News or Noise? The Importance of Doing Nothing

A friend of mine likes to say that, despite his love of flying, he'll never understand sky-diving. "Why would any sane person jump out of a perfectly good airplane?" The answer, of course, is maybe that no fully sane person would. Perhaps you need to be just a little bit crazy to want to try something so adrenalized, so mind-bendingly dangerous.  

Which is a lot like investing in individual stocks. It's unquestionably far safer to set our retirement fund to auto-purchase a little bit of an S&P 500 index every pay period (SPY), and then forget about it. We could just stay on the plane and land with it. But some of us are a little nuts. We believe we can reach the ground faster, and with a huge grin. 

In today’s stock market, it feels like huge swings come every day. The ups are easy, and we don’t much care where the surge originates. But the downs … It can seem like you're suddenly falling through the sky, but you don't remember jumping. Small news items ("The Federal Reserve might wait a little longer to cut interest rates by a quarter-percent..") send Wall Street traders reeling. Online forums are awash with so-called strategies to deal with the fallout and financial TV commentators scream "SELL!". 

Individual investors must struggle to keep our wits about us, and our portfolios intact. Chaos today distracts us from profits tomorrow. Some of us stare into the gloom and actually forget what our goals were, or how we intended to achieve them. The red in our portfolios combined with media frenzy generate real fear. 

It’s difficult to remember this is normal. Market moves sometimes feel like Armageddon. This is our life savings! But it happens, and we’ve seen it before. ‘Corrections’ take place every couple of years and substantial day-to-day swings happen all the time. 

When your assets are slashed by 2-4% in a day, it stings. Take a breath. Get a massage or a cocktail or go for a walk, and think it through. This is all just the other side of the coin on Wall Street. In fact, it’s the frightening moments like this that make public companies the fastest rising asset class over time. That speedy growth is a reward for the scary drops and the volatility. It’s what we signed up for, and it’s why we invest in stocks. 

You knew it would be difficult. Not because we don’t know how to do a discounted cash-flow model or what a moving average is supposed to mean and so, ultimately, we can’t decide what stocks to buy. In actuality those are just practical, tactical decisions and are not so tough. Analytical skills can be learned: understanding an income statement, debt ratios, competitive market analysis, and so on. We’ve talked about assessing businesses here before. And the 6 critical criteria. And what financial data matters.

What makes profitable investing so difficult to master is that it’s more an art than a science. To be among the very best individual investors you must have focus, grit, and an iron stomach. Especially, you must be able do something truly rare: manage your fear. 

Harder than it sounds. In fact, the overwhelming majority of mutual fund managers are no better hanging on through downturns than anyone else, even with their MBAs and years of practice. According to the New York Times last year, from 2017 to 2022, not one of the 2132 studied funds

You have to see through the haze caused by past  
performance, standard practice, and groupthink

beat the S&P 500 index every year. Not one! These are experienced professional managers. They're highly paid. They’ve been trained in deep math, asset diversification and market psychology. So then why? One reason is that the managers we hire are often more impacted by those tiny news items— ‘noise’— than the rest of us. They breathe CNN Financial and Fox Business and Bloomberg feeds all day long, so they have trouble seeing the forest for the trees. They care a great deal that there's threat of a product liability lawsuit, or that the C.F.O. retired, or that the 3rd quarter results were a little thin. How does that matter over a 10-20 year timeline? As a result many managed portfolios are all churn and no return. 

Investing is hard because we have to separate the news from the noise on social media, news sites, TV. If we sell every time things slide a little our investment strategy quickly morphs to ‘Buy high, sell low’. Tough to make money with that approach. 

Investing is hard because we have to ‘be greedy when others are fearful’— Warren Buffett's most-quoted line. Which is to say when those around us are panic selling and running for the hills, we need to stand brave, scouting for bargains to pluck even as the stampede worsens.

Investing is hard because we also have to ‘be fearful when others are greedy’: if the kids’ soccer coach and the plumber and the Uber driver are all talking about their Nvidia profits, it might well be time to trim our holdings and take a long trip— it’s going to get ugly. 

