Fire Your Broker

A brief word about portfolio management:

You have a broker. Or a portfolio manager. Or a money manager, or an account manager or an investment specialist or a personal banker at Chase or at Schwab, or wherever. It is this person's job to oversee, protect, and grow your stock investments: allocate, buy, sell, and generally ensure you own the right things in the right amounts at the right times.

Chances are good that you don't need him.

You can go it without him. I have. I am untrained, and I've been successfully buying stocks since 1992, with an average annual return around 20%. I've beaten the S&P 500 almost every year and I've blown the doors off the brokers I've hired over the years to race me. I've done it buying mainstream companies, brand names you already know like Apple, Netflix, Starbucks, Amazon, Ford, Google, and Under Armour. What's so hard that you can't do it too?

Chances are your broker or portfolio manager costs you around 1% of your assets per year. Some special ones charge close to 2%. Which doesn't seem like a lot of money, unless you have millions under management. But here's the thing: you pay every year, regardless of performance. You pay when he makes you less than the S&P 500 index made. You pay even when your portfolio loses money-- as in negative growth. Let's say the market crashed, you feel lousy, your portfolio looks like it's spiraling the bowl. Don't fret: your manager gets paid anyway.

Untrained, I have been successfully buying stocks since 1992. I see an average annual return around 20%

Because that manager's compensation is screwy, her incentives are screwy. It's in her best interest to make you happy enough so you commit more money to her care, not to make high returns on your investment portfolio. And perhaps surprisingly, those are not the same.

A happy customer might be one who is listened to. A happy customer in many cases is one who doesn't lose sleep worrying about being ripped off, or about the next big down cycle or even a recession. But the most likely scenario is this: a happy customer is one who can be lazy and do essentially nothing. Just gets a statement every month which shows the money is still there, plugging along, and that's it. So what if it's down a point from last year, or up two points? I worked hard to put it there and it's right where I left it.

Inflation in the U.S. historically averages a little over 3%. And if investment management fees average about 1%, then your portfolio has to clear 4% just to keep even with the economy. Is yours doing that, year in and year out?

Don't even get me started about mutual funds, which as an investment class have a terrible track record. They rarely even keep up with their own costs plus inflation. Bill Barker of The Motley Fool does a nice overview of the problem in a recent column: click here.

Index funds and ETFs are great, with extremely low investor costs-- usually around .25%. But because the baskets are so big, the standout performance of any one stock you own in that basket is going to make little difference to your total return.

It's about observation of the marketplace, attention to the news, focus on the industries/companies that interest you, and most of all, patience with the money you've placed

You've been told for years that investing is too complex, too difficult, that it takes years of study and hard-won experience. You've been told that individual investors in the stock market are about as safe as toddlers jaywalking. That the big banks and funds and other institutional investors hold all the cards and have rigged the game against you. That you need a seasoned pro to fight them. But you've been told this because it serves the community of financial managers for you to believe this. The more people give them money to manage, the more they make. Regardless of performance.

Successful investing is not nearly as hard as they've been telling you. It is far from rocket science. It's about observation of the marketplace, attention to the news, focus on the industries/companies that interest you, and most of all, patience with the money you've placed. I've detailed the path and many other topics to help you get going:

• Getting started
• Discovering potential targets
• Analysis without math
• Analysis with a little math
• Weeding out bad seeds
• Coping with fear
• When to sell

You'll likely bet wrong a few times, just the like the pro you hired. But if you pay attention and follow your passions, your wins will outnumber your losses and your gains will more than pay for everything.

So fire your portfolio manager, and get out there and do it yourself. At the very least, scale her back and take over some of your own stock management. Use her for a little of the money but mostly to ask questions, to bounce ideas around. You'll learn, stretch yourself, do better and will earn the pride of your own triumph. 

What are you waiting for? 

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As always, please leave a comment and let me know what you think about the post, or about anything on my site. I always answer legitimate questions. Thanks!

Frequently Asked Questions - Continued

Still more questions I see often:

What does it mean when I buy a stock and it goes down immediately? Should I sell it?

