Category Archives: Building Wealth
Top Investing Rules
The number one rule of investing is: Don’t lose money. In other words, preservation of capital and management of risk are most important for investors than maximizing returns and income.
What follows are 10 proven rules of investing to make you a more successful — and hopefully to build wealth — investor.
Rule No. 1 – Never lose money
Legendary investor Warren Buffett stated that “Rule No. 1 is never lose money. Rule No. 2 is never forget Rule No. 1.” The Oracle of Omaha’s advice stresses the importance of avoiding loss in your portfolio. When you have more money in your portfolio, you can make more money on it. So, a loss hurts your future earning power.
What Buffett’s rule essentially means is don’t become enchanted with an investment’s potential gains. Instead, focus on downside investment risks and preservation of capital. If you don’t get enough upside for the risks you’re taking, the investment may not be worth it. Focus on the downside risk first, counsels Buffett.
Rule No. 2 – Think like an owner
Think like an owner. Remember that you are buying fractional ownership of companies, not just stocks.
While many investors treat stocks like gambling, real businesses stand behind those stocks. Stocks are a fractional ownership interest in a business, and as the business performs well or poorly over time, the company’s stock is likely to follow the direction of its profitability.
Investing involves an analysis of fundamentals, valuation, and an opinion about how the business will perform and produce cash in the future.
Rule No. 3 – Stick to your process
The best investors develop a process that is consistent and successful over many market cycles. Be discipline and don’t deviate from your process because of short-term challenges and market volatility.
One of the best strategies for investors: a long-term buy-and-hold approach. You can buy stock funds regularly in a 401(k), for example, and then hold on for decades. But it can be easy when the market gets volatile to deviate from your plan because you’re temporarily losing money. Don’t do it.
Rule No. 4 – Buy when everyone is fearful
When the market is down, investors often sell or simply quit paying attention to it. But that’s when the bargains are out in droves. It’s true: the stock market is the only market where the goods go on sale and everyone is too afraid to buy. As Buffett has famously said, “Be fearful when others are greedy, and greedy when others are fearful.”
The good news if you’re a 401(k) investor is that once you set up your account you don’t have to do anything else to continue buying in. This structure keeps your emotions out of the game.
Rule No. 5 – Keep your investing discipline
It’s important that investors continue to save over time, in rough climates and good, even if they can put away only a little. By continuing to invest regularly, you’ll get in the habit of living below your means even as you build up a nest egg of assets in your portfolio over time.
The 401(k) is an ideal vehicle for this discipline, because it takes money from your paycheck automatically without you having to decide to do so. It’s also important to pick your investments skillfully – here’s how to select your 401(k) investments.
Rule No. 6 – Stay diversified
Keeping your portfolio diversified is important for reducing risk. Having your portfolio in only one or two stocks is unsafe, no matter how well they’ve performed for you. So experts advise spreading your investments around in a diversified portfolio.
“If I had to choose one strategy to keep in mind when investing, it would be diversification,” says Mindy Yu, former director of investments at Stash. “Diversification can help you better weather the stock market’s ups and downs.”
The good news: diversification can be easy to achieve. An investment in a Standard & Poor’s 500 Index fund, which holds hundreds of investments in America’s top companies, provides immediate diversification for a portfolio. If you want to diversify more, you can add a bond fund or other choices such as a real estate fund that may perform differently in various economic climates.
Rule No. 7 – Avoid timing the market
Experts routinely advise clients to avoid trying to time the market, that is, trying to buy or sell at the right time. “Time in the market is more important than timing the market.” The idea here is that you need to stay invested to get compounding returns and avoid jumping in and out of the market.
And that’s what Veronica Willis, an investment strategy analyst at Wells Fargo Investment Institute recommends: “The best and worst days are typically close together and occur when markets are at their most volatile, during a bear market or economic recession. An investor would need expert precision to be in the market one day, out of the market the next day and back in again the following day.”
Experts typically advise buying regularly to take advantage of dollar-cost averaging.
Rule No. 8 – Understand everything you invest in
“Don’t invest in a product you don’t understand and ensure the risks have been clearly disclosed to you before investing,” says Chris Rawley, founder and CEO at Harvest Returns, a fintech marketplace for investing in agriculture.
