Philosophy

Investment Goals & Objectives

Three basic concepts of investor utility—introduced by the mathematician Bernoulli in 1738 —are still the basis of most methodologies of money management. The first concept is that investors prefer to earn more return on their investments rather than less. The second is that investors prefer less risk to more risk, although they may have difficulty describing exactly what risk is. The third is that investors exhibit decreasing marginal utility of wealth; that is, if someone is wealthy enough to own four houses, gaining the wealth to buy house number five is less important than gaining the wealth to buy the first house.

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The nexus of an investment plan that meets an investor’s objectives usually centers around risk. Your acceptance of risk revolves around how well you sleep at night. If daily or monthly changes in the value of your portfolio keep you awake, your asset allocation will be different from the investor who checks his portfolio value annually. One’s ability to accept risk also centers on the goals you hope to achieve with your portfolio and the length of time you have to keep your money invested. Investing for the short term normally leads you to think safety first; but, if you are investing for an event in the distant future, a greater acceptance of risk creeps into your outlook.

The ultimate goal of most investors is not merely to accumulate wealth, but to accumulate sufficient wealth for future consumption. If consumption needs are modest, consumption is deferred to future generations or bequests to charitable organizations. Family circumstances and lifestyles evolve over time. The resulting changes require adjustments between returns obtained and risks taken. Investing too much (or too little) in stocks may severely impact your ability to meet your objectives. We feel it is important to try to come to terms with your situation and goals. There are no easy answers, but time spent on this issue will probably do more good than time spent trying to figure out if tech stocks are about to catch fire again.  


Asset Allocation & Diversification

As a general rule, investors have three objectives when investing in securities. These objectives are stability of principal, current income, and growth.  Unfortunately, there is no single security which satisfies all of these objectives.  Satisfaction of the three objectives requires the utilization of three types of securities or asset classes: cash equivalents, bonds, and stocks.

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The portion of an investment portfolio which satisfies the stability of principal criterion consists of cash, money market funds, and high-quality, short-term (one to two year maturities) bonds. While cash equivalents offer relative price stability and income, the income generated from these securities can vary greatly as short-term interest rates change.

As the key attribute of bonds is income generation, they are used to satisfy that objective. Said income may provide for living expenses or assist in the portfolio’s growth through reinvestment. Although bond prices fluctuate, the swings are usually less dramatic than those of stock prices. And bond prices sometimes rise when stocks fall. Because bonds and stocks do not always move in sync and bonds generally fluctuate less than stocks, bonds can smooth out the returns of a stock portfolio. Importantly, the income and relative stability of bonds may help investors to endure—both emotionally and financially—the inevitable stressful stock market downturns. Thus, bonds do more than satisfy the portfolio’s income objective.

While stocks provide a modest contribution to a portfolio’s income objective, their utilization in a portfolio is primarily for growth. Stock values fluctuate with the growth and decline of the economy, the success or failure of the particular business represented, and changes in investor psychology. However, reflecting the growth in the U.S. economy, their long-term trend has been upward providing investors with growth and inflation protection.

With the intent of reducing risk, diversification within each asset class is also important.  The bonds should be of varying maturities and represent a variety of industries. The stock portion of the portfolio should be diversified, not by following a mechanical formula but by analytical selection of those companies and industries most likely to prosper.

Not only does proper diversification reduce risk, it also increases the probability, through the law of large numbers, of better returns. In any portfolio, all stocks do not rise or fall equally in a given period. Returns are often concentrated in a few issues which significantly outperform the rest of the portfolio. Since the winners are not known in advance, a reasonably diversified portfolio is more likely to have these winners than a portfolio concentrated in a few stocks.

Diversification is best achieved as a by-product of developing a wide variety of ideas and expressing those ideas via securities in a portfolio. Viewed in this way, the adequacy of the diversification is dependent upon the breadth of knowledge and experience of the portfolio manager. In other words, experience counts.

Maintaining a balanced portfolio of stocks, bonds, and cash equivalents is a sensible way to moderate the various risks in the securities markets.  Stocks make good sense for maximum long-term return and optimum protection against inflation; bonds, depending on their quality and maturity characteristics, offer varying degrees of income and principal stability; and cash reserves provide ready liquidity and the peace of mind of complete principal stability. Today’s volatile conditions clearly amplify the merits of a well-diversified investment portfolio. 