Most of the time you should do nothing, unless it drops enough that you’d consider buying even more. Stocks go down about 1/3 of the time, it’s just a fact of the market. And in my experience, that frequently happens just after I’ve purchased, a phenomenon I’ve never understood. No matter: assuming you did your homework prior to buying the stock in the first place, and that you continue believe in the long term success of the company you bought, then you should just sit on your hands and wait it out. I’ve had companies drop 10%, 20% or more in the weeks after my purchase. My recent buy of GoPro (GPRO) is down about 40%.

If your stock drops substantially, it might be worthwhile to reexamine your investing thesis regarding that company. Did something important happen—a big lawsuit, a change in business strategy, executive leadership fired or departed, a new and daunting competitor—or is it simply the market getting worried about something small, like an unusually bad earnings report or a rise in inventories? If something substantial has taken place at the company that makes you question the future of the business, you could sell and chalk the whole thing up to a learning moment. But if it’s a smaller thing you probably want to just ride it out.

Why is it a big deal that the Fed might raise rates? What does that mean and should I worry?

The Fed is the Federal Reserve, a government body which tries to manage the supply of money in the economy in part by raising and lowering the Fed Funds Rate—an interest amount banks charge one another to borrow money held at the Federal Reserve. This rate has been effectively at zero (.25%) since late 2008, in the depths of the great recession.

In the short run, raising the fed funds rate tightens the money supply by making it more expensive for banks to borrow funds to lend, and that makes the loans then made by those banks more expensive. Which means it costs more for people to borrow, which generally slows buying behavior, which slows the rate of the rise of stocks and can cause a few days of market price declines. Raising the fed funds rate is a slow-motion braking system for the economy.

Historically speaking, the current rate is absurdly low. It must come up sometime or the Federal Reserve has no levers it can pull to loosen the money supply, a necessary ability. Ultimately, businesses and individuals will continue to borrow to buy equipment and materials, to hire and train workers, to buy buildings, and so on, regardless of the borrowing costs. People adapt. So in the long run, raising rates generally means nothing.

What is the greatest stock purchase you’ve ever made?

Apple, Hands down, no contest, but it was completely a luck play. I bought Apple stock in 1997—when Steve Jobs returned to the company and got Microsoft to invest $150 million, which he used to develop and introduce the first iMac—for a split-adjusted $0.54 per share. Which seems brilliant in hindsight, but I was just getting started as an investor and didn't do even basic research. I made a dangerously speculative investment because I loved the new products and I reasoned that the founder could maybe turn the company around. 

At about $119 today, Apple has been better than a 200-bagger for me over that period. And while I've sold shares off periodically over the years to rebalance my overweighted portfolio, I never sold it all. The argument can be made that that one success has made possible much of the rest of my portfolio over the years. Certainly it showed me the rewards possible from investing patience.

What is seed investing? How is that different from venture capital? Can I buy stock in a company that has not “gone public”?

Seed stage is the first outside money to be invested in a company—when the founders discover they’ve tapped their own savings, credit cards, home equity and relatives’ generosity to the breaking point and they want early investors to help fund the company’s growth. Seed investment is extremely high-risk, because a failure of the business in the future means those investors lose everything. By the same token, of course, it can be highly lucrative if the company succeeds. But even then the investors rarely see their money for several years or longer.

Venture capital—VC—is the next stage of outside financing in a young company. VC funding usually comes with strings, such as strategy advice, leadership/management assistance, seats on the company’s Board of Directors, and so on. VC firms are professional investors who are well-financed, generally well-connected, and experienced in getting small upstart companies from seed-stage to the next level, where the business can be sold to a larger firm or taken to the stock market with an initial public offering, or IPO.

Shares of seed-stage and VC-backed companies are generally unavailable to most people. Those shares are held by the founders and those early investors, who tend to be wealthy, experienced investors who both fully understand the risks and illiquidity of private stock ownership and who can afford the losses which frequently result.

I’ve read about companies lately splitting their shares into two different classes of stock. What does that mean?

This is the new trend. It’s confusing for existing shareholders because the new shares trade under different ticker symbols and at different prices. But what’s happening isn’t really all that important or exciting for most of us.