Whatever you’re investing in, you need to understand how it works. If you’re buying a stock, you need to know why it makes sense to do so and when the stock is likely to profit. If you’re buying a fund, you want to understand its track record and costs, among other things. If you’re buying an annuity, it’s vital to understand how the annuity works and what your rights are.
Rule No. 9 – Review your investing plan and goals regularly
While it can be a good idea to set up a solid investing plan and then only tinker with it, it’s advisable to review your plan regularly to see if it still fits your needs. You could do this whenever you check your accounts for tax purposes.
“Remember, though, your first financial plan won’t be your last,” says Kevin Driscoll, vice president of advisory services at Navy Federal Financial Group in the Pensacola area. “You can take a look at your plan and should review it at least annually – particularly when you reach milestones like starting a family, moving, or changing jobs.”
Rule No. 10 – Stay in the game, have an emergency fund
It’s absolutely vital that you have an emergency fund, not only to tide you over during tough times, but also so that you can stay invested long term.
“Keep 5 percent of your assets in cash, because challenges happen in life,” says Craig Kirsner, president of retirement planning services at Stuart Estate Planning Wealth Advisors in Pompano Beach, Florida. He adds: “It makes sense to have at least six months of expenses in your savings account.”
If you must sell some of your investments during a rough spot, it’s often likely to be when they are down. An emergency fund can help you stay in the investing game longer. Money that you might need in the short term (less than three years) needs to stay in cash.
Investing is effectively about doing the right things and about avoiding the wrong things. And, it’s important to manage your temperament (emotions) so that you’re focused and disciplined to do the right things even as they may feel risky, scary or unsafe.
References:
https://www.bankrate.com/investing/golden-rules-of-investing/
Lessons of Warren Buffett
An understanding of the investing lessons of Warren Buffett.
1. Value investing works. Buy bargains which involve buying assets at a price below the asset’s intrinsic value. Value investing takes time, focus, discipline and patient, and is a hard process to implement and follow. It requires a lot of work to determine the fair value of a particular business. If investors could predict the future directions of the stock market, they would certainly not choose to be value investors. But no one can accurately forecast future prices. Value investing is a safe and successful strategy in all investing environments. The biggest obstacle for a value investor is to remain disciplined and patient in every circumstance the market and life might throw at him. Most people quit value investing and long- term investing for this exact reason: because they lack the discipline and cannot sit through periods of poor performance.
2. Quality matters, in businesses and in people. Better quality businesses are more likely to grow and compound cash flow; low quality businesses often erode and even superior managers, who are difficult to identify, attract, and retain, may not be enough to save them. Always partner with highly capable managers whose interests are aligned with yours.
3. There is no need to overly diversify. Invest like you have a single, lifetime “punch card” with only 20 punches, so make each one count. Look broadly for opportunity, which can be found globally and in unexpected industries and structures.
4. Consistency, discipline and patience are crucial. Most investors are their own worst enemies. Endurance and long-term perspective enables compounding.
5. Risk is not the same as volatility; risk results from overpaying or overestimating a company’s prospects. Prices fluctuate more than value; price volatility can drive opportunity. Sacrifice some upside as necessary to protect on the downside.
6. Unprecedented events (or Black Swan events) occur with some regularity, so be prepared.
7. You can make some investment mistakes and still thrive.
8. Holding cash in the absence of opportunity makes sense.
9. Favor substance over form. It doesn’t matter if an investment is public or private, fractional or full ownership, or in debt, preferred shares, or common equity.
10. Candor is essential. It’s important to acknowledge mistakes, act decisively, and learn from them. Good writing clarifies your own thinking and that of your fellow shareholders.
11. To the extent possible, find and retain like-minded shareholders (and for investment managers, investors) to liberate yourself from short-term performance pressures.
12. Do what you love, and you’ll never work a day in your life.
13. “The first rule of investing is to not lose money, the second rule is to never forget the first one,” states Warren Buffett. Loss avoidance must be the cornerstone of your investment philosophy. Investors should not stick to bonds or avoid risks at all, but rather that “an investment portfolio should not be exposed to losses of principal capital over five to ten years”, according to Klarman. This, concentrating on avoiding big losses is the safest way to ensure a profitable investing outcome.