Market Timing; Diversification

“It’s time in the market, not timing the market that makes for successful investing.”
–Thomas W. Phelps
100 to 1 in the Stock Market (1972)

Individuals who build substantial estates through their financial investments tend to be those who “Buy right and sit tight.” Buying right simply means purchasing stocks with favorable long-term fundamentals at attractive prices. Sitting tight suggests focusing on the long-term fundamentals of a company as opposed to responding to the latest news developments and rumors.

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Most portfolios are traded excessively. In large part this situation stems from an emphasis on short-term performance. Everywhere one looks an emphasis on short-term results is encouraged. The major financial publications remind us quarterly which mutual funds are doing well and which are doing poorly. The Wall Street Journal pits the picks of professional money managers against stocks selected by throwing a dart. Results are measured over a six-month period. Seldom are we reminded of the virtues of patience.

Experience has taught us that we cannot pick stocks that will rise this quarter and fall next quarter, and we have yet to meet anyone who consistently does. Yet, many investors, even professional money managers, who believe they are long-term investors find it difficult to be patient. They start with sound research and careful thought that identifies attractive companies in promising industries. Then, perhaps because they are bombarded with too much “news” they slip into trading stocks and believing they can play the quarter by quarter game.

The whole process is analogous to predicting the winner of the next point in a tennis match vs. predicting the winner of the match. Armed with the knowledge of the records of the opponents, it is much easier to forecast the winner of the match than to forecast the winner of the next point. So it is with investing.

Advocating a buy and hold approach is intended to counter unproductive activity (trading) and is not a recommendation to put stocks away and forget them. Judicious pruning of a portfolio is warranted, but the focus should be to identify what might be more permanent deterioration as opposed to that of a more temporary nature.

Jumping from one stock to the next in an attempt to be in the right place at the right time results in much “shooting where the rabbit was.” Successful investing is rarely a matter of short-term timing. It is a matter of consistency and patience.


Retirement Saving

“$1,000 left to earn interest at 8% a year will grow to $43 quadrillion in 400 years,
but the first hundred years are the hardest.”
– Sidney Homer

There is a serious flaw in today’s workplace retirement system:  too many working Americans save too little, with the risk that many will struggle financially in retirement. Forty or fifty years ago many workers joined companies that offered pension or profit-sharing plans. With forty to forty-five years of employment, the accumulated pension or profit sharing plus social security provided for a comfortable retirement. Today’s worker is unlikely to find an employer-sponsored pension or profit-sharing plan. Instead, at best, a 401(k) plan is offered. To accumulate assets in a 401(k), the employee must contribute (i.e., reduce take home pay)—and many either contribute very little or nothing at all. The responsibility of providing for retirement has shifted from the employer to the employee.

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It is important that employees get an early start saving for retirement.  Today, the typical working life is from age twenty-two to sixty-two—or forty years—with approximately twenty years in retirement or a 2:1 ratio of working to non-working years. It is a little scary to think that every two years of work must finance one year of retirement.

Such a demanding task was not always so. In the original state sponsored retirement pension program instituted by Chancellor Otto Von Bismark for Germany in 1889, the retirement age was seventy. Adult life expectancy was about seventy-two. Work, on average, began at age sixteen, so that gave fifty-four working years to finance two years of retirement.

Then consider America in 1950. At that point in our country’s history, work started on average at age twenty and retirement averaged age sixty-seven with life expectancy of seventy-six for about nine years of retirement. During that period, an employee had five years of work to prepare for each year of retirement.

Getting back to the present, we thought it would be helpful to give you an idea of the required savings rate needed over forty years of work to finance twenty years of retirement. Of course, the outcome depends on the assumptions you use. In an article in the September 5, 2005, Barron’s, Alex J. Pollock made the calculation assuming one would need 70% of the final working year’s salary during retirement (some would say this percentage should be 80% or 90%); that labor productivity and wages would grow at a reasonable 1.5% annual rate during the working career; that the savings would be in a tax-deferred account; and that we could expect returns during the accumulation and consumption periods of 6–7%. Using those assumptions, it would take a savings rate of 14% of pre-tax income during the working years to fund the retirement years. While the 14% savings rate includes the employee’s contribution to social security and any contribution toward a retirement plan made by an employer, the additional amount a worker must save to get to the 14% level is quite substantial.