Investing is hard because it means decoding Wall Street jargon, a financial dialect deliberately conjured to confuse and scare us into hiring “experts” to manage our investments for a fat fee. 

Investing is hard because putting our savings into the market means not buying something fun today in the hope that we’ll have the ability to work less decades from now.

If Jim Cramer's 'Mad Money' was a stock, I'd sell

Perhaps most importantly, investing is hard because it means fighting the constant urge to do something, anything, to speed or improve our returns. When really what’s best is generally doing nothing at all. Investing well is boring stuff, a bunch of totally front-loaded decisions followed by years of sitting on our hands. 

But how else can we do it? Even the widest-held stocks these days are off-the-charts volatile (Microsoft, Tesla, Apple, Amazon, Nvidia), so the financial media machine uses that to frighten us and take our money. To protect us. The market has terrifying long drops, during which we watch our hard-won gains gutted. And never in all our schooling (even the MBAs!) do we get the emotional training for proper long-term investment strategy. 

A little crazy can be a good and necessary thing.

We're All Biased. Don't Let it Impact Performance

We all make judgments, big and small, on a constant basis: 

I'm pretty sure my car can fit in that space. $40 should be more than enough to spend on a gift for my nephew. Acid rock has no musical value. Neither of these presidential candidates is truly fit for office.

All the time, every day, we have to gauge our options and make a choice. And we believe we are generally being rational, that we have given consideration where appropriate. That we've assessed the available data and decided using sound, rational analysis.

But we haven't. More often than not, our emotions and our patterns are guiding those judgments from the shadows. This is as true in investing decisions as it is in ordering dinner. But for most of us it turns out to be much more expensive.

Recency Bias occurs when a memorable event in the immediate past colors thinking and decision-making: shark attacks have always been quite rare, but heavily publicized recent shark encounters around Cape Cod sway beach-goers to stay out of the water. For investors, a long bull market irrationally affects thinking about future market performance, making success seem inevitable. Or devastating losses after a market crash in the near past keep otherwise sensible investors from buying in.

To ensure you are not falling victim to recency bias, look further back than your own experience. Investigate a stock's history going back 5, 10, 20 years. Look at its industry and even the broader market over a longer span. In the longer view, any recent event seems relatively insignificant.

Loss-Aversion Bias is the idea that a stock in your portfolio which has declined since purchase should not be sold, because it "will come back up." Perhaps it will. Perhaps, in fact, it will return to and rise even higher than your purchase price. However, converting what is currently a "paper loss"— the lost value exists only on your brokerage statement— to a real loss by selling the stock at a lower price is fundamentally repellant; the human psyche often rejects as impossible those things which appear uncomfortable or painful, or dangerous. (see: Under Armour 2017-present.)

Getting around loss-aversion bias is tricky. Typically we must first disassociate our emotions from our stock holdings, not easy. (Do you own Microsoft? Netflix? Have you held them a few of years? Do you love them? There you go.) If you are successful in divorcing emotion, you need to get into the reeds on that devalued stock you own: 

• Are all the reasons you bought it still true? 
• Does it still have a strong competitive position? 
• Products solid, customer loyalty strong, management seems to know what it's doing? 
• Inventory levels look historically average? 
• Does the business still have more than enough cash for operations? 

If these are all true, then perhaps you are correct, and the stock will rebound and maybe you should pick up some more of it. If not, however, you'll need to do some more digging: the market clearly disagrees with your assessment.

Confirmation Bias is very common but virtually impossible to self-detect. It is the tendency to subconsciously run incoming information through a preexisting preference filter, such that we confirm what agrees with our beliefs and reject what does not. This can lead to ignoring important material events, such as the rise of a worthy competitor, the deterioration of the business's product pipeline, or a degrading of the company's executive decision-making. Or the business makes a sizable acquisition in a seemingly-unrelated field (why did AMC theaters buy a gold mine??). All these should be cause for concern.

This is not to say that no corporation can adjust to or recover from such events, as these things occur all the time even in very strong companies with fast-rising stocks. However, to counteract confirmation bias we must do an objective, detached examination of any developments which materially affect stock value. Sometimes a down stock doesn't come back up, it just goes down, and down ... (Zoom Video, a pandemic staple, just can't get its act together.)