14. Ignore Market Price Fluctuations which are completely unrelated to the value of the investment or asset. When the stock’s market price goes down, the investment may be seen as riskier regardless of its fundamentals. But that’s not risk. Investors should expect prices to fluctuate and should not invest in securities if they cannot tolerate market volatility.
15. Avoid Leverage At All Costs.
References:
Margin of Safety
“A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.” ~ Seth Klarman
Berkshire Hathaway CEO and Chairman, Warren Buffett, is known for his value investing approach, which involves finding companies that are undervalued by the market and investing in them for the long term. To invest like Warren Buffett, there are a few things you need to know.
- First, you need to have a clear understanding of what value investing is and how it works.
- Second, you need to be patient and be willing to hold onto your investments for the long term.
- Third, you need to have the discipline to stick to your investing strategy even when the market is going against you.
When deciding on how to invest in a company, the first step is to determine its worth or intrinsic value. According to Warren Buffett, the best companies to buy are those that are inexpensive to buy. His investment strategy is based on a few simple principles:
- Buy quality companies that have a competitive advantage (moat),
- Buy them at a reasonable price with a margin of safety, and
- Hold them for the long term.
These principles of margin of safety have helped Buffett generate incredible returns over his career. Margin of safety is a strategy that involves investing only in securities at a significantly lower intrinsic value than their market price.
The margin of safety (MOS) allows investors to avoid overpaying for an investment or asset, and it protects investors from the potential of loss if the market price of the asset falls. Buffett has said that the margin of safety is the key to his investing success.
The margin of safety is a measure of how much room there is between the price of the stock and its inherent value. The wider your margin of safety, the less likely it is that overly optimistic valuation inputs will harm your investment.
Value investing is the process of making investment decisions using margin of safety. It is critical for value investors to find a high-quality, easy-to-understand company with good management priced below its intrinsic value.
The purpose of using a margin of safety in buying is twofold.
- If your investment does not grow as quickly as you originally anticipated, you may be forced to make more conservative investments in your portfolio. If your estimates are correct, you will be able to achieve a better rate of return over time due.
- If you purchased the investment at an extremely low price.
Discounted cash flow (DCF) is a method of valuing a company or asset using the principles of time value of money.
The objective of DCF is to find the value of an investment today, given its expected cash flows in the future. One popular way to value a company is using the discounted cash flow (DCF) method. This approach discounts a company’s future expected cash flows back to the present day, using a required rate of return or “hurdle rate” as the discount rate. The idea is that a company is worth the sum of all its future cash flows, discounted back to the present.
The DCF formula is: Value of Investment = Sum of (Cash Flow in Year / (1 + Discount Rate)^Year)
The “discount rate” is the required rate of return that an investor demands for investing in a company. This rate is also known as the “hurdle rate.” There are two ways to calculate the discount rate.
There are two ways to calculate the discount rate.
The first is the weighted average cost of capital (WACC). This approach considers the cost of all the different types of capital that a company has, including debt and equity.
The second way to calculate the discount rate is the discount rate for equity. This approach only considers the cost of equity, which is the return that investors demand for investing in a company.
Once the discount rate is determined, the next step is to estimate the cash flows that a company is expected to generate in the future. These cash flows can come from a variety of sources, including operating income, investments, and financing activities. After the cash flows have been estimated, they need to be discounted back to the present using the discount rate.
The present value of the cash flows is then the sum of all the future cash flows, discounted back to the present.
“If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it’s over the Grand Canyon, you may want a little larger margin of safety.” ~ Warren Buffett
References:
Warren Buffett’s Investing Top Four
“Don’t look at a stock like it is a ticker symbol with a price that goes up and down on a chart. It’s a slice of a company’s profits far into the future, and that’s how they need to be evaluated.” ~ Warren Buffett, Chairman and CEO, Berkshire Hathaway
Warren Buffett’s philosophy is simple. Buy with a “margin of safety” undervalued companies with strong fundamentals and balance sheet, and then wait. It’s possibly the most boring way to invest in the world. But it’s effective.
For Warren Buffett, deciding what stocks to buy is “simple but not necessarily easy,” according to CNBC Warren Buffett Guide to Investing.
