multiple, the cheaper the stock. There are many versions of the PE, from the trailing twelve month (TTM) PE, to the forward earnings PE, to Shiller's cyclically adjusted price to earnings (CAPE) ratio. Here are instances when I find PE's especially useful (not an exhaustive list):
Example using PE
The TTM PE seems to be the most commonly used version, especially in summaries of stocks at financial websites. When I research individual stocks, I usually start at this screen, or one like it:
The PE's best use here is to reinforce the other important figures. The two most telling things on Microsoft's (MSFT) screen are the revenue and EBITDA (cash flow) figures. $85 and $27 billion reinforce the company's status as one of the most wildly profitable in history. The 2.55% dividend yield proves they send money to shareholders at a higher right than the average for S&P 500 companies.
Along with the $447 billion market cap (the total market value of the company), the 27 PE verifies that this company is no secret and that it will not be "easy" to make money owning it.
Continuing the query into MSFT will show how I use another version of the PE multiple. Knowing 27 slightly higher than the benchmark S&P 500 TTM PE of 25, I next wonder how it relates to its tech industry peers:
Google really is the best for directing me immediately toward the work of the best experts. Yardeni's packet of Forward P/Es is exactly what I want.
The exclusive use here of Forward P/Es (and not TTM) reminds me that after the very first search of a company, I usually never consider the TTM again. (Another useful version is Shiller's CAPE, but more on that later hopefully.) The Forward P/Es of course use estimates of future earnings, which because they are a form of future telling are inherently inaccurate, but they represent the best wisdom of the professionals who follow the companies and therefore are great for telling you exactly what you want to know: the optimism (or pessimism) of the market participants as reflected in the multiple.
So of course the TTM uses a more accurate picture of earnings because it uses what was earned in the past. But we aren't looking for an earnings number right now. We are asking how much the market likes the company, and therefore how expensive it is, versus its peers.
But first I have to calculate MSFT's Forward P/E:
56.57 (current quote) divided by 2.90 equals a Forward P/E for MSFT of 19.5, which you can see represents a premium versus the tech sector average:
As always the PE analysis I did here serves to help understand how investors value MSFT. The next steps in evaluating the investment opportunity have less to do with its PE, so I'll stop here for now.
Future post: CAPE
The PE's best use here is to reinforce the other important figures. The two most telling things on Microsoft's (MSFT) screen are the revenue and EBITDA (cash flow) figures. $85 and $27 billion reinforce the company's status as one of the most wildly profitable in history. The 2.55% dividend yield proves they send money to shareholders at a higher right than the average for S&P 500 companies.
Along with the $447 billion market cap (the total market value of the company), the 27 PE verifies that this company is no secret and that it will not be "easy" to make money owning it.
Continuing the query into MSFT will show how I use another version of the PE multiple. Knowing 27 slightly higher than the benchmark S&P 500 TTM PE of 25, I next wonder how it relates to its tech industry peers:
Google really is the best for directing me immediately toward the work of the best experts. Yardeni's packet of Forward P/Es is exactly what I want.
So of course the TTM uses a more accurate picture of earnings because it uses what was earned in the past. But we aren't looking for an earnings number right now. We are asking how much the market likes the company, and therefore how expensive it is, versus its peers.
But first I have to calculate MSFT's Forward P/E:
Future post: CAPE
Fundamental Indicators
Focusing on certain metrics is one of the best ways for value investors to out preform the market as a whole. There is no exact way to analyze a company’s strength. Numbers aren’t everything and can be misleading at times. However, it is always a good idea to use fundamental analysis rather than solely gut instincts. Additionally, it is important to understand the significant difference between fundamental analysis and technical indicators. At the most basic level, fundamental analysis uses financial statements to judge the quality and price to own a business while technical analysis uses charts and figures to judge how other investors and traders view the business.
Expounding further, fundamental analysis looks at the balance sheet, cash flow statement, and income statement to determine a company’s value (intrinsic value). By using this method, investors can make determinations if the current trading price of the stock is above or below its intrinsic value. If the current price is below the intrinsic value, the stock is considered a good investment. Value investors are not as concerned about the supply and demand (fluctuations) of the stock market. They choose stocks based on their overall potential as a company. Consider this quote from Ben Graham:
But note this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.