Basically, a company splits shares to make them appear more affordable to a broad range of potential buyers: “Why spend $100 for a piece of the company? We’ll do a 2-for-1 split and they’ll only cost $50!” But you’ll get half as much ownership, so it doesn’t matter. But the different-classes splits we’re seeing lately do something else: they divide voting shares held by management (and existing shareholders) from non-voting shares which can be bought and sold as well, usually at a small discount. It’s simply a way of having shares split without diluting the voting shares crucial for founders and executive leadership to execute their will, which as an investor is a good thing.

If you’re deciding which class of shares to buy, it comes down to whether you prefer the small discount (usually 5-10%) that non-voting shares provide, or the right to vote your shares—in a company which millions, or hundreds of millions, of outstanding shares.

What is an appropriate amount to keep in cash as I manage my investment portfolio?

As a rule of thumb, I try to keep about 10% of my investment portfolio in cash. Warren Buffett has called this “dry gunpowder”—the cash needed to be able to take advantage of surprising market opportunities, such as a sudden price drop on a particularly great company. It’s also just a good habit to hold a little back for rainy days.

What represents a great buy today?

Speaking for myself, I’m not really a value investor, I’m a growth investor. A stock’s price today is of less importance to me than its price many tomorrows away, and I’ll pay what seems like a lot per share if I think the company will be bigger and more valuable in the distant future, regardless.

There are always terrific businesses available; it’s a matter of “risk” tolerance (really volatility tolerance, which is not the same). I frequently look at companies widely considered to be overpriced by the media and the Wall Street types on TV and which sometimes see wild swings of their share prices—Netflix (NFLX), Amazon (AMZN), Zillow (ZG), Tesla (TSLA), etc—because these companies aren’t priced in the market by traditional profit-based pricing models. They are shaking up industries, changing the way we do business and live our lives as citizens and consumers. They break the rules, and they frequently forgo profits near-term to reinvest for maximum long-term impact. Their share prices reflect not their earnings but their potential.

Also great buys today are those firms I consider to be “forever stocks,” the ones you can buy today and probably forget about for 20 or 30 years. When you look up in the distant future (or your newborn nephew is told he has stock you gave him decades before), these well-run, long-term managed companies will likely still be doing well. These companies provide a product or a service that will likely still be valuable then as it is today: Disney (DIS), Starbucks (SBUX), even Ford (F) and Hershey (HSY).

I’ll continue to keep track of questions I get and revisit the FAQ posts from time to time. I urge you to read previous FAQ posts here and the second part of my FAQ here if haven’t read them before. And of course feel free to comment on anything you see on this blog or ask me questions directly. I will try to get back to you quickly.  

Diversification - A Controversial Notion

People ask me all the time if their holdings are diversified enough. It's probably the single most-common concern among investors: are they sufficiently protected against a net asset loss event. And like most such questions, the answers vary dramatically depending upon that individual's situation, needs, tolerance of volatility, tolerance of risk, and level of involvement in the investment portfolio.

The concept is simple enough, and probably 95% of analysts and financial planners will tell you diversification is one of the key factors in managing the risks associated with any single investment. Just spread your invested dollars across different asset classes, different industries, market caps, global regions or even countries:

Asset classes--

• Stocks, or Equities
• Bonds, or corporate/municipal debt
• Commodities like copper, wheat, natural gas, pork bellies
• Real Estate
• Treasury bills
• Collectibles like art, vintage automobiles, sports memorabilia, fine wines, etc
• Cash, or cash equivalents

Market cap--

• Small cap (company valuation $300 million - $2 billion)
• Mid-cap  (company valuation of $2b - $10b)
• Large cap (company valuation upwards of $10b)

(For more details on the asset classes and what broad diversification would involve, read this great NerdWallet overview.)

With proper diversification, if a substantial pullback hits U.S. biotech, or South American heavy equipment manufacturing, that investment makes up a small portion of your overall portfolio so most of your money is ok. Imagine you had a big stake in light crude oil a few years ago, before prices fell over 60% globally due to a supply glut ... It simply makes sense to make sure your eggs are in more than one or two baskets. 