Overconfidence Bias, just as it sounds, is the misperception that we have an edge where others do not. It stems from success, sometimes from success in completely unrelated areas. (The fact that you were a 300-level philosophy T.A. in college does not generally indicate you will be able to competently replace your own iPhone screen.) Do you know someone who felt super smart about their getting in on the run-up in GameStop or AMC stock during Covid? How do they feel about it now? 

The only way to overcome overconfidence bias is by questioning yourself and your data on a constant basis. Also, getting your butt handed to you a few times will also get the job done. Nothing to be ashamed of: no one who's been stock investing long enough can honestly say they've been burned from sheer hubris.

Action Bias is the most troublesome of all. Put simply, action bias is the tendency— the need— to do something, really anything, to fix your portfolio and goose your returns. But nearly always the most appropriate response, when earnings are reported or when news comes in, is to do nothing. No doubt you know all about this: ever thought about getting off a clogged freeway in favor of surface streets? Probably won't save you time, but at least you'll be moving, right?

Action bias gets everyone eventually. Russia is making gains in Ukraine, China's economy is sliding, Apple is being by the US Justice Dept, the election will disrupt the market ... Time to sell everything and cash in before it all goes to hell? No, time to sit on your hands. Or, Nvidia just keeps climbing, so obviously it's overvalued and we should sell and take the profits, right? Wrong, looks like the business is cheaper now (based on revenues and profits) than a year ago.

About 95% of the time, the correct reaction in these moments is to do nothing at all. You did your research early on, before you bought each of these stocks. You say you're in for the long haul, meaning 5-10 years or even more— this is your first home, or your kids' college tuition, or retirement funding. As a rule, don't make long term decisions on short-term news. If you are indeed doing careful analysis at the beginning, then once you own the company you must trust the managers that work for you, and trust your own earlier judgment.

And really, it's all judgment. Stock picking and stock investing is more art than science, no matter what you read about uptick volumes and Fibonacci retracement and resistance levels. No one knows what an individual stock is going to do, never mind the entire market. So do your homework, make your play, pay attention, guard against your own biases. Then do it again. And again. You'll do fine.

Portfolio Don'ts

Warren Buffet's 60-year investing partner, Charlie Munger— who died late last year one month shy of his 100th birthday—  famously said about the astonishing success of Berkshire Hathaway since the early 1960s: 

"It's not brilliance. It's just avoiding stupidity."  

But what comprises stupidity? Is it one-time foolishness or a pattern of dumb? A reckless mistake? A poorly devised strategy? Can someone of average intelligence achieve truly impressive investment returns? (I did.)

The reality is the list of don’ts in investing is probably longer than the list of do’s. But they're pretty much all quite intuitive. Which means they’re more accessible to regular folks who have never studied finance or who have crazy schedules and simply can’t put in the time to nail the details. Which is to say, if you can just avoid touching the third rail, you’ll probably do fine. 

 

Don’t invest in mutual funds.

I have previously expounded on this subject but I’ll nutshell it here: if you feel you aren’t ready to pick your own stocks, get yourself an online brokerage account at Morgan Stanley/E*Trade or Schwab/TD Ameritrade and pick up a couple of exchange traded funds (ETFs), which hold a basket of companies but trade as a single stock. The easiest are the large-basket ETFs like SPY and VOO which mimic the movement of the largest market index of 500 different stocks. 

 

If instead you insist on buying into a mutual fund, you’ll pay 1.25% of your assets per year for that fund manager’s ‘expertise.’ 1: something like 90% of those managers do not even keep up with the growth of the S&P 500 index, which you can have for a fraction of the cost (see SPY, above); 2: that cost becomes absolutely massive over time as your portfolio grows and that rate compounds; 3: your money will be much less liquid should you need to access it. It's like paying someone for the privilege of being robbed— you lose twice. Don’t believe me? Read this. 

 

Don’t worry about the price of a share unless you’re spreading your investment around.