In his Berkshire Hathaway 1977 annual letter to shareholders, he listed four attributes he wanted to see when investing, whether he’s buying the entire company for Berkshire, or just a slice of it as a stock.
1. “One that we can understand…”
When Buffett talks about “understanding” a company, he means he understands how that company will be able to make money far into the future.
He’s often said he didn’t buy shares of what turned out to be very successful tech companies like Google and Microsoft because he didn’t understand them. At the 2000 annual meeting, a skeptical shareholder told Buffett he couldn’t imagine him not understanding something. Buffett responded, “Oh, we understand the product. We understand what it does for people. We just don’t know the economics of it 10 years from now.”
2. “With favorable long-term prospects …”
Buffett often refers to a company’s sustainable competitive advantage, something he calls a “moat.”
“Every business that we look at we think of as an economic castle… And you want the capitalistic system to work in a way that millions of people are out there with capital thinking about ways to take your castle away from you, and appropriate it for their own use. And then the question is, what kind of a moat do you have around that castle that protects it?”
— 2000 BERKSHIRE ANNUAL MEETING
A “moat” consists of things a company does to keep and gain loyal customers, such as low prices, quality products, proprietary technology, and, often, a well- known brand built through years of advertising, such as Coca-Cola. An established company in an industry that has large start-up costs that deter would be competitors can also have a moat.
3. “Operated by honest and competent people …”
“Generally, we like people who are candid. We can usually tell when somebody’s dancing around something, or where their — when the reports are essentially a little dishonest, or biased, or something.
And it’s just a lot easier to operate with people that are candid.
“And we like people who are smart, you know.
I don’t mean geniuses… And we like people who are focused on the business.” — 1995 BERKSHIRE ANNUAL MEETING
The quality of the business itself, however, takes precedence.
“The really great business is one that doesn’t require good management. I mean, that is a terrific business. And the poor business is one that can only succeed, or even survive, with great management.” — 1996 BERKSHIRE ANNUAL MEETING
4. “Available at a very attractive price.”
“The key to [Benjamin] Graham’s approach to investing is not thinking of stocks as stocks or part of a stock market. Stocks are part of a business. People in this room (Berkshire shareholders) own a piece of a business. If the business does well, they’re going to do all right as long as they don’t pay way too much to join into that business. — 1997 BERKSHIRE ANNUAL MEETING
Buffett’s goal is to buy with a “margin of safety” or when the market price is below a company’s “intrinsic value.” Buffett has said that the margin of safety is the “most important concept in investing.”
“The three most important words in investing are margin of safety…” ~ Warren Buffett
“The intrinsic value of any business, if you could foresee the future perfectly, is the present value of all cash that will be ever distributed for that business between now and judgment day.
“And we’re not perfect at estimating that, obviously.
“But that’s what an investment or a business is all about. You put money in, and you take money out.
“Aesop said, ‘A bird in the hand is worth two in the bush.’ Now, he said that around 600 B.C. or something like that, but that hasn’t been improved on very much by the business professors now.” — 2014 BERKSHIRE ANNUAL MEETING
References:
Focus, Discipline and Patience are Wealth Building Super Powers!
Gratitude
“I have every possession I want. I have a lot of friends who have a lot more possessions. But in some cases, I feel the possession possesses them, rather than the other way around.” ~ Warren Buffett
Never allow all the things you selfishly covet or you want make you forget about all the things you have or currently possess. Put a little gratitude in your life today and be thankful for all you already possess.
Moreover, happiness doesn’t mean everything is pleasing or perfect. Instead, happiness means that you can choose to see beyond the problems and imperfections, and embrace an attitude of gratitude.
The endless pursuit of hollow amenities and fruitless assets that barely add any value to your life are often so intoxicating that people loose sight of things that truly make them happy and bring them joy such as personal relationships, joy and peace in abundance.
“Sometimes you have to stop staring at your problems and start seeing how beautiful life really is.” ~ Anonymous
Don’t wait for great. Be Great everyday! Don’t allow a little negativity keep you from feeling grateful for everything that is going right and for everything that is good and pleasing in your life.
