Career, Family And Living For The Lord
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A Twenty-Five Year History

In providing the title for this chapter, I will confess that SMART is an acronym rather than an adjective and that each letter of the acronym represents a different aspect of setting objectives. The "S" stands for "specific". When someone is focusing on investing, they need to set specific goals. I, for example, have tried for years to earn a minimum of twelve percent each year on my total investments. The second letter, "M", stands for "measurable." When a person establishes a specific goal, that goal must be measurable, or the individual will never know if they have or have not attained it.

The letter, "A", stands for "action-oriented." Investing objectives must be expressed in such a way that a person can take some kind of positive action or actions towards seeing them accomplished. The letter, "R", stands for "realistic," which ties closely to whether or not the goal is attainable. If the goal is impossible to reach or not very realistic, such as trying to earn a one hundred percent annual return on your investments for ten years in a row, then it will not be a very good objective. The final letter, "T", stands for "timely" or "time-oriented." Whenever someone sets a goal for him or herself, they need to express that goal in terms of a timeframe. If my objective is to earn a twelve percent return on my investments, but I never indicate whether that desired return is per year or per century, then I have not established a SMART objective.

All of that having been said, I will say once again that I have tried for the past fifteen years to earn a twelve percent annual return on my total investments. What needs to be considered next is how a novice investor can realistically go about reaching such an ambitious goal.

In general, there are three types or classes of investments - stocks, bonds, and cash. Within those types, there are additional divisions, such as foreign stock, domestic stock, convertible bonds, junk bonds, Treasury bonds and so forth, but those additional divisions are not that important for this discussion. In general, the stock market has returned on the average between twelve and fourteen percent per year for the past seventy to seventy-five years. This average return even includes the Stock Market crash of the late twenties and early thirties. By contrast, bonds have typically returned nine to ten percent per year, and cash has usually returned in the neighborhood of five percent per year. All of these returns are averages based on a large number of years, so what happens in any one year may or may not be close to the averages.

Now, let me explain how these historical returns should play into an investing philosophy. Based on such returns, I am reasonably certain that I cannot reach my twelve percent annual return goal if I invest all of my money in just cash types of investments. I also cannot reach my goal if I stick exclusively to bonds. Yet, if I put all of my money into stocks, then I will almost certainly incur a lot more risk. In investing, as with most other issues in this life, risk and return are closely related. Safe investments usually do not return very much, but good returns are usually linked to a fair amount of risk. The solution to this problem is encompassed in the following two investing concepts: (1) diversification and (2) balance.

Diversification means that you do not put all your eggs in one basket. If that basket were to develop a hole, then you might lose everything! A good investing principle demands that you distribute your funds across a variety of areas so that if one area drops, another will most likely rise to prevent any catastrophic losses. Balance means that you, in addition to diversifying, also try to distribute your funds across each of the three general types of investments mentioned above. Cash provides a very low return. Yet, even cash has a place in most people's portfolios because it will probably mean that you will be able to avoid having to sell your stocks in the middle of a down market if you were to experience an emergency.

In the next two sections, both of these principles will be discussed, diversification through mutual funds and balance through what I call the "by the years method." I think that that part of this discussion will be interesting and beneficial to anyone who has any kind of genuine interest in investing.

When it comes to investing, my favorite vehicle is mutual funds, and I have three pretty simple reasons for feeling this way. The first is simplicity. Once a person has selected the fund for their money and opened their account, mutual fund investing can be very easy and automatic. It is possible to have the mutual fund company automatically take a specified sum of money from your checking account each month and apply it directly to your account. Regular monthly savings in a good mutual fund will reap huge benefits over time, and many or even most fund houses do not even charge a direct fee for this service. The second reason that I like mutual fund investing is diversification. Many people are concerned about losing their hard-earned money, and rightfully so. All of us have had to work hard to gain what we are able to have, and we do not want to squander it away on foolish investments.

The good thing about mutual fund investing is that it is not a get-rich-quick scheme or even a get-something-for-nothing hoax. Mutual funds give the average investor access to the entire stock market at one time without requiring that person to be an investment expert. If I felt that I had to do a lot of research to select the right companies for my own investment dollars, then I would be much less anxious to recommend investing to others. However, with mutual funds, the individual stocks are selected by the mutual fund company, and the investor does not have to know anything about the companies which are selected. Mutual funds provide natural diversification because they invest in a fairly large number of companies. At any one time, the average mutual fund will probably be invested in as many as fifty or even more different companies. Spreading your money over such a wide range of companies greatly reduces the risk that you will ever lose any money, much less lose everything. The bottom line is obvious. Your money is probably as safe in a mutual fund as it is in your local bank.

