If you're competing in a fictional stock portfolio challenge with fake money, you should take big risks to try to outscore your opponents. If you're investing real money, even if it's a small amount, you should play by different rules. In my mock portfolio at http://www.marketwatch.com/game/little-steps-to-wealth , I'll only make trades that I would make with real money in my own account, or that I would make on behalf of those who have entrusted me with handing their investment accounts.
Over the course of a short "game," taking chances on high risk/ high reward stocks might pay off, over the long haul it will not. If you're playing along with your own mock portfolio, use whatever strategy you like. A year, however, is a very long time.
What kind of return should you expect in your own real investment account? Well, it depends on your strategy which may vary as we discussed the other day. At an absolute minimum, if you are simply trying to preserve your existing wealth, you need to outpace inflation. In 2014, the US inflation rate was 0.8% according to usinflationcalculator.com . If your investment account made just a one percent gain and had no downside risk, you'd have successfully preserved your wealth.
Most of us are not rich enough to be at the point where breaking even is an acceptable investment goal. The truth of the matter is, most people, even professionals, suck at picking stocks for a variety of reasons. Greed is one of those reasons, lack of patience is another. The biggest reason is that we can't know everything about every stock, and we certainly can't predict the future. So, when the economy, or at least the stock market, is in a period of growth, a good rule of thumb is that your investment account gains should match or exceed broad stock market gains.
As reported by CNN Money, in 2014, the Dow (a more conservative assortment of big, generally safer stocks) rose 7.5%. The S&P 500 (a broader selection of 500 large companies traded on the major US indices) rose 11.4%. The NASDAQ (a market consisting of a very broad collection of stocks of all sizes and risk levels) rose 13.4%. For most people not approaching or already in retirement, your 401k, IRA or other investment account should be meeting those returns.
If your investment account is professionally managed by an investment adviser, ask him or her why he or she didn't at least meet those returns, chances are she or he didn't. When choosing an investment, don't just look at its historical returns, compare them to the returns of the major indexes for the same period. If it consistently underperforms the market, but carries risk roughly equal to the broader market, you be better off just buying an index fund.
Index funds, especially if you own several different ones, such as a Dow Jones Industrial Index Fund, a NASDAQ index fund, and maybe a smattering of foreign index funds from various parts of the world, are just about the highest level of diversification you can get in a stock portfolio. If you have a long investment horizon, then that's not a bad way to go.
If you have very little to invest, and need to make bigger gains in order to reach your financial goals, then you might want to take a more aggressive approach. A more aggressive approach generally entails bigger risks. You might be more likely to lose money over a period of time than you would with a more diversified approach. That extra risk should be offset with a better chance for bigger gains. That's not always true, but, in theory, it should be.
Personally, I'm not a big fan of broad diversification. Diversification generally protects you from big losses, but it also generally insulates you from big gains. I prefer to own a relatively small number of investments each of which I know very well.
For example. Ship Finance Limited (SFL) is a company that I have followed for years. It closed today (2/19/2015) at $15.46. That's a pretty good price for this stock, especially when one considers that it pays a quarterly dividend of 41 cents/ share. That works out to a 10.6% return exclusive of any changes in the price of the stock.
Buying a dividend paying stock gives you an advantage since you will be getting regular cash payments regardless of the performance of the stock price. A large, stable company that has a long history of stable or increasing dividends might pay something like 1.5-4.0% and be considered an excellent income stock. Let me remind you that SFL pays out 10.6% and has a consistent history or increasing dividends over time. It is a stable company, though not without some risk. According to Yahoo! Finance, 7 analysts who follow SFL have an average stock price target of $18.93/ share, with a high of $23 and a low of $15.
The truth is, this stock trades in a range generally from $15- $18/ share although it sometimes exceeds that both higher and lower. If one can buy it at the lower end of that range, one should. If it gets into the $19 range (with no major changes in their business), one might consider selling and waiting for it to fall back a bit.
Ship Finance is company that buys ships such as oil tankers, deep water drilling ships, container ships, bulk freighters, and chemical carriers and then leases them out to other companies that operate them. They generally get a flat daily rate, plus a share of the profits made by the lessee. The relationship with many of the lessee/ operating companies is somewhat incestuous. A controlling interest in SFL is owned by Hemen Holding or directly by Jon Frederiksen and family. Not coincidentally, the same principals own large stakes or even controlling interest in Golden Ocean, Frontline Shipping, Golar LNG, Seadrill, as well as significant stakes in a number of others. Hemen Holding, by the way, is a Frederiksen-controlled investment company.
What that means is that SFL is the financial lynchpin of the entire shipping empire. Through this arrangement, SFL is able to hand off the majority of the financial risk to these other companies while enjoying a large share of the profits. If a ship is sold, profit goes back to SFL. If one of these shipping companies has financial difficulty, SFL can just take back its ships and lease them to someone else or sell them outright for a windfall. Free cash flow is very good for SFL enabling it to make these large dividend payments.