Gratitude must become a 24 hour / 365 day mindset, so that you don’t take what you have for granted.
Research shows that gratitude can:
- Help you make friends. One study found that thanking a new acquaintance makes them more likely to seek a more lasting relationship with you.
- Improve your physical health. People who exhibit gratitude report fewer aches and pains, a general feeling of health, more regular exercise, and more frequent checkups with their doctor than those who don’t.
- Improve your psychological health and emotional well-being. Grateful people enjoy higher wellbeing and happiness and suffer from reduced symptoms of depression.
- Enhance empathy and reduces aggression. Those who show their gratitude are less likely to seek revenge against others and more likely to behave in a prosocial manner, with sensitivity and empathy.
- Improve your sleep. Practicing gratitude regularly can help you sleep longer and better.
- Enhance your self-esteem. People who are grateful have increased self-esteem, partly due to their ability to appreciate other peoples’ accomplishments.
- Increase in mental strength. Grateful people have an advantage in overcoming trauma and enhanced resilience, helping them to bounce back from highly stressful situations.
References:
May you have Peace, Joy and Patience in Abundance!
Federal Reserve Policy and the Stock Market
“Don’t Fight the Fed” is an old market cliché that was very applicable during the longest bull market in US history. It is also very applicable currently as the Fed implemented policies to slow the economy by raising interest rates and selling assets from its balance sheet. ~ Chris Vermeulen, Seeking Alpha
In 1977, the US Congress officially gave the Federal Reserve a multi-part mandate to maximize employment, maintain prices near an acceptable inflation target of around 2%, and moderate long-term interest rates. In general terms, Fed policies are supposed to stimulate the economy when it’s weak and cool it when it’s too hot.
The adage highlights the strong correlation between Federal Reserve policy and the direction of the stock market.
“Don’t Fight the Fed” embodied the sentiment that if the Fed was stimulating the economy with accommodative policies, it made little sense to bet against the market’s bullish trend. Effectively, when the Federal Reserve’s monetary policy is loose, markets tend to move higher, volatility is subdued, and investors’ risk is limited, so it makes sense to stay invested and ride the wave. Why “fight the Fed” by selling stocks when it’s on your side?
The Fed held interest rates near zero and instituted a policy called quantitative easing—where it bought mortgage-backed securities and U.S. Treasuries to increase the money supply in hopes of spurring lending and capital investment.
When the Federal Reserve is on a mission to slow the economy down in order to tap down inflation, technology and growth stocks are generally hurt as the cost of capital and borrowing money increases. Thus, the old adage, “Don’t fight the Fed” becomes an important one for investors to abide.
With inflation being persistent in the U.S., Fed officials have taken a new monetary stance that is far less appealing for investors.
The Fed is in Quantitative Tightening mode and has raised interest rates and sold assets from its balance sheet. This calendar year, the Fed has raised interest rates four times and has begun shrinking its balance sheet after years of quantitative easing pushed its holdings to nearly $9 trillion. Its intent is to cool the economy and reduce inflation.
The adage, “Don’t fight the Fed”, is a warning to avoid stocks, or at least to take a more conservative approach to investing.
As a result, investors should take a more cautious approach in this tightening environment and prioritize defensive stocks with pristine balance sheets and steady revenue growth that can survive inflationary pressure.
Inflationary economies tend to punish unprofitable technology and growth companies, despite their potential. Without profits or cash flow, it’s simply too hard to improve quarter over quarter at a time when money becomes more expensive to borrow.
References:
Assessing Small Capital Companies
Historically, small-cap stocks have been shown to outperform the rest of the market because of greater growth opportunities. A massive company is limited by its existing size. ~ U.S. News and World Report
Small cap company pundits recommend that investors review several key financial metrics and ratios to properly evaluate small cap companies. Following these metrics and ratios, you will be well on your way to finding a few hidden gems in the small cap market.
Each small cap company should be evaluated on fundamental factors to identify which ones can exhibit durable long-term growth.
- Growth measures include revenue growth rate;
- Profitability measures include operating profit and earnings per-share; and
- Capital efficiency measures include return on invested capital.
In short, investors should seek to invest in the top-tier of eligible small cap companies .