Lots of people get weirded out by the cost per share. They think that if they only have $100 to invest in a particular stock and one share is $100, better to find a different business for $20 per share and buy 5 shares. Which is ridiculous: if you’re going to put to work the same dollar amount, then 10% of share appreciation is 10% wealthier either way. Go with the company which best fits your investment model and your interests. Where share price matters is if you want to spend your limited investment budget on several businesses or ETFs to diversify. 

 

The other thing that happens is that people avoid companies analysts describe as “overvalued,” whose shares have risen substantially over recent months or which are pushing higher PE ratios. The thinking is that if it’s gone up that much it’s probably close to tapped out, and the price will flatten or even fall. But no matter what analysts say, that stock’s price has risen because investors overall have decided it’s worth a lot more than previously thought. Perhaps the company acquired a competitor, or announced an international expansion, justifying the rise. If instead you only buy stocks “on a dip” or that you think are cheap, you miss out on some amazing opportunities (think Apple, Microsoft, Netflix, Nvidia—no one accuses their stocks of being bargains). Companies with rising valuations tend to keep rising until something changes: a new competitor, a corporate scandal, an economic shock. If you stop worrying about how high the price looks today, and measure it instead against what you believe to be its growth potential tomorrow, you’ll have a much clearer understanding of the real value. That's why you want to own it in the first place.

 

Don’t buy blind.

When we hear from a gym pal or the deli guy about a great value stock, a sudden opportunity that "won’t last long," our inclination is to believe they know something we don’t and therefore we should hop to it. But it ought to be a red flag: if you’re hearing about it from someone else, then you’re not following that business or you would already know this information. Which means you're buying something you likely know nothing about. Plus, if word has gotten around, then any amazing value price is likely already over. Don’t succumb to the temptation to go in with your friend just because. Learn about that business. Do a little research. Understand what the company does, how they stack up against competitors, what sort of leadership they have, how their growth trajectory looks. Get a feel for things. If you don’t understand how the company makes money today, then you can't see how big the opportunity is in the future and you can't possibly assess it as an investment. Never forget: you’re buying an ownership stake in an ongoing business. Where is it headed? How will it achieve that? What obstacles will it face? Look before you leap.

 

Don’t be in a hurry. 

Unlike in the movies, investing is not shorting orange juice futures one time and then finding yourself living on a yacht in the Bahamas. Investing is a lifelong process. It requires an understanding that the value of your assets will rise and fall in in the near term but, with dedication and patience, will almost certainly increase substantially over time. 

 

Many people succumb to action bias, which is just the need to do something with your investment portfolio beyond just watching it grow. Because most folks don’t have an endless supply of incoming cash with which to buy more or different stocks, they instead move the money they have from one investment to another, looking for higher or faster returns. But that eliminates any one company's ability to earn them a substantial return over time, it kills the stunning advantage brought by compounding interest, it generates capital gains taxes, it takes time and energy and increases frustration. Instead, buy smart and sit tight: investing, not trading. Your returns will demonstrate the difference. 

 

Don’t sell on movement.

Everyone sets out to buy low and sell high. But the reality is often very different: we buy high and sell when it drops because we fear it will keep dropping. For obvious reasons, this is a terrible  investing strategy.

 

Once you own shares, don’t sell unless you must. I go into greater detail in previous posts here and here, but the basic idea is that if you did at least a little due diligence prior to purchase, and you still like the company and believe in their capacity to grow, then you shouldn’t sell just because it has moved up or down. Stocks swing, sometimes a lot, and sometimes very quickly. When a stock you own drops substantially following a missed quarterly earnings report, that is a Wall Street analyst’s problem, not the company’s or the shareholder’s problem. If you still believe in the company, Hey its shares are now on sale! If the shares rise, maybe even more than you expected, Wonderful, you've made more than you thought! You bought it to hold it, expecting it would go up— now let it do that. The money is supposed to work for you, not the other way round. Sell only when something really bad has happened at the company or when you need the money for something else. Trust your purchase, trust your judgment. Patience is rewarded.

 

Don’t let your emotions take over.