I could go on about the global shipping market in general, but suffice to say that SFL is to a large extent insulated from the biggest risks while enjoying large upside potential when things are booming. It provides a significant amount of cash in the form of dividends to Hemen Holding and to Jon Frederiksen who controls the aforementioned companies. It is essentially the cash funnel from these companies to him (and other stock holders). That's a good part of the reason why the dividend is safe.
So, right now, if I buy SFL at $15.46, I'll make 10.6% in dividends (or more if the dividend is raised yet again) over the next twelve months. Without a penny change in the stock price, that beats the Dow gains for last year. That's a good place to park money in my opinion. I'll talk in more detail about dividends, ex-dividend price drops, and other complicating factors in a future post. For now, buying and holding a good dividend paying, stable company is generally a good thing -Note: I am NOT including real estate trust or commodity trusts in this group even though their dividend payouts may look extremely high, there are other complicating factors that make them much riskier and offset the value of the dividend (or return of capital as the case may be...). I'll talk about why in a future post as well.
So the first investment in my mock portfolio will be to place an order tonight to buy SFL tomorrow (2/20/2015). I will place an order for 60 shares because the accounts in the game have margin trading privileges. That means that the value of my investment account is used as collateral to allow me to essentially borrow the equivalent amount (up to another $500 -the exact amount depends on your investments) at an interest rate (for this game) of 8%. because SFL pays 10.6%, that means I get a net of 2.6% -ish (compounding aside) on the borrowed money. The downside is that if the value of my portfolio drops, I have to immediately sell off stocks to allow for the reduced borrowing ability even if its not a good time to sell. Bad calls on margin trades can devastate your account quickly.
I'll talk more about the details of margin trading another time. Beginners should not trade on margin, period. It's fine for the mock portfolio, and because I'm confident in my experience, I would (and do) trade on margin and would buy SFL at this price on margin with real money.
One more thing that I'll mention, is the Free Ride prohibition. In cash stock accounts (non-margin accounts), investors like you and I are prohibited from buying a stock and selling it before the purchase settles (three days). This would allow us to buy a stock and sell it without ever having cash enough to pay for it in our account. It's ok for Wall Street types and millionaires, but the average investor without margin privileges can't do it. It's another example of rigging the game in favor of Wall Street..., but I digress. Because the accounts in the game have margin privileges, this prohibition does not apply.
OK, that's it for today. Tomorrow morning, when the market opens my mock account portfolio will show 60 shares of SFL (assuming the opening value of that purchase remains below $1000).
Disclaimer: I do own SFL in my own real account and/or in one or more of the accounts I manage for others.
Over the course of a short "game," taking chances on high risk/ high reward stocks might pay off, over the long haul it will not. If you're playing along with your own mock portfolio, use whatever strategy you like. A year, however, is a very long time.
What kind of return should you expect in your own real investment account? Well, it depends on your strategy which may vary as we discussed the other day. At an absolute minimum, if you are simply trying to preserve your existing wealth, you need to outpace inflation. In 2014, the US inflation rate was 0.8% according to usinflationcalculator.com . If your investment account made just a one percent gain and had no downside risk, you'd have successfully preserved your wealth.
Most of us are not rich enough to be at the point where breaking even is an acceptable investment goal. The truth of the matter is, most people, even professionals, suck at picking stocks for a variety of reasons. Greed is one of those reasons, lack of patience is another. The biggest reason is that we can't know everything about every stock, and we certainly can't predict the future. So, when the economy, or at least the stock market, is in a period of growth, a good rule of thumb is that your investment account gains should match or exceed broad stock market gains.
As reported by CNN Money, in 2014, the Dow (a more conservative assortment of big, generally safer stocks) rose 7.5%. The S&P 500 (a broader selection of 500 large companies traded on the major US indices) rose 11.4%. The NASDAQ (a market consisting of a very broad collection of stocks of all sizes and risk levels) rose 13.4%. For most people not approaching or already in retirement, your 401k, IRA or other investment account should be meeting those returns.
If your investment account is professionally managed by an investment adviser, ask him or her why he or she didn't at least meet those returns, chances are she or he didn't. When choosing an investment, don't just look at its historical returns, compare them to the returns of the major indexes for the same period. If it consistently underperforms the market, but carries risk roughly equal to the broader market, you be better off just buying an index fund.
Index funds, especially if you own several different ones, such as a Dow Jones Industrial Index Fund, a NASDAQ index fund, and maybe a smattering of foreign index funds from various parts of the world, are just about the highest level of diversification you can get in a stock portfolio. If you have a long investment horizon, then that's not a bad way to go.
If you have very little to invest, and need to make bigger gains in order to reach your financial goals, then you might want to take a more aggressive approach. A more aggressive approach generally entails bigger risks. You might be more likely to lose money over a period of time than you would with a more diversified approach. That extra risk should be offset with a better chance for bigger gains. That's not always true, but, in theory, it should be.