The third reason that I like mutual fund investing is because I started out my investing career with the Dean Witter Reynolds brokerage house. I did all of my own research, never asked my analyst to do much of anything, and still had to pay about five percent in commission every time I either bought or sold. After a few years of that, I realized that Dean Witter Reynolds was getting a significant portion of my profits. I next set up an account with Charles Schwab, which saved me some of the cost of commissions, but I still had to do my own research. Finally, I decided in the early nineties to get out of individual stocks altogether, and since then, I have only invested in mutual funds.

Mutual fund investors are able to avoid the problems which I experienced with the above two brokerages. First, if you select a no-load mutual fund, then there are no direct fees to be paid. Every dollar invested goes directly to your investment. Then, each year, the fund accesses a very small fee for its services, but this fee is reflected in the sales price rather than being charged as a direct commission. The fee is very small when compared to a broker, and the collection of the fee is totally transparent to the investor. The mutual fund investor also avoids the problem of having to do his or her own research. Mutual funds are usually staffed by a team of investing analysts who do the research for the fund and even assist in the selecting of investments. Instead of having to find the best companies for your investment dollars, the mutual fund company does that for you. What could be easier?

Because of the Stock Market crash of the twenties, many people worry about losing their money through stock investments. For a few reasons, however, I have never felt that this concern is really valid. First of all, the nature of the stock market is altogether different than it was seventy years ago. Back then, if a person had one dollar invested, he or she could borrow eight dollars off that one dollar for the purpose of additional investing. This sort of borrowing and investing based on current investments is called "buying on margin," and the way the technique worked in the twenties was that the investor or borrower had to always maintain at least the eight-to-one dollars borrowed and invested relationship. That meant that a drop in the original investment of twenty-five percent, from one dollar to seventy-five cents, would have also meant that the maximum margin borrowing would only be six dollars, or eight times seventy-five cents. If the borrower had still had an outstanding loan of eight dollars, then he or she would have had to come up with an additional two dollars right away to pay back on the loan.

When the amount to pay back on a margin loan is only two dollars, then the consequences of a twenty-five percent market drop are not very great. However, when the investor must immediately come up with two million dollars or some other inordinately large sum of money to cover their margin borrowing, then the consequences can be much more deadly. People with that kind of severe financial problem are often driven to unwise extremes, such as jumping off buildings and taking their life. In the twenties, the market drop was so severe because too many investors had borrowed too much money on margin. They had wanted to take a chance so that they could make even more money, but in the end, their greed and impatience cost them dearly.

In the present market, this collapse based on excessive margin buying cannot happen again because the rules of the game have changed. In the twenties, an investor could borrow eight dollars for every dollar invested. Now, an investor can only borrow one dollar for every dollar invested. Reducing the amount that an investor can borrow on margin greatly reduces the sudden financial impact which can result from an unexpected deep market drop. Of course, for most investors, such as myself, margin buying probably still should not be contemplated, even by today's rules. When I invest, I only use my own money.

A second reason why I do not concern myself with the worry of huge losses, like those of the twenties, is because most mutual funds invest in top quality companies. I usually ask people what they believe the chances are that companies like Exxon, Mobil, IBM, XEROX, General Motors, and Microsoft will all go belly up at the same time without warning. To me, the chances are very, very slim. Besides that, most mutual fund and market analysts follow the market constantly. If they ever suspected such a big drop coming, then they are very much in a position to get out of the market fast and protect their client's money. My opinion is that no one needs to worry at the present time about losing money with mutual funds. In ten years, when the Baby Boom generation starts taking money out of the market for retirement, then the conditions of the market may once again change. But for the present time, I do not concern myself with losing money from any of my investments.

"Investing by the years" is a simple method for determining how much of your money should be invested in the stock market at any one time. Younger people, who ideally can let their money remain invested during just about any market downturn, are not as restricted as older people who might have to use their savings for retirement. For this reason, younger people can usually afford to have a larger percentage of their funds invested in the stock market. The investment principle in the previous section was concerned with diversification. The one in this section is concerned with balance.

The right balance between stocks, bonds, and cash is important. Stocks have historically returned a greater return than either bonds or cash, and they are likely to continue to do so. During the nineties, the stock market has probably returned close to twenty percent annually, while cash investments have been down around four or five percent. People make more money with stock mutual funds because stocks generally do better than cash, but investors in stocks also incur greater risk. Having the right balance among all their investments gives the investor maximum flexibility. If the market goes down and the investor needs cash, then a solid cash reserve will meet that need and prevent the investor from having to sell in a down market. In another instance, if the market goes down and the investor does not need the cash but would like to shop for market bargains, then he or she will be in a position to use that cash to buy more shares of their mutual fund and lower their overall average buy price.

