Investment Quiz

The following was taken from Weston Wellington's Down to the Wire dated July 11, 2012.  Weston is a Vice President of Dimensional Fund Advisors and his Down to the Wire provides timely commentary and insight in response to prominent financial media headlines and topics concerning investors today.

Investment Quiz
by Weston Wellington
 
Question:
The twenty-two prominent firms listed below share a common characteristic. What is it?

• AT&T Inc.
• Abbott Laboratories
• Allstate Corp.
• Altria Group
• Amgen Inc.
• Berkshire Hathaway 'A'
• Bristol-Myers Squibb
• Coca-Cola Co.
• Colgate-Palmolive
• Costco Wholesale
• Hershey Co.
• Hormel Foods
• Johnson & Johnson
• Kimberly-Clark
• Eli Lilly & Co.
• Merck & Co.
• Monsanto Co.
• PepsiCo Inc.
• Union Pacific
• Verizon Communications
• Wal-Mart Stores
• Weyerhaeuser Co.

Answer:
If you guessed each firm is a constituent of the S&P 500 Index, you would have been close--but wrong. (Weyerhaeuser is not included.) If you guessed that each firm pays a dividend, you were close again--but still wrong. (Berkshire Hathaway has not paid a dividend since 1967.) The correct answer is that the stock price of every firm on the list (and dozens of others) hit a fifty-two-week new high last week.

It is also intriguing to see a long list of homebuilding and building materials firms on the new high list, including nine of the eleven stocks in the Standard & Poor's Supercomposite Homebuilding Sub-Industry Index. If we cheat and include the previous week, M.D.C. Holdings also makes the list, making it ten out of eleven. KB Home is the lone holdout.

• D.R. Horton *
• Hovnanian Enterprises Cl 'A'
• Lennar Corp 'A' *
• Louisiana-Pacific
• Lennox Intl. Inc.
• M.D.C. Holdings *
• M/I Homes *
• Meritage Homes *
• NVR Inc. *
• Pulte Group *
• Ryland Group1 Standard Pacific *
• Smith (A.O.)
• Toll Brothers *
• USG Corp.

We don't want to read too much into this exercise lest we get tempted to start predicting market trends by studying the squiggles in stock price charts. But we suspect many investors would be surprised to learn how many widely held stocks are quietly inching their way higher despite unsettling news from unemployment numbers, European finance ministers, or the presidential campaign trail. Investors waiting for a more opportune time to purchase stocks may discover that, by the time cheerier news headlines appear, the price tags on a wide range of businesses are sharply higher.

Footnotes & References:
* Standard & Poor's Supercomposite constituent.
NYSE New Highs and Lows, Wall Street Journal, (accessed July 9, 2012).
Standard & Poor's Stock Guide, June 2012.

Gordon's Note:
The focus of an investor should be on developing an Investment Plan based upon his or her goal's and risk tolerance, implementing the Plan with diversified asset class investments, and remaining disciplined throughout the various market cycles.  Those activities will increase the investor's probability of having a successful investment experience.

Forget Facebook: Markowitz Stresses Diversification

Plenty of investors, motivated by greed and the media’s general hoopla, got caught up in the Facebook IPO frenzy. The result? Another big win for Wall Street. Days before the IPO, Facebook increased the number of shares it would offer to the public by 25 percent. Sure, this meant more hopeful investors could get in on the social media action, but, most significantly, it added to the wealth of Facebook founders and diluted the value of shares to be bought by retail investors. That’s how Wall Street rolls.

So, when Facebook closed its first day of trading, up only 23 cents, at $38.23, and disgruntled retail investors grumbled, investors who got in on Facebook’s ground floor and had sold shares all day were doing cartwheels.

Sometimes it takes a circus-like atmosphere to remind us that investing should be a long term, rationally-driven activity, not short-term speculation motivated by media hype and emotions.

Perhaps the most compelling reflection on the Facebook IPO came in an article written by Jeff Sommer “Before Leaping, Listen to a Giant.” The “giant” is Harry M. Markowitz, who, Sommer writes, “may have had a greater influence on current theories of finance and investing than any other living person.”

In the article, Sommer quotes Markowitz, the winner of the 1990 Nobel Prize in Economics and the Father of Modern Portfolio Theory, as saying, “Most people don’t need to think much about individual stocks. You can put yourself in a position to say, ho-hum: Facebook, JPMorgan, they may be up, they may be down — it doesn’t really matter.”

Markowitz’s advice to individual investors? Buy “broad low-cost stock and bond index funds instead” and allocate them in a proportion that gives you a level of volatility with which you are comfortable.” Where have you heard that before? Indexing may not have Facebook’s flash, but it’s more solid than ever in today’s volatile market. And diversifying your portfolio between stock and bond funds chosen in accordance with your risk tolerance and future goals will always be more prudent than plowing money into the latest hot stock.

Buffett: Stocks Beat Bonds

Fortune recently published an article by Warren Buffett where the Oracle of Omaha divides the investment world into these three asset classes:

• Investments denominated in a given currency, including money-market funds, bonds, mortgages, bank deposits, and other instruments. “Most of these currency-based investments are thought of as safe. In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge,” writes Buffett.
• Assets that will never produce anything, but that the buyer hopes someone will pay then more for in the future. “Tulips, of all things, briefly became a favorite of such buyers in the 17th century,” notes Buffett. “Today, the major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful).”
• Investments in productive assets like businesses, farms, or real estate. “Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment,” Buffett writes. “Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See's Candy meet that double-barreled test. Certain other companies -- think of our regulated utilities, for example -- fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.”

Buffett says that stocks will be the “runaway winner” over the long-term, however, “currency based” and “sterile assets” will always be the most popular when fear preys upon the market. In fact, in the wake of ongoing volatility, investors have pulled money from U.S. stock mutual funds each of the last five years, including $100 billion in 2011. And at the same time, they poured money into bond funds each of the last six years, including $110 billion last year.

Notably, those saving for retirement or supporting themselves in retirement have a different investment horizon than Buffett’s “forever.” And that’s where we come in -- working with clients to identify their goals and risk tolerance, build an appropriately diversified asset allocation plan, and manage the portfolio based on reason, not emotion.

Time to Re-assess Market Risks/Rewards?

According to Jim Parker, Vice President, DFA Australia Limited, understanding investment risk begins with accepting that “the market itself has already done a lot of the worrying for you.” As Parker notes, “Markets are highly competitive, which means that new information is quickly built into prices. Instead of trying to second guess the market, you work with it and take the rewards that are on offer.”

To put yourself in the best position to “take the rewards,” it’s wise to work with an advisor to build a diversified portfolio designed to meet your long-term goals – and meet periodically to review your progress and make necessary changes to ensure you are still on course.

If the Great Recession has altered your perception of risk, now may be a good time to meet to re-assess your risk tolerance. Remember, how much risk you decide to take involves assessing three inter-related factors: your future goals; your age and investment time horizon; and additional personal factors such as your current net worth and natural temperament.

As you consider where you fit in the risk spectrum, remind yourself of the Catch 22 inherent in the risk and return equation. That is, while Merriam-Webster’s Collegiate Dictionary defines risk as “possible loss or injury,” risk also is present in opportunities that will be lost if you totally avoid risk. The simple truth, according to Parker, is: “If there were no risk, there would be no return.” Your chances of getting the balance just right are much greater if you work with a financial advisor who combines what Parker refers to as the “accumulated knowledge of financial science” with in-depth knowledge about you.