Saturday, January 12, 2013
It's a new year... and it's time to set some goals.
Although we can't guarantee investment success, we can deserve it. We deserve it by following a few simple, key guidelines. If you don't have these things taped up on your computer screen yet, it's time.
First and foremost, the No. 1 goal for 2013 is to not lose money. We manage the risk of loss in three important ways. First, we do our best to only buy investments when they are attractively priced. That means, you have to know how to value operating companies (on the basis of their cash flows), asset development companies (on the basis of their proven reserves), and bonds (on their discount to par and yield to maturity).
We've written about these topics many times. This year, promise yourself that you will fully understand the value of what you're buying. And no matter what... don't pay too much for your investments.
The second way we avoid losses is by using trailing stop losses. These are mechanical exit points where we will sell a stock if the price has moved against us by a predetermined amount – normally 25%. We don't tell our brokers about our stop-loss points. We don't enter the stops into the market, either. Telling the market where your stops are is just like showing your poker buddies your hand before you start the bidding.
Keep your stops on a spreadsheet. Or even better, use software like TradeStops to manage your portfolio. (We receive no compensation for recommending TradeStops.) Make 2013 the year you fully embrace trailing stops. Make this the year you don't ignore any stops or hold onto any losing positions.
The third and most important way we minimize risk with our investing is by having a relatively diversified portfolio. It's difficult to give any useful advice about position sizing and portfolio allocation to a broad audience because everyone's asset base is unique. But I recommend everyone understand two important rules of thumb...
First, it's OK to have a big asset – like a business or a ranch – that dominates your balance sheet, if you're in control of the asset and if you have positive carry (positive cash flow). Looking at my own balance sheet, for example, I have two very large assets (compared with everything else): my publishing company and real estate holdings. That's OK because I have total control over both assets, and they provide me a significant amount of cash flow.
On the other hand, when it comes to passive, minority stakes in companies (like holding shares of stock), I never buy a position size larger than 5% of my portfolio. I don't have control over these assets. And as an outside, passive investor, I will always have an information gap. I must diversify.
All passive equity investors ought to have at least 12 stocks. You should have a note card made up about each one, so you can easily explain each business, your reason for investing, and the conditions that would cause you to sell. Maintaining your portfolio shouldn't take more than an hour a month, if you're organized. Make 2013 the year you do it.
At the beginning of each year, my long-term wealth-building goal is to make one substantial investment in a very high-quality, capital-efficient business. To do so at the right price (less than 10x average annual free cash flow) takes a bit of luck... I can't manufacture a great opportunity to buy a company like Hershey, McDonald's, or Coke. But I can be prepared so that if such an opportunity comes along, I'll be ready.
I suggest you do the same by keeping at least 10% of your portfolio in cash. This will allow you to make a big bet (double the normal position size) if the right opportunity comes along.
Take an hour this week and review our work on capital efficiency (here and here). Write down the names of five or 10 companies you'd love to own for the next 10, 20, or 30 years. Keep the list somewhere handy... you never know when a big market correction will come along.
One final goal for 2013... Make sure you've purchased some kind of paper dollar hedge. Although you can hedge against the growing risk of inflation (and a collapse in the bond market) in a number of ways... the best is to simply buy gold bullion. I strongly suggest that if you haven't put 5%-10% of your portfolio in gold yet, you should do so now. Store the gold outside banks. I recommend self-storage facilities that are secure.
Our political leaders are now on a runaway, suicide course. They've come to believe that narrowing the tax base and printing billions and billions of dollars is the formula for prosperity. It's complete madness.
The latest example is the trillion-dollar coin nonsense that's being pushed by certain folks on Wall Street. They say Treasury Secretary Tim Geithner should just mint up a $1 trillion face-value coin and deposit it with the Treasury... That, these idiots claim, will circumvent the debt ceiling.
These theories have all been tried in many other places around the world – Zimbabwe, Argentina, Germany after World War I... and they never work. No nation in history ever became wealthier by going deeply into debt and then printing the money required to repay the loans. It will not work here, either.
Unfortunately, the success the Fed has enjoyed (so far) in expanding the monetary base and manipulating the Treasury bond market has greatly emboldened our politicians. These men are crazy, stupid fools... who are completely blind to the inevitable catastrophe they will cause. Protect yourself from the coming monetary mayhem while you still can. Make 2013 the year you put yourself on a gold standard.
Date Range:1/3/2013 to 1/10/2013
Date Range:1/3/2013 to 1/10/2013