But here's the thing: I've been a committed investor for over 20 years, and I've done very well. But I've always been poorly diversified and I have no plan to become more so. My portfolio weathered the tech bubble popping and following pullback from 2000-2003, and the great recession of 2008-2010. It was painful to watch, but I found that patience alone got it done: wait it out and everything comes back.

The problem for me is that diversification requires two things I've been unable to withstand. First, diversifying means investing broadly rather than deeply, which ensures average returns. The more different classes or industries or countries you place your money in, the less any one catastrophe can hurt you-- and the less any one home run can help you. I work hard to position my money just so. I'm swinging for home runs: Apple, Netflix, Starbucks, Tesla.

The second reason, as I've discussed on this blog before, is that I invest in things I know, things I understand, things I already pay attention to. It's the only way I know to get consistently positive returns. When I wander off that path, I fail at a rate close to 50%. And I just don't have enough familiarity or understanding of everything on the planet to intelligently make those choices. Brazil or China? Casinos or publishing or health care? Beats me. I'll stick to my knitting.

Certainly I am diversified to a point. I own stock in a number of American companies which derive a substantial portion of their revenues from countries outside the U.S., including Amazon, Disney, and Starbucks. I own stock in some huge large-cap companies, including Apple, Google -- sorry, Alphabet-- and Berkshire Hathaway, as well  as some mid-cap companies like Zillow and FireEye. My smallest-cap is Imax, maker and licenser of those gigantic movie systems, but even that is a mid-cap. I have no small-cap stocks. 

A little over 10% of my assets are in real estate, a portion which was once much higher and which I'd like to increase again. And I have about 7% in savings, earning nothing, so I can take advantage of attractive opportunities that come along. 

Which means the bulk of my holdings are in large cap, consumer-facing businesses. I've got retail, automotive, insurance, banking, entertainment and social media in there, but even then most of those have a substantial tech component. So really I'm not at all diversified. Because that's the stuff I know, the industries and the companies I follow in the news, business models I understand and companies for whom I am a customer. 

My approach will not work for most people. Normally, investors want to put their money into something safe for a long time, and ignore it. They want asset growth, but also stability and forgettability. That means exchange-traded index funds which are more liquid and lower cost than mutual funds and which move up and down with the entire market, or segments of the market. Since the market always rises over long periods of time, they're happy and they don't have to worry. They don't have to know anything about the companies and they won't be brought down by any big pullback-- in the long run. 

It's a good solution, but it doesn't work for me. Again and again I choose volatility and company-specific risk if it gets me faster growth, and I'm willing to ride the roller coaster through the big dips. I've studied my companies and I've chosen carefully. I'm patient with my holdings and encourage and nurture my portfolio as if I'm growing a bonsai tree. It works, and it's the only way I know 

Diversification is just not for me. 

Drifting to Fifty | Random unrelated nugget of the week

Broaden your musical tastes. Try some jazz, a little R&B, international, even country. The choices are endless, easy to sample, and have never been more inexpensive. Good music enriches your life and will pay dividends forever.

Where Investing Ideas are Born

By now, if you're reading this post and it's not your first time to this blog, you've already gotten started with your portfolio. (If you haven't, start with this post: Three Lies You've Been Telling Yourself.) We've covered a lot of ground over the past few months. We've talked about

• Stocks to Buy Now
• Biases that will Hurt Your Returns
• Preparing for a Market Crash, 
• What to Do During a Crash, and 
• Frequently Asked Questions about investing, among other topics.

One thing I haven't spent much time on is where to get the ideas for new investments. As I've said before, I avoid accepting stock tips. Most tips are bogus, pushed by someone who stands to gain a commission or similar if you buy, regardless of whether the suggested stock appreciates. I hate salespeople.

So where do the ideas originate?

First off, I read a lot. I read online and on paper, and I spend most of every day on it. Business analyst reports and financial blogs and the Wall Street Journal and Bloomberg BusinessWeek and Business Insider and The Economist. Throw in a little New York Times, Financial Times, Fortune magazine, my local business paper and Yahoo!Finance. The stuff that could be relevant is everywhere.