Here are seven key metrics that should be reviewed before buying any stock. These indicators should help you get most of the way in understanding a company, its operations, and its underlying business.
1. Institutional activity. Pension funds, mutual funds, hedge funds, insurance companies and corporations that buy and sell huge blocks of shares can create tremendous volatility in prices. To lessen this risk in your investments, try to buy shares in companies where institutions own less than 40% of their shares.
2. Analyst coverage . Another indication of future share volatility is the number of Wall Street analysts covering a stock. Analysts – like the big institutions – have a herd mentality. When one sells, so do the rest, resulting in great numbers of shares changing hands, and usually leading to price declines. It’s best to avoid companies with more than 10, or fewer than 2 analysts following them. (You need some analyst interest or you may be waiting a long time for price appreciation, even in the strongest and most undervalued company) .
3. Price-earnings ratio (P/E) . The price of one share of a company’s stock divided by four quarters of its earnings per share, the P/E ratio is of utmost importance in determining if a company’s shares are over- or under-valued. For the best perspective, go to Reuters , then select Ratios and compare the current P/E of the company to its average P/E for the last 3-5 years, to its estimated future P/E and to the average P/E of its industry or sector. One note: If a company’s P/E is more than 35, it might be too pricy. You may want to stick with companies that are trading at lower P/Es, particularly if you are fairly new to investing.
4. Cash flow. One of the most important parts of a financial report is its Statement of Cash Flows, which is a summary of how the company made and spent its money. The Total Cash Flow From Operating Activities represents the cash the company took in from its primary business operations.
It’s important that this number be positive, or at least trending positive over the course of a year. After all, if the business isn’t making money from its primary product – not from investing in real estate or the stock market – then you probably want to pass it by.
5. Debt/equity. This ratio is how much debt per dollar of ownership the business has incurred. Compare the firm’s historic debt/equity ratios, so you can find out if its debt level over the past few years has been rising too rapidly. Debt isn’t bad, as long as it is used as a springboard to grow sales and earnings. Next, contrast the company’s ratio with its competitors and its industry so you can further determine if your company’s debt position is reasonable.
6. Growing sales and income. One rule of thumb is to buy shares in companies whose sales and net income are growing at double-digit rates. I cannot emphasize this enough, as, appreciation in stock prices is generally precipitated by growth in earnings (which usually follows expansion of sales) . It’s certainly possible to buy stock in a company that has no earnings growth (a new business, or a tech company in the late 90’s, for example) and still make money on the shares – short-term – but it’s not a formula for serious, successful long-term investing.
7. Insider activity. Investors will also want to review the buying and selling activities of a company’s insiders – its top officers and directors. A sudden rush to sell large quantities of the firm’s shares may be a good indicator that the business is falling on rough times. Likewise, a large increase in purchases may mean good news is on the way.
No single financial metric or ratio will determine the validity or potential of your investment. It is of utmost importance that you take a complete look at a company’s financial strength and its future growth prospects, by conducting a thorough analysis – over time – usually a 3-5 year track-record.
Many small caps stay small because they have structural problems, management lacks the capability to grow the business, or their niche simply isn’t large enough to support a bigger enterprise.
In contrast, many small cap companies can graduate to greater things, earning shareholders tremendous returns along the way.
References:
Warren Buffett: Morgan Housel’s Viewpoint
“Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win.” ― Morgan Housel, The Psychology of Money: Timeless lessons on wealth, greed, and happiness
More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact:
Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child, writes Morgan Housel in his seminal book, The Psychology of Money: Timeless lessons on wealth, greed, and happiness.
Warren Buffett’s estimated net worth is $110 billion as of November 2022. Of that, $109.2 billion was accumulated after his 50th birthday. $107.5 billion came after he qualified for Social Security, in his mid-60s. Warren Buffett is a phenomenal investor.
But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century.
Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Consider a little thought experiment. Buffett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inflation.16
What if he was a more normal person, spending his teens and 20s exploring the world and finding his passion, and by age 30 his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22% annually), but quit investing and retired at age 60 to play golf and spend time with his grandkids. What would a rough estimate of his net worth be today? Not $110 billion. $11.9 million. 99.9% less than his actual net worth.
Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. If you had invested $10,000 with Warren Buffett in 1966, today you would have over $160 million! That same $10,000 invested in the S&P would be $140,000.
Buffett’s skill is investing, but his secret is time. That’s how compounding works. Think of this another way. Buffett is considered by many to be the most famous and successful investor in history. But he’s not necessarily the greatest—at least not when measured by average annual returns.
“Doing well with money isn’t necessarily about what you know. It’s about how you behave. And behavior is hard to teach, even to really smart people.” ~ Morgan Housel
References:
- Morgan Housel, The Psychology of Money: Timeless lessons on wealth, greed, and happiness., Harriman House, September 8, 2020.
- https://www.goodreads.com/work/quotes/65374007-the-psychology-of-money
- https://www.celebritynetworth.com/richest-businessmen/richest-billionaires/warren-buffett-net-worth/
Small Cap Investing
A focus on finding small cap companies with great fundamentals and big growth prospects.
A small-cap stock is a stock of a publicly-traded company whose market capitalization ranges from $300 million to approximately $2 billion, explains Corporate Finance Institute. The word “cap” in this term refers to a company’s market capitalization.
Savvy investors cannot afford to overlook small-cap growth companies. Although, there are several pros and cons of investing in small-cap stocks that must be considered.
Small-cap companies, in general, tend not to get the same kind of publicity as their large-cap siblings. They aren’t going to lead a segment on CNBC or the home page of the Wall Street Journal on a daily basis.
With smaller market capitalizations, small-cap companies tend to fly under the radar.
The Rise of Small-Cap Stocks
Reasons that people may invest in small-cap companies are capital appreciation — they think the stock price will go up and dividends — where the company pays you to hold it.
But some of these are solid companies and excellent small-cap stocks to buy.
Small-cap equities are more sensitive to the economy (inflation, rising interest rates and dollar strength), so a robust economic rebound would favor them.
Small-cap stocks are popular among investors because of their potential for providing better returns in the long term relative to their large-cap peers.
The advantages of investing in small-cap stocks are:
1. Growth potential – Relative to bigger companies, small-cap companies show significantly higher growth potential. For small-cap companies, it is easier to grow significantly their operational and financial base than is the case for most large-cap stocks.
Picking the right small-cap stock can turn into a profitable investment.
2. High probability of inefficiencies in the market – Information about the small-cap stocks is harder to find compared to large and mid-cap companies. Analysts typically give little attention to these companies; thus, there is a high probability of improper pricing of small-cap stocks. This situation creates vast opportunities for investors to leverage the inefficiencies in market pricing and earn a great return on their investments.
3. Financial institutions do not push prices up – Financial institutions, including mutual and hedge funds, should comply with certain regulations that do not allow them to invest heavily in small-cap stocks. For this reason, it is unlikely that the stock price will be artificially pushed up because of large investments from major financial institutions.
Nevertheless, there are some disadvantages of investing in small-cap stocks:
1. High risk – Investing in small-cap stocks involves higher risk. First, small-cap companies may have an unreliable and faulty business model which can result in company’s management not being able to adjust the business model, and can result in poor operational and financial results. And, small-cap companies usually have less access to new capital and new sources of financing. Due to this reason, it is more likely that the company will not be able to bridge gaps in its cash flows or expand the business because of the inability to undertake the necessary investments.
2. Low liquidity – Small-cap stocks are less liquid than their large counterparts. Low liquidity results in the potential unavailability of the stock at a good price to purchase or it may be difficult to sell the stocks at a favorable price. Low liquidity also adds to the overall risk of the stock.
3. Time-consuming – Investing in small-cap stocks can be a time-consuming activity. Due to the under-coverage of small-cap stocks by financial media, institutions and analysts, the amount of available research on small-cap companies is usually limited.
Moreover, small cap technology and all small cap stocks are discounted to a great degree by investors in a rising interest rate environment, purely due to the fact that they have the bulk of potential earnings and cash flow far out into the future. The higher long-term rates are, the less those future earnings and cash flow are worth. This goes for virtually all unprofitable growth tech stocks.
Essentially, small-cap stocks may provide investors with an opportunity to earn a substantial return on their investments. However, this type of investing should be approached with caution as small-cap stocks are often risky and volatile.
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