As noted by Sidney Homer, the power of compounding is unbelievably strong. Today’s young workers need to take advantage of that phenomenon and start saving early and aggressively to assure a comfortable retirement.


Contrary Opinion Approach

“Consensus is the security blanket of the insecure.”
–Pierre Rinfret, Economist

An important aspect of our investment approach is that of contrary opinion. James L. Fraser, founder of Fraser Management, defines a Contrarian as one who “. . .is early though he is not a forecaster and rather works toward thought-out conclusions. We have to think through a given problem before we gain a fresh and different approach to a solution.” He further states, “The object of contrary thinking is to challenge generally accepted viewpoints on the prevailing trends in politics, socioeconomics, business, and the stock market.”

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Essentially, the theory of contrary investing is to avoid that which is popular or to avoid the crowd. The power of the crowd and the influence of the crowd on one’s emotions can be a dangerous element in investing as crowd behavior leads to extremes. Following the crowd can be rewarding for a time. However, the crowd or majority will be wrong at turning points when it matters the most, as hopes and fears often run ahead of reality. Contrary thinking is one of the best ways to stay aloof from the psychology of the crowd.

The classic Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay, originally published in 1841, reviews a broad range of scams, manias, and the tulipomania of 17th Century Holland. History is replete with examples of rational individuals succumbing to the irrationality of the crowd. As MacKay points out, “Men it has been said, think in herds, it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.” It is fascinating to be reminded of how little human nature has changed and how the pattern of events repeats itself over and over. The objects of speculation change, but greed and fear are always there.

One key to success in securities investments, especially stocks, is to be where others want to be later. Studies by Avner Arbel and Steven Carvell at Cornell University indicate neglect is the key characteristic in identifying securities likely to outperform. They defined neglected stocks as those generally ignored by analysts and institutional investors. This is true contrarian investing. Fraser supports this view when he states, “It continues to be stocks that have lower expectations that will prove rewarding in the market place.”

It is far easier to explain the contrarian approach than it is to apply it consistently. The difficulty is that contrary thinking goes against human nature. It is only natural to feel more comfortable with your position if it is reinforced by others. Yet, to succeed, one must at critical times do the opposite of what seems to be the sensible thing that everyone else is doing. Contrary investing is not infallible, but one’s chances for success are greatly enhanced by doing what seems to be contrary.

Take comfort in knowing

Investment Basics

Does investing seem mysterious and complicated to you? Sometimes it seems better to avoid saving for your future rather than put yourself in an uncomfortable situation. This section provides some basics that will help you better understand the investment world — knowledge is power.

Although there are countless investment products, we stick to a proven strategy of buying stock in undervalued companies that demonstrate promising long-term growth potential. We find that investors appreciate our investment style because it is a philosophy that everyone can easily understand.

Value Investing

Value Investing is an investment system that comes from concepts that Ben Graham & David Dodd taught at Columbia Business School beginning in 1928. Later they refined their teachings and published them in their 1934 book Security Analysis. In general, value investing involves some form of fundamental analysis and buying securities at apparent bargain prices. This discount of the market price to the economic value (also intrinsic value or true business worth) is what Benjamin Graham called the “margin of safety.”

Fundamental Analysis

We looks at a stock purchase as if we were going to buy the entire company. We believe that following a consistent process is vital before buying stock shares. When we look for outstanding companies, they must fit all four of these criteria:

  • Good businesses that we understand, have a competitive advantage and possess high profit margins.

 

  • Companies that have little or no debt and significant free cash flow, and deploy capital wisely.

 

  • Enterprises with superior management teams; leaders who are honest, ethical, energetic and have a strong track record of increasing the economic value of their organizations.

 

  • Businesses we can buy at a discount to our estimate of economic value – this is our margin of safety.