When it comes to creating wealth, there is nothing magical about the process. However, it helps if you are open to grounding yourself in a few timeless principles.
After 40 plus years of investing in stocks, bonds, mutual funds and ETF’s, I’ve learned a thing or two about increasing our wealth through investing. And, at times, decreasing it by learning the hard way. 40 years? That’s right, but I’m not as old as you think.
MY INVESTING BIOGRAPHY
Here are a few facts from my investing biography.
HOW I GOT STARTED
My Dad helped me buy my first stock when I was about 10 years old with the profits from mowing lawns and delivering newspapers. Due to his encouragement, I bought shares in the dividend reinvestment plan (DRIP) of the electric utility Commonwealth Edison (ComEd).
With part-time work, scholarships and a little help from my parents I was able to graduate college debt free. Fortunately, I went to an affordable in-state public university. Compared to today, it didn’t cost that much. Less than $15,000 room, board, tuition, fees and books for a bachelors degree and my CPA certification for the entire 4 years.
Of course, I wasn’t living an extravagant lifestyle. Rather, I shared a dumpy apartment with a couple of other dudes. In addition, I ate like crap, wore cheap clothes and studied a lot in the library. I liked girls, but I was scared of them. So, I mostly stayed away. My school was great. In fact, I loved it and felt very comfortable there. But, it was nothing like some of the luxury campus facilities you see today.
And, my Dad made sure I never touched the ComEd DRIP. Furthermore, it just kept growing as dividend reinvestment plans will do – drip by drip by drip. As a result, 11 years later when I graduated it was worth about $10,000. Maybe that doesn’t sound like much in today’s terms? However, it was 1986 and I was 21 years old. Look out world here I come!
GETTING GOING IN THE “REAL WORLD”
I dabbled in individual stocks in my early 20’s as a young working adult. Most of all, I remember owning Disney. If only I would have held on to it. I’m sure it would be worth a small fortune today.
However, the stock market was on a tear and mutual funds were becoming popular. Hence, they brought investing to the masses. There was no internet. Company financial information and stock prices were primarily accessed by hard copy quarterly filings, annual reports, newspapers, and magazines. Opposite of the real-time information we have at our fingertips today.
To make a stock trade, you had to pick up the phone and call your broker. In addition, confirmations and statements were sent through the US postal service by snail mail.
REALITY STRIKES AT A YOUNG AGE
On October 19, 1987, I was working on a client audit located in the Chicago Board of Trade. The client was a discount stock brokerage firm called Rose and Company. A few years later they were bought out by and consolidated into Charles Schwab.
On that day, called Black Monday, the Dow Jones industrial average plunged 23%. It remains the largest single-day drop in its history. People crowded into the lobby of Rose and Company to see what was happening in the stock market. The company’s phone lines were jammed and panic was in the air.
Our audit team was asked to leave. The client was overwhelmed and couldn’t deal with us being there too. The stock market losses on black Monday were part of a longer-term bear market. It took several years for those bear market losses to be fully recovered.
A CHANGE IN MY INVESTMENT STRATEGY
Over the coming months, I decided to let mutual fund managers do my investing work. I sold my stocks including the ComEd DRIP and created a diversified portfolio of actively managed equity and bond mutual funds. Why?
Jack Bogle started the first Vanguard index fund in 1976. However, indexing wasn’t that well known or popular at the time. If ETF’s even existed, very few people knew about them. Rather, actively managed mutual funds were the popular choice. In addition, I didn’t want to hold individual stocks anymore.
INVESTING IN THE 1990S AND EARLY 2000S
From my mid-20s until age 40, I dollar cost averaged into a diversified portfolio of mutual funds. I mainly focused on growth with a little fixed income thrown in for diversification. Dividend growth stock investing was less popular during this time. One reason was high tax rates. Dividends did not receive the favorable tax treatment they do today. They were taxed as ordinary income.
Mrs. DD and I were entering our peak earnings years. Our combined incomes and dividends put us in the top tax bracket. Between the Federal and State governments, 45% of every dollar paid in dividends was given right back to the tax man.
Due to the taxes, investing for dividends just wasn’t worth it. On the other hand, capital gains were only taxed if they were realized based on the sale of a holding. Therefore, investing for growth was much more tax efficient at that time. So, that is what I did.
And, don’t forget the stock market suffered a 46% decline from August 2000 through September 2002. Ouch! The 13-year-old bull market was over with a big bang when the internet and dot com bubble burst.
A NEW OPPORTUNITY!
To get the economy and financial markets moving in the right direction, we got the “The Jobs and Growth Tax Relief Reconciliation Act of 2003”. Also known as the “Bush tax cuts” for former President George W. Bush.
