The New Rules of Building Wealth
Beat the S&P (and your hedge-fund buddy) with 8 simple tips from the most trusted financial brains in the game Mark Adamle remembers the exact moment when he strayed from the rules of investing. It was December 1999, the world was still giddy with dot-com millionaires, and he had just come into his tidy Christmas bonus. Who could blame him for reading a business-magazine article about which stocks to own for the next decade? So half of his bonus went straight into WorldCom, and the other half into Lucent Technologies. You can guess how this story turns out. "I was smacked around pretty good," says Adamle, 47. "I thought I was a gunslinger, and I got burned." That's when he rediscovered his humility, stuck to some core principles of investing, and got his portfolio back on the right track. After all, Adamle—a senior VP of Intersport, a sports-programming producer for networks like ESPN—had been a pretty good saver over the years, ever since marriage and his two kids entered the picture. Now, by sticking to his rules, and with the help of his financial planner, Ray Evans, he's been able to rack up solid 16 percent annual gains. | |
So you've done your mutual-fund screens, crunched the Morningstar ratings, and come up with the top performers. Now take all that data and throw it out the window, because it's not past performance but low fees that will likely determine your ultimate financial success. | |
Sorry to say, but when it comes to investing, the deck is usually stacked against the individual. Big institutional money moves markets, leaving the scraps to the rest of us. | |
But why does Joe Average hold the upper hand in this scenario? Because the institutional players—such as a huge Fidelity mutual fund—are lumbering organisms that don't move all that quickly in reaction to earnings news. "Their decisions are made by committee," says Zacks. "They think about it, they meet, they discuss, they get analysts to review the situation, and only then do they decide to purchase." Meanwhile, you've hopefully scooped up the stock and seen some quick gains. | |
Earnings numbers are the definitive blueprint for figuring out how a company is doing. So why are so many money managers these days looking at another, but related, marker? It's free cash flow, and it's an extremely honest indicator of company fortunes. Basically, it reveals how much money remains in corporate coffers after the bills are paid and all the dividends are distributed. It's much harder for a firm to get away with financial shenanigans and a questionable quality of earnings reports when you're looking at the hard facts of how much scratch is left at the end of the day. Finance.yahoo.com, for instance, has a helpful "cash flow" option that separates out that information for you when you're researching a stock. "It's what the true value of a company is," says Bob Smith, vice president of fund giant T. Rowe Price and manager of its Growth Stock Fund. | |
You might think that the big challenge of investing is picking the right stock or fund to add to your portfolio. But you'd be only half right, according to asset-allocation king Roger Ibbotson, chair of Chicago's Ibbotson Associates and a professor at the Yale School of Management. Where you slot that investment is what's really going to determine the quality of your retirement. | |
Chess grand masters don't think about just the move of the moment. They're thinking about what the chessboard is going to look like seven or eight moves down the line. You should look at your personal- wealth situation in the same way, says Dan Fuss, vice chairman of investment firm Loomis Sayles. "It's human nature to look at a 6-month to 1-year time horizon," he says. "But you have to look much farther out than that and figure out the longer-term trends." | |
TIPS, or Treasury Inflation-Protected Securities? They might look attractive right now because of inflation fears, but keep in mind that the Treasury is planning on rolling out more and more TIPS, so beware of oversupply. Stocks? Earnings for your widget manufacturer may be stellar now, but if the Chinese are starting to make widgets (and you can bet they are), then your financials 5 years down the road may turn into a horror show. | |
It might seem bizarre for one of the top money managers to counsel hoarding cash. After all, equities have a long-term average of 10 percent annual gains, while your cash will do little more than sit in a bank. | |
Traditionally, stock buybacks were a solid indicator of a company's encouraging financial future. If a firm spent its free cash snapping up its own shares, it demonstrated the executives' faith in the company, and their belief that the stock was undervalued and would prove to be a terrific investment. | |
One marker, though, is a helpful tip-off: a company's number of outstanding shares. A key rationale for buybacks is to reduce that number, thereby increasing earnings per share and boosting the company's overall valuation. But only 39 percent of companies buy back stock for that reason, according to Howard Silverblatt, Standard & Poor's equity-market analyst. Others might do it to boost mergers-and-acquisitions activity, like buying another company with stock. Firms such as Dell have been gathering stock for years without reducing the total number of outstanding shares, says Henry McVey, chief U.S. investment strategist at Morgan Stanley. | |
It's kind of like George Costanza's famous dilemma on Seinfeld. Every natural instinct he possessed was terrible, which meant the opposite instinct had to be right. And so it is, unfortunately, with our investing behavior. "If people always acted rationally, then no one would ever make mistakes," says Markus Brunnermeier, a behavioral economist at Princeton University. "But once you introduce human judgments, then you're in the area of irrationality. And when it comes to investing, people have many biases." | |