I also listen to several podcasts when I'm in the car, a combination of stock analysis discussion by The Motley Fool crew and general interest (NPR's Fresh Air and Planet Money are favorites).

Many news stories have an investment angle beneath the surface: hurricanes on the east coast-- what does that mean for insurance companies' costs, revenues for local tourism? Twitter got a new (former) CEO, which relieved a point of market stress and popped its stock price. Consumer credit tracker Experian was breached, allowing hackers to steal T-Mobile customer data-- bad for both businesses-- but another breach is proof positive of the need for network-security companies like FireEye, Fortinet, and Barracuda.

So I cross paths with a lot of companies, all day. I'm keeping up with the ones I care about, whether I'm a current shareholder or a former/future shareholder. But of course I also find new ones through this process, and once I've read about something enough times or heard it discussed a bunch, it might merit further investigation and I'll do some digging on my own. That's where a lot of the ideas hatch.

But you can't do this all day, you probably have a more traditional job to worry about, separate from your investing. So let's consider some other places I find ideas.

I'm a consumer, like anyone. I buy clothing and food, shopping in stores and online. I buy entertainment and travel, I use a smartphone and a laptop, own a car and appliances and a house. I bank, I get medical care and prescriptions, play sports and use a credit card. Every one of those products and services I just listed is offered by a multitude of companies in which I could buy stock. Stands to reason. But why would I do that? How can I know they're right for my portfolio?

As I've discussed in a previous post, I like to buy stock in companies I've transacted business with. Obviously, it starts with a product or a service which impresses me-- I think my tastes and tolerances are pretty mainstream, so if I like something, others will as well. That means the company has at least a fair chance of pleasing its customers, which is a great place to start. for me, this approach has worked out with Netflix, Under Armour, Amazon, Disney, Apple, Google and others.

With Amazon, for example, I started with an excellent online shopping experience: books, then CDs and DVDs, then some kitchen stuff. Then I had some returns (clothing) and a complicated exchange (wrong gas grill), and those went surprisingly smoothly. So I dug into the company's competitive position, management, strategy, and financials. It was actually the financials where I got hung up-- almost 20 years in business today and barely earning a profit-- but I liked everything else about the operation and so chose to overlook that in favor of greater profitability later on. And I've been happy as a shareholder.

I get still more ideas by trend-watching. I've got teenagers, and teenagers are the
pinnacle of trendy. They pay attention to fashion, to technology, to entertainment (movies, music, TV, games), to professional sports. Teens are tomorrow's primary consumers, so as an investor I want to know where they'll be spending. I pay attention to what they're into, how they like to relax and what they buy. Lots of useful clues there: they hate the new version of EA Sports' best-selling Madden game; they love Starbucks'; they complain about their Lululemon yoga pants unravelling; they avoid McDonalds, they want iPhones (Apple) but not Android phones (Google).

Social media (Facebook, Twitter, Instagram, etc.) is another good source for ideas. What's been happening and what are people talking about online? Are there business implications? What does that mean for investment?

For example, The Volkswagen emissions scandal is still playing out and getting a lot of public attention. What does VW's behavior mean for car manufacturers and dealership service centers? Will Ford and General Motors benefit by converting VW owners? Or will it be Toyota, Nissan and Tesla-- each of whom sells clean vehicles-- that get those customer who will run from German makes?

There's a new movie about Apple founder Steve Jobs, and the word on social media is that it's an unflattering portrait of a man our culture has turned into an icon. Will the movie turn off buyers of Apple's pricey products in the U.S.? What about in China, where most of the stuff is actually made? What will that do to the stock price?


It really just goes back to one of my earliest posts, Awareness. If you make a habit of looking for a business angle, you'll often find one. Of course sometimes you'll discover that the investing takeaway is to sell a stock, or at least to avoid owning it (Volkswagen right now). But you'll be on the right path just to be thinking about the impact that current events, trends, news stories and conversation topics have on shares you own, or could own. You'll be looking at the world like an investor.
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Please write me or tweet with questions or comments. I welcome the feedback as I work to make this blog a more helpful and easy-to-use resource. It is my goal to respond to you within 24 hours.