The Bush tax cuts leveled the income tax playing field for dividend income. The tax code finally taxed dividends at the same lower rate as capital gains. This cut represented a huge tax reduction on dividend income. With the 2003 tax law in the books, I became a dividend stock investor about 13 years ago, at the age of 40. And, I’ve never looked back.
WHACKED DOWN AGAIN
Just when it looked like financial independence was in our grasp, the financial crisis and great recession struck in 2007. After having recovered all of its losses from the early 2000’s bear market, the S&P 500 dropped 53% from October 2007 to March 2009.
Fortunately, the economy and the financial markets have recovered to new post-recession highs. Most of us know that story. We have all lived it the last several years.
Even though dividend growth stocks are my primary investment focus, we still own some ETF’s as well as closed and open end actively managed mutual funds. Our investments are internationally diversified across a wide spectrum of bonds, equities, commodities, and real estate through both taxable and tax-advantaged accounts. I have never taken the increased risk of trading on margin. This strategy works well for our current stage in life
It will be interesting to see what happens when the next bear market rolls in. Why? There is a whole generation of young investors that have never experienced large losses on their investments. And, many of the rest of us have forgotten how it felt. Or, believe it won’t happen again. What will cause the next bear market and how will we react? I don’t know. Only time will tell.
If you don’t believe me, will you believe Warren Buffet? In his latest annual letter to shareholders, he warns that losses of 50% or more are not only possible in the future, but inevitable. My past experiences suggest he is right.
Turn the investing odds in your favor. The best way, in my opinion, to handle this uncertainty is to practice solid, fundamental investing principles. We all need to start somewhere. A strong foundation to work from is a must.
Here are 15 investing principles for you to consider. Look for more detail on each one of them in past investing articles and future posts.
A FEW GOLDEN RULES TO GET US GOING
Start early. Building wealth through investing takes time. The earlier in life you start, the better your chances for success. Not everyone is as fortunate as me to start at 10 years old. But that’s okay. If you haven’t started yet, start now. It will never be earlier than today.
Avoid market timing. Few people know which direction the stock market will go next. Or, when it will suffer a correction. So, don’t try to time the market.
Invest for the long term. Markets and asset prices go through up and down cycles. However, over the long run, you stand a better chance of earning positive returns on your investments.
MAKE A PLAN
Determine your investing objectives. Is your objective capital appreciation, income or total returns? Are you investing for retirement many years away? Or, to make a down payment on a house in a few years.
Know your risk tolerance. How will you react when you lose money. If you will sell at the first sign of a loss, you are risk averse. Therefore, your investments should be very conservative. Of course, less risk likely means less reward.
What’s your strategy? What will you invest in? Individual stocks, ETF’s, real estate, certificates of deposit? Where will the money to invest come from? How often will you make investments?
Determine your asset allocation. Asset allocation is the mix of assets you hold.
Cash, bonds, stocks, commodities and real estate are some of the major asset classes. Most noteworthy, asset allocation is one of the primary drivers of investment returns. It should be consistent with your risk tolerance. Bear markets do happen.
EXECUTE YOUR PLAN
Diversify your holdings in each asset class. If you hold stocks, bonds or real estate, don’t just own one company or property. Own a portfolio of several, or invest through a diversified fund(s) that holds many. Also, consider international investments. With diversification, if one investment goes bad, it won’t take your entire investment portfolio down with it.
Know what you are investing in. Do you understand what you are buying and why you are buying it? Research your investments. Either that or stay away.
Invest on a regular basis. This strategy is known as dollar cost averaging. It reduces your risk of putting all your money into an investment at its peak price.
Reinvest all dividends. If you do not need to spend your dividends, reinvest them. DRIPs are one method where the dividend is automatically reinvested back into the security that paid it. Another method is to let the dividends accumulate in cash and reinvest them in a lump sum into an investment of your choosing.
KEEP COSTS & TAXES LOW
Minimize investment costs. Focus on low-cost funds or individual securities. Furthermore, keep trading to a minimum to avoid transaction fees.
Minimize taxes. Also, minimize trading to avoid capital gains taxes. In addition, utilize techniques like tax loss harvesting.
Use tax-advantaged accounts. Maximize your 401k and IRA options or their equivalents in other countries.
ADAPT AS CIRCUMSTANCES CHANGE
Monitor your investments. On a periodic basis monitor and review your holdings against these principles. In addition, learn from your mistakes. Most importantly, make adjustments as your circumstances change.
So, that’s my 40 years of investing experience poured out in a blog post and some key principles I have learned. And now, what are your thoughts? In addition, have I missed any investing principles you think are important?
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