On the other hand, technical traders believe that the strength of the company is reflected in the stock price. Therefore, they believe that the information that is most important can be found by analyzing charts. Value investors, including Warren Buffett, call this approach speculation. Ben Graham stated the following:
There is a lot of juggling with figures that can be done now as always; but none of these methods in itself gives a dependable results. To a great extent the figures selected are determined by the general attitude of the man who is selecting them, and that general attitude is very often determined in turn by what the stock market has been doing. When the stock market is at 750 you take an optimistic attitude and use some favorable figures; but if it should have a severe decline most people would jump back to the older and more conservative evaluation methods
Now, with respect to stock market forecasting as such, as a separate occupation or amusement, I don’t there is any good evidence that a recognized and publicly used method of stock market forecasting can be relied upon to be profitable. Let me illustrate what I mean by reference to the famous “Dow Theory”…I found that when I studied the record from 1898 to 1933, a period of about 35 years–the results from following this mechanical method were remarkably good…in the 1920’s and early 1930’s, the public’s interest in the Theory increased enormously…The Dow Theory became extremely popular after 1933. I studied the consequences of using exactly the same method in the market after 1933, and I found peculiarly enough that in no case in the next 25 years did one benefit through following the Dow signals mechanically.
I, along with Buffett and Graham, believe in value investing, and a good place to start is by looking at the metrics listed below. But, first, as a disclaimer, these metrics are extremely useful but by no means paint the entire picture. A former student of Graham recalls a story in this video where Graham spent an hour comparing companies “A” and “B.” The class determined that company “A” appeared cheaper than company “B” only to find out that that the two companies were in fact the same company. The important lesson here is to use the metrics below while keeping in mind the overall context of the company, industry, and historical data.
Finally, consider this quote by Graham, which is also in the link above. Graham said,"If you want to make money on Wall Street, you must have the proper physiological attitude. No one expressed it better than the Philosopher Spinoza. ‘You must look at things in the aspect of eternity.’”
*The links below lead to general definitions of suggested metrics to consider. In future posts, we will go into more detail about how to use these metrics.
Expounding further, fundamental analysis looks at the balance sheet, cash flow statement, and income statement to determine a company’s value (intrinsic value). By using this method, investors can make determinations if the current trading price of the stock is above or below its intrinsic value. If the current price is below the intrinsic value, the stock is considered a good investment. Value investors are not as concerned about the supply and demand (fluctuations) of the stock market. They choose stocks based on their overall potential as a company. Consider this quote from Ben Graham:
But note this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.
On the other hand, technical traders believe that the strength of the company is reflected in the stock price. Therefore, they believe that the information that is most important can be found by analyzing charts. Value investors, including Warren Buffett, call this approach speculation. Ben Graham stated the following:
There is a lot of juggling with figures that can be done now as always; but none of these methods in itself gives a dependable results. To a great extent the figures selected are determined by the general attitude of the man who is selecting them, and that general attitude is very often determined in turn by what the stock market has been doing. When the stock market is at 750 you take an optimistic attitude and use some favorable figures; but if it should have a severe decline most people would jump back to the older and more conservative evaluation methods
Now, with respect to stock market forecasting as such, as a separate occupation or amusement, I don’t there is any good evidence that a recognized and publicly used method of stock market forecasting can be relied upon to be profitable. Let me illustrate what I mean by reference to the famous “Dow Theory”…I found that when I studied the record from 1898 to 1933, a period of about 35 years–the results from following this mechanical method were remarkably good…in the 1920’s and early 1930’s, the public’s interest in the Theory increased enormously…The Dow Theory became extremely popular after 1933. I studied the consequences of using exactly the same method in the market after 1933, and I found peculiarly enough that in no case in the next 25 years did one benefit through following the Dow signals mechanically.
I, along with Buffett and Graham, believe in value investing, and a good place to start is by looking at the metrics listed below. But, first, as a disclaimer, these metrics are extremely useful but by no means paint the entire picture. A former student of Graham recalls a story in this video where Graham spent an hour comparing companies “A” and “B.” The class determined that company “A” appeared cheaper than company “B” only to find out that that the two companies were in fact the same company. The important lesson here is to use the metrics below while keeping in mind the overall context of the company, industry, and historical data.
Finally, consider this quote by Graham, which is also in the link above. Graham said,"If you want to make money on Wall Street, you must have the proper physiological attitude. No one expressed it better than the Philosopher Spinoza. ‘You must look at things in the aspect of eternity.’”
*The links below lead to general definitions of suggested metrics to consider. In future posts, we will go into more detail about how to use these metrics.
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