Personally, I'm not a big fan of broad diversification. Diversification generally protects you from big losses, but it also generally insulates you from big gains. I prefer to own a relatively small number of investments each of which I know very well.
For example. Ship Finance Limited (SFL) is a company that I have followed for years. It closed today (2/19/2015) at $15.46. That's a pretty good price for this stock, especially when one considers that it pays a quarterly dividend of 41 cents/ share. That works out to a 10.6% return exclusive of any changes in the price of the stock.
Buying a dividend paying stock gives you an advantage since you will be getting regular cash payments regardless of the performance of the stock price. A large, stable company that has a long history of stable or increasing dividends might pay something like 1.5-4.0% and be considered an excellent income stock. Let me remind you that SFL pays out 10.6% and has a consistent history or increasing dividends over time. It is a stable company, though not without some risk. According to Yahoo! Finance, 7 analysts who follow SFL have an average stock price target of $18.93/ share, with a high of $23 and a low of $15.
The truth is, this stock trades in a range generally from $15- $18/ share although it sometimes exceeds that both higher and lower. If one can buy it at the lower end of that range, one should. If it gets into the $19 range (with no major changes in their business), one might consider selling and waiting for it to fall back a bit.
Ship Finance is company that buys ships such as oil tankers, deep water drilling ships, container ships, bulk freighters, and chemical carriers and then leases them out to other companies that operate them. They generally get a flat daily rate, plus a share of the profits made by the lessee. The relationship with many of the lessee/ operating companies is somewhat incestuous. A controlling interest in SFL is owned by Hemen Holding or directly by Jon Frederiksen and family. Not coincidentally, the same principals own large stakes or even controlling interest in Golden Ocean, Frontline Shipping, Golar LNG, Seadrill, as well as significant stakes in a number of others. Hemen Holding, by the way, is a Frederiksen-controlled investment company.
What that means is that SFL is the financial lynchpin of the entire shipping empire. Through this arrangement, SFL is able to hand off the majority of the financial risk to these other companies while enjoying a large share of the profits. If a ship is sold, profit goes back to SFL. If one of these shipping companies has financial difficulty, SFL can just take back its ships and lease them to someone else or sell them outright for a windfall. Free cash flow is very good for SFL enabling it to make these large dividend payments.
I could go on about the global shipping market in general, but suffice to say that SFL is to a large extent insulated from the biggest risks while enjoying large upside potential when things are booming. It provides a significant amount of cash in the form of dividends to Hemen Holding and to Jon Frederiksen who controls the aforementioned companies. It is essentially the cash funnel from these companies to him (and other stock holders). That's a good part of the reason why the dividend is safe.
So, right now, if I buy SFL at $15.46, I'll make 10.6% in dividends (or more if the dividend is raised yet again) over the next twelve months. Without a penny change in the stock price, that beats the Dow gains for last year. That's a good place to park money in my opinion. I'll talk in more detail about dividends, ex-dividend price drops, and other complicating factors in a future post. For now, buying and holding a good dividend paying, stable company is generally a good thing -Note: I am NOT including real estate trust or commodity trusts in this group even though their dividend payouts may look extremely high, there are other complicating factors that make them much riskier and offset the value of the dividend (or return of capital as the case may be...). I'll talk about why in a future post as well.
So the first investment in my mock portfolio will be to place an order tonight to buy SFL tomorrow (2/20/2015). I will place an order for 60 shares because the accounts in the game have margin trading privileges. That means that the value of my investment account is used as collateral to allow me to essentially borrow the equivalent amount (up to another $500 -the exact amount depends on your investments) at an interest rate (for this game) of 8%. because SFL pays 10.6%, that means I get a net of 2.6% -ish (compounding aside) on the borrowed money. The downside is that if the value of my portfolio drops, I have to immediately sell off stocks to allow for the reduced borrowing ability even if its not a good time to sell. Bad calls on margin trades can devastate your account quickly.
I'll talk more about the details of margin trading another time. Beginners should not trade on margin, period. It's fine for the mock portfolio, and because I'm confident in my experience, I would (and do) trade on margin and would buy SFL at this price on margin with real money.
One more thing that I'll mention, is the Free Ride prohibition. In cash stock accounts (non-margin accounts), investors like you and I are prohibited from buying a stock and selling it before the purchase settles (three days). This would allow us to buy a stock and sell it without ever having cash enough to pay for it in our account. It's ok for Wall Street types and millionaires, but the average investor without margin privileges can't do it. It's another example of rigging the game in favor of Wall Street..., but I digress. Because the accounts in the game have margin privileges, this prohibition does not apply.
OK, that's it for today. Tomorrow morning, when the market opens my mock account portfolio will show 60 shares of SFL (assuming the opening value of that purchase remains below $1000).
Disclaimer: I do own SFL in my own real account and/or in one or more of the accounts I manage for others.
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