Investing well, and I’ve said this before here, requires a steady hand on the wheel and your eyes on the horizon. There’s just no way around it. Stocks rise in the long term, but they gyrate all over the place in the shorter term. Some of it is nauseating. This is especially true of young companies, technology companies, and of fad companies, whose products or services might turn out to be just a momentary cultural obsession and will fall as fast as they rose—think GoPro cameras, 3D printers, Zoom video-conferencing, Peloton bikes. If you act on your emotions, you might save yourself a headache or a sleepless night but over time you will have terrible returns. Never buy on a whim of fancy, and never sell in a panic. Buy with some vision, some thought and analysis, and then then sit on your assets for years if you can. That’s it. Containing yourself is extremely hard, but it’s certainly not complicated.

 

Don’t wait.

You’ve been hearing it since you landed your first job, if not earlier: the longer you put off the start of your investing career, the less time you’ll have to earn enough to stop working. 

Take a look at this chart of Warren Buffett’s personal wealth. Can you see the huge hockey-stick shape to the right? His net worth grows steadily enough over time but really accelerates in the last decade or so. That’s compounding interest. I keep saying it: the longer you do it, the faster you’ll earn and the more you’ll have. Investing is the slow boat, so get on now. For more on the subject of waiting to get started, have a look at this.

 

The Math-less Rules of Finance

Happy New Year! I hope you were an investor in 2023 and that you owned one of more of the Magnificent Seven (the band names change, but many of the members don’t): Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Tesla. Averaged, these massive wealthy businesses more than doubled in 2023 and their stellar performance was responsible for the value increase of nearly the entire US stock market. For those of you keeping score, I was fortunate to own 5 of the 7, so I managed a pretty wonderful return in 2023.

So, on to 2024. Today I want to tell you about some mathematics-free rules of finance. Lots of people think that to do well in the market, you need to love the numbers. Spreadsheets, charts, formulas… Nonsense. Of course it helps to be able to know basic arithmetic, but in fairness you need that for cooking, laundry, even golf. That is not the key to financial success. I will give you a handful of concepts you can easily grasp without an MBA or even a calculator. 

1.  Always pay your full credit card balance

We’ve all heard this before. Yet most Americans carry a debt balance on at least one credit card, and often two or more. Many pay only the ‘Minimum Due’ every month, which only compounds the problem (sorry, couldn’t help myself). Just so we’re clear: this is a sucker’s game. Paying only Minimum Due will put you deeper into the hole over time. Credit cards charge you nothing at all if you pay them off every month. But if you carry a card balance— one card I use demands up to 30% annual interest if I’m foolish enough not to pay it down. That’s absolutely bananas, nearly 5x the going lending rate in any other context. Pay that card off, and do it now. You should be living below your means— see “Do Without,” below. If you come even quickly, get a proper loan from a bank or a credit union or even a parent, and use that to pay off your cards. You’ll be charged a fair interest rate and you’ll have an easier time working down the balance.

 

2.  Play only your own game
We all get distracted and outright enraged when a celebrity or a sports star or even someone we know starts touting some amazing business they bought into and now they’re up 1,000%. How much they’ve made, how it’s only the beginning, how you can get in too. Or we read about a company like Amazon which is up nearly 80% in 2023 alone and we shoulda-woulda-coulda. But in reality we all have different financial goals, different timelines till retirement, different risk tolerances. Trying to match someone else’s investments assumes we are the same. That person might be more way knowledgeable about bio-tech or the banking sector, or be half your age and so can afford to take more big swings. Your portfolio will develop and diversify naturally over time to reflect your interests, your experience, your ability to handle risk and volatility and so on. Get comfortable with that.

Entire stock market, 1775-2014

3.  Always be a buyer
I get asked all the time what I think the market will do next month, or next year. When do you think the Fed will cut interest rates? Are we heading into a recession? I respond with the truth (I have absolutely no idea) and then by asking why they want to know. It’s nearly always because they want to buy shares of something and don’t know if it’s the right time. But here’s the trick: it’s always the right time. Sure, don’t buy shares of a business that the financial news says is in dire straits— such as Boeing, AMC Theaters, Rivian at the time I write this. But in general, if you don’t need the cash for a few years, be a buyer. Whatever happens next quarter or next year, the long term trend in the markets is always upward.
 