In investing, my objective is always to own the most shares possible for the least average buying price possible. If I purchase one hundred shares of a mutual fund which sells for ten dollars per share, then my average buying price is the ten dollars per share. If that fund rises to fifteen dollars per share and I buy another one hundred shares, then my total investment is twenty-five hundred dollars, and my average buying price becomes twelve dollars and fifty cents. I will, on occasion, intentionally buy more of a fund when it is rising in price, but in general, such a practice violates my least-average-buying-price objective. When a fund's value rises, I usually either remain with my present position, or I sell. If the fund's value decreases, then I usually remain with my present position, or I buy.

Part of my buying and selling strategy is based on opportunity. I always try to hold back enough cash so that I can buy an issue if I find a good deal. The "by-the-years" principle, which I did not originate, is how I am able to accomplish this goal. Younger people should probably have a greater percentage of their funds invested in stock-type investments than older, and a simple way to ensure that this will always happen is to subtract your age from one hundred. The twenty-year-old should be eighty percent invested, the fifty-year-old should be fifty percent invested, and the eighty-year-old should be twenty percent invested. This computation of subtracting your age from one hundred and using that value as a percentage of total market investments is very simple, plus it will always guarantee that a person seeks more conservative investments as they age. The principle probably should not be treated like a hard-and-fast rule, but it is certainly a good guideline for determining about how much of your money you want to commit to stock market mutual funds.

A few years ago, I purchased a book by Martin Zweig which talked about his mathematical model for investing. He has a Doctorate's Degree in Mathematics, and that was probably why I took such an interest in what he had to say. His model takes into consideration factors such as the Federal Reserve's handling of interest rates and also the movement of the Value Line statistic. After reading his book, I set up a worksheet which I then filled in about once per week. I believe that Dr. Zweig's model is pretty good, but I also think that it is much too sophistocated and complicated for the average investor. I eventually got tired of doing even the little bit of record keeping required by his approach, and I stopped using it.

In my own investing, I have tried to develop a technique for timing when I buy and sell my mutual funds. Many investment advisors, however, would warn against a principle such as mine, and I sort of agree with them. Critics of market timing advocate dollar cost averaging, where the investor buys the same dollar amount of a fund each month over a long period of time, and then just sits on their investment until they are ready to start using the money. The good thing about buying and sitting is that it is easy, plus it is low maintenance because the investor does not have to do very much. Another good thing about buying and sitting is that some analysts have found that most timing practices would have had investors out of the market on specific days which were among the market's best ever.

The chief criticism of trying to time the ups and downs of the market is that it cannot be done with complete certainty. The example which I gave a couple of sections ago illustrates the point. I cited the case of a mutual fund whose value had gone from ten to fifteen dollars per share. I indicated that I would ordinarily sell so that I could protect my profits. But if I did sell and the fund continued to go up, then I would not earn as much money because of my owning fewer shares. If, on the other hand, the fund's value came down, then I would be a financial genius because I would have gotten out of the market and made a nice profit before the drop.

The problem in all of this is that no one knows the future of the stock market or of the mutual funds which invest in that market. Therefore, I have used my own buying and selling principle over the past five to ten years, and it seems to work well for me. My first rule is that there are not any absolutes. If I think that I want to keep a particular issue, then I do not sell no matter what my buying and selling principle recommends. Similarly, if I really want to buy an issue, then I will again ignor my own principle to buy something that I want to own. In short, I only obey my principle if it is consistent with what I feel that I want to do.

My second rule is that I buy or sell based on the quantitative change in a particular mutual fund. In the earlier example of the fund that went from ten to fifteen dollars per share, my original investment was one thousand dollars, one hundred shares at ten dollars per share. If the fund's value rose to fifteen dollars per share and if I felt inclined to sell some of what I owned, then I would sell five hundred dollars worth of shares and bring my total holdings back down to one thousand dollars. If a fund dropped and I felt inclined to buy, then I would buy enough to bring my total holdings back to the original one thousand dollars. My buying and selling algorithm basically brings my holdings back to the original holding by either buying or selling the necessary shares. This algorithm is not very difficult to use, and it will always guarantee that the investor owns the most shares for the least amount of money.

The problem with my algorithm is a fundamental problem with all investing. A mutual fund that is dropping may continue to drop and, even worse, may never come back up. Investing is fairly safe, but it is not foolproof. With mutual funds, I have observed that most of them track fairly close to each other, and what this means is that most of them go in the same direction, whether up or down, over long periods of time.

I have discussed my buying and selling principle in this section, but like the Zweig model, I do not endorse it wholeheartedly for the average investor. As I indicated at the beginning of this chapter, I partly invest just for the fun of it. Part of my fun through the years has been in developing my own methods for making investment decisions. But like most analysts, I cannot claim that what I do is any better or any smarter than what someone else might do. If you are like me and you want to have fun with investing, then I would recommend that you try some of the various investment principles which are out there and have fun with them. If, however, you are only interested in your bottom-line return, then a simple, low maintenance, dollar-cost-averaging, buy-and-hold approach is probably as good as anything else.