I have a friend, Blake, who netted a million dollars in cash when he downsized by selling a McMansion and buying a smaller home. About a year after the sale, I asked him what he had done with the money and I was flabbergasted when he told me that he had been holding it in his checking account. He didn’t know what the interest rate was, so I checked. It was 0.01 percent. That’s right, one one-hundredths of a percent.
I asked why and Blake said he didn’t want to lose any money. True enough, his money wasn’t going to go below $1 million, but it wasn’t going to go much above $1 million, either. He was losing a lot of money compared to how much money he might have if he invested in stocks. A return of 0.01 percent on $1 million is $100 in a year’s time. A portfolio of blue-chip stocks with 2 percent dividend yields would generate $20,000 in dividends in a year’s time. There is a pretty big difference between $100 and $20,000.
It gets worse. With normal 5 percent dividend growth, the anticipated long-return from the blue-chip stock portfolio is 7 percent. If dividends and prices go up by 5 percent the first year, the first-year return is $70,000, compared to $100. That’s a heavy price to pay for safety.
It is true, as Blake said adamantly, there is no guarantee what stock prices will be day to day, week to week, or year to year. Stock prices could drop 5, 10, even 20 percent in a single day, even more in a year.
I tried to convince Blake of the wisdom of a value-investor perspective. Invest in ten, twenty, or thirty great companies with 2 percent dividend yields and then forget about it. Don’t check stock prices every day. He could think about something else—his family, his job, his hobbies. While he is minding his own business, his stock portfolio will pay $20,000 dividends the first year, somewhat more the next year, and even more the year after that, with all dividends automatically reinvested.
Ten years from now, he can check his portfolio. He will have accumulated ten years of healthy dividends reinvested to earn even more dividends. The market prices of his stocks will almost surely be higher ten years from now than they are today, probably much higher. The economy will be much larger, corporate earnings will be much higher, and dividends will be much higher—so will stock prices. If the dividends and earnings on his stocks grow by an average of 5 percent a year and price-earnings ratios are about the same then as they are today, his portfolio will be worth about $2 million, as opposed to $1,001,000 if he leaves his money in a checking account paying 0.01 percent interest for ten years
Blake reluctantly agreed to invest $500,000 in stocks. Wouldn’t you know it, he called me the next day to complain that the value of his portfolio had dropped by $195. (No, I am not making this up.) He wanted to sell his stocks before he lost any more money.
Other people are the exact opposite. I have another friend, Emma, who gets the same thrills from buying and selling stocks that other people get from winning and losing money in Las Vegas. Every weekday morning, Emma bolts out of bed, excited to start a new day filled with buying and selling stocks. News tidbits, stock price blips, and chat-room rumors provide jolts of excitement as Emma moves quickly to buy or sell before others do. By the end of the day, she has sold everything she bought during the day because she doesn’t want to be blindsided by overnight news. Emma wants to be in control, to begin every day with cash that she can deploy during the day as she does battle with other investors.
On weekends, Emma is bored and restless. For some people, Monday is Blue Monday—the day they have to go back to work. For Emma, Monday is Merry Monday—the day she gets to start living again.
Emma is a gambling addict. Some people love to watch slot-machine wheels spin; Emma loves to watch stock prices dance. Profits are exhilarating. Losses are an incentive to keep betting, hoping to recoup those losses and believing that she is due for a win. Day-trading stocks is entertainment, but it is not cheap.
I hope this book will convince you that Blake and Emma are bad role models. Sensible investors can make a lot more money than Blake’s checking account without taking as many risks as Emma’s dice rolls. The secret is value investing—buying solid stocks at attractive prices, and leaving them alone.
Value investing is admittedly more adventurous than checking accounts and more boring than day-trading, but it is more rewarding than both.
Part I of this book will argue that a value-investing strategy can help intelligent investors select profitable investments without unbearable financial stress. Part II will describe several detailed examples of value investing.
Excerpted from MONEY MACHINE: The Surprisingly Simple Power of Value Investing by Gary Smith. Copyright © 2017 by Gary Smith. Published by AMACOM Books, a division of American Management Association, New York, NY. Used with permission.
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