4.  Do without

In order to invest successfully over the long haul, you need first to have the capital with which to buy those investments. You need to cut up that third credit card, stay away from the outlet mall or the electronics sale. Focus on what you want your life to be like in the future. Don’t fret too much about that daily cappuccino habit, but no, you really don’t need a BMW or a Rolex when you’re 25. What you invest thoughtfully today instead of spending on yourself will grow and compound over the years and the decades and be worth 10x, 100x, 1000x in your middle age. Those investments made when you’re young could one day enable you to fund a college education for your niece or to retire and travel in your 50s. Admittedly, this is blue-square intermediate difficulty.

5.  Be patient
Corollary to the above: this all takes time. A tiny percentage of people get rich quick— tech entrepreneurs, basketball phenoms, pop stars (harder to stay rich). The rest of us have to take the slow train. But the slow train is available to anyone, requires only a little understanding and preparation, doesn’t require Lebron’s jump shot or Van Halen’s guitar skills. It’s just slow. So be patient. Make investing a habit— if your work offers automatic paycheck-subtracted IRA investing or better yet, matching deposits, grab that with both hands at least until you can do it without prompting. This is a long process that will absolutely pay off decades from now. Difficulty: black-diamond.
 
6.  Manage panic

What happens often is someone has developed a strong investing habit, starts putting the money to work early and continues to build the portfolio as their income grows. But then there’s a recession and the accompanying market pullback. Stocks do fall, and sometimes they fall hard. Your job is to not cave to fear. The reason stocks grow faster than most other asset classes is because they are more volatile. A successful investor has to absorb those inevitable drops and not sell out. Look at Netflix in late 2021 when we were still in the throes of the pandemic and many of us were watching too much TV. The stock hit $690 on October 25. But exactly six months later, on April 25 2022, the stock was trading at $190, a nearly 75% drop. It wasn’t just Netflix, it was most of the tech sector. Millions of investors were bailing out as it got worse and worse. Now, a little over a year and a half later, Netflix hasn’t recovered those delirious highs but it’s back up to $474 a share— 2.5x from the 2022 bottom. Investors who refused to sell didn’t have to do anything to get out of that hole except hang on! Difficulty: double black-diamond/experts only, at times even for the most seasoned of us. You have to have ice in your veins but this is a skill worth learning.
 

7.  Don’t be stupid

So much of successful investing comes down to just not making dumb mistakes. Many of these you already know: Don’t wait to start putting money away. Don’t put all your eggs in one basket. Don’t lend to friends and family (Give money, if you want to help. Better for your relationships not to expect if back). Don’t buy a lot of stuff which depreciates— cars, TVs, furniture, clothing. Don’t be in a big hurry, and don’t fall for the pressure tactics. Don’t sell into a market panic. And if it sounds too good to be true ... 
 

8.  Buy what you know

This is the same advice they give to aspiring writers. Start with your own experience, your own interests. Computer nerd? Look at software companies and network security and hardware manufacturers. Sports fan? Look at the betting businesses, makers of fan apparel, broadcasters. It is much easier to know and understand what matters in the news about your investment if you fully understand that business. You’ll know what it means to the company if they can’t find enough good new hires, or if there’s a competitor with a new technology or they’re facing regulation overseas. With enough exposure to reports about the business and the ups and downs of that business, you’ll grasp what should constitute real concern for you and what shouldn’t.
 
9.  Separate news from noise

When you own shares of a company, the overwhelming majority of what’s happening in the market, or on TV, or in the newspaper, or with quarterly earnings reports … does not matter.

You don’t care that the Wall Street Journal is predicting a market decline. You don’t care that Barclay’s just ‘downgraded’ the stock. You don’t care that Mad Money’s Jim Cramer says to sell. You don’t care that a big, wealthy business is expanding into the same industry. You don’t care that earnings came in a little under analyst expectations. All you care about is that your business is healthy and well-run. That it offers great products and has a deep competitive moat. 98% or more of the stuff you read or hear about every day is just noise and will not affect your shares in the long run. Maybe a piece of news creates a little bump your company will have to endure, but it will likely pass. The media makes money by getting and holding your attention. They do that with shock, danger, fear, hand-wringing, and warnings. Stay focused on your invested businesses. Forget what that yo-yo said, and think for yourself: will it affect the success of the company a year or two from now? Probably not. 

10. Sell only for one of the Four Reasons

I’ve covered this at length in a recent post, so I won’t belabor it here. Just know that when you’re a buy-and-hold investor, there’s no such thing as ‘the top.’ Who imagined 20 years ago that Apple, in 2003 a maker of unpopular computers and a clever new MP3 player, would be the most valuable company on the planet? How many people sold after a few years of stellar growth thinking, How much higher can it go? How many sold in 2011 when Apple founder and tech icon Steve Jobs died, thinking, That’s the end of an era, it can only drop from here. (Since 2011 by the way, Apple is up over 1,200%). If you’re going to sell, have a very very good reason. Read more about my Four Reasons here.

Wintry Efficiency

Every year about this time, my family and I sit down and decide our annual giving plan: how much can we afford to donate this year, and to which charities will we give? When the kids were small we told them what we were doing so they’d appreciate their good fortune, that most people don’t have what we have and many simply don’t have enough, and that these folks depend in part on people like us to help. As the kids got older they found causes of their own— spinal injury research, protecting dolphins and tigers, addressing climate change— and we encouraged them by donating in their names to those as well. 

When most people give to a non-profit, for the sake of simplicity they write a check or just put the donation on a credit card. But did you know that many non-profits, particularly larger ones with more healthy and updated infrastructure, accept gifts of stock directly? 

Sounds weird and complicated; what's the point? If you sell a stock during the year which is worth more than you paid, you’ll be on the hook for capital gains taxes on that sale. Sure, you can then use the proceeds from that sale for charitable giving. But you will have paid capital gains tax on investment dollars to be given away, making your gift that much more costly. And you can write off the dollar value of the charitable gift itself, but not for the difference between that and the value of the sold shares.

 
If instead you donate appreciated stock shares directly, you’ll pay no gains tax (you didn’t sell it, so you never realized the gain) and you can deduct the entire value of that stock gift at the time you gave it from your taxable income. In other words, depending on your gains tax rate, most of us would save 15-20% right there, plus the charity gets a gift of larger total value. Then the non-profit can choose to hold those stock shares for future gains, or sell it themselves for the cash. Read more details here.
 
So when you are researching the charities you like online, look for those that can accept donations of stock.. sometimes that option requires a little digging. Or locate a live chat or donation hotline and ask. 
 
Give as much as you can. Do it efficiently for them as well as for you. And do it every year. 

 

Your Portfolio's Year-End Needs

Your Portfolio's Year-End Needs

Today I want to discuss some of the things you want to do as the year comes to a close: specifically, cleaning up your portfolio.
 
In the life of a patient and talented investor, a year is a short time. I say here repeatedly that you should be thinking at least 3-5 years out when adding a business (or an ETF, or a fund) to your portfolio. It often takes that long to see how that investment will turn out. 
 
But life moves faster than that. Things pan out differently than you expect. Sometimes your expenses rise rapidly— graduate school, medical bills, a dying car. Sometimes the market goes your way quickly, and suddenly you’re worried about having more dollars than you planned invested in a single business. And sometimes you own a stock which is not showing the value growth you’d expected, so you want to move some of your money around. The end of the year is a good time to comb through your portfolio looking for the obvious winners and losers, taking note of your performance and perhaps making some adjustments.
 
As I’ve written about in a previous post, there are exactly 4 reasons to sell a stock. 

1. Thesis incorrect: you bought stock in a business expecting it to rise in the near future but even after a year or more, the investment has done poorly and now you want out.
2. Rebalancing: when one business in your portfolio has increased in value far more than others you hold and is now a larger share of your total investments than you’re comfortable with.
3. Opportunity Cost: the stock you own did well for a time but now has stopped growing, and you’d frankly like to place the money somewhere else: into a different stock, towards a child's tuition, on Taylor Swift tickets ..
4. Loss Harvesting: you have taxable income elsewhere— your paycheck, profits on stock sales, you sold your house, etc— and you want to unload a loser stock to offset those gains.

I’d like to spend a few minutes going through these one at a time and personalize them for you with my own recent experience.

 

Thesis incorrect: Personally I have always got one thesis or another that has proved or is proving wrong. Earlier this year I bought Peloton because it was so beat up since the end of the pandemic— down 95% from its high— that I thought, with a high quality and addictive product, they’d find a way to recover. Or at least they’d get bought by Apple, Nike or some other giant. Instead, as of last week Peloton was down another 20% from my purchase. It was a small, “play money” position I held, so I simply gave up and dumped it. Some of the best things just make bad businesses.

 

Rebalancing: Once you been managing even a modest portfolio for a while, you will at some point own a business which, in a given year or two, wildly exceeds your expectations and certainly beats all your other holdings. Since January 1^st of 2023, Nvidia has climbed 220% as of this writing. That staggeringly fast growth is a bonanza for investors, of course. But it means
now I hold considerable risk that I was not exposed to at the start of the year. Just one critical employee departure, or a flawed high-value product, or a particularly stringent ban of one of their more advanced chips … then the stock drops and my portfolio takes a sizable hit. So I sold about 20% of my holdings in Nvidia (like Buffett says, “Be fearful when others are greedy”) and put that money to work elsewhere, keeping my upside— minus taxes— and diversifying towards safety.

 

Opportunity Cost: I’ve owned Starbucks for years. In fact Starbucks was one of the first companies I ever invested in, the day it went public in 1992. I sold it 6 months later for a huge 90% gain— huge mistake is more like it as today it’s worth 30,000 times more than my 1992 purchase price. I got over it, buying again in the late 90s, and have held it since. But Starbucks’ growth has slowed as others in the US copied the business model, as the company has tried and failed at adjacent lines of revenue, as the CEO chair has rotated out of, and into, and back out of Howard Schultz’s hands. Today the company faces union issues in the US and Chinese competitors are coming fast. So I decided it was time to scale back my holdings and put those dollars into younger, more energized businesses. I sold down about 70% of my Starbucks stock over the past year. 

 

Loss Harvesting: As you know, of course, you are taxed on money you make. In the US federal tax code, the converse is also true: generally speaking, when you lose money trying to make money through investment, a portion of those losses can come back to you in the form of what are basically tax credits. 
 
Stay with me. Let’s say that you bought Stock A two years ago. It’s been climbing, and you’d like to pocket your initial investment to reduce single-company risk and reinvest elsewhere to diversify— no different than taking some winnings off the blackjack table. In our example let’s say you bought Stock A for $5,000 (your ‘cost basis’) and now it’s worth $10,000, a ‘capital gain’ of $5,000 if you sold all of it. If you sold $5,000 worth of Stock A, pocketing $2,500 profit in the process, the IRS would ultimately expect you to pay a 20% tax on your gain, or $500. 
 

But let’s also say you additionally had Stock B, which since your purchase has dropped in value. Assume you purchased Stock B for $5,000 and now it’s worth $2,500. If you sell Stock B, your $2,500 ‘capital loss’ on Stock B will offset the $2,500 capital gain from Stock A. So, no tax due. And if your capital losses exceed your capital gains in a particular tax year, you can carry those losses forward into future years to offset gains there. 
 
In my case, I owned Zoom Video which I bought in late 2021. For two years I watched as this capable business failed again and again to capitalize on its obvious popularity through the pandemic. They released fancy new products and features, but they had no obvious response to competition from heavyweights entering their business, and they ultimately lost value steadily. So late in 2023, in light of my Nvidia sale (a substantial taxable gain) I opted to harvest the Zoom loss by selling out completely. Those losses will largely offset my Nvidia gains this year. 

 

Naturally there are several particulars involved in nailing this strategy, such has how long you owned Stock A (a year or more is optimal), how much you can offset in a given year, and a rule which says you can’t repurchase Stock B for at least 30 days or face a wash sale violation. But by and large, loss harvesting is a handy cost saver to ease your investing mishaps.

As always, reach out with questions. I'm always available at robin@zagaco.com,