In a fast-paced investment landscape, top-performing securities and sectors can change by the hour. What tends to remain consistent, however, are: adopting a margin of safety, investing in what you understand and holding great companies for the long term.
MARGIN OF SAFETY
In investing, as in many facets of life, it’s best not to cut too close. This is the guiding principle behind adopting a “margin of safety,” most widely associated with economist and investor Benjamin graham.
A stock with a big safety margin trades at a share price well below what the stock is worth, which can be measured by a variety of metrics, such as price-to-earnings or price-to-book ratios. The bigger the gap between the share price and the stock’s intrinsic value, the better.
That way, if market conditions go against the stock, its value might still have room to increase (or, at least, decrease less).
In his classic work The Intelligent Investor, graham explains that “the function of the margin of safety is … that of rendering unnecessary an accurate estimate of the future.” In other words, the margin of safety allows you to be wrong about a stock and yet potentially still make money. This isn’t to say that cheap stocks can’t get cheaper; they certainly can. But the downside is much bigger with an expensive stock that has little or no margin of safety because, for example, the price reflects high investor expectations. In contrast, a stock with a large margin of safety won’t necessarily have favorable expectations priced in and therefore may be more resilient to negative surprises.
UNDERSTAND WHAT YOU OWN
Another piece of classic investment wisdom is to focus on investments you understand. Famed money manager Peter Lynch put it this way: “If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand.” Consider the market bubble of the late 1990s and early 2000s. The impulse to capture huge gains in new technology stocks led countless investors to brush aside the fact that they really didn’t know what the companies did or how their business models worked. Things didn’t end well for many when the market crashed in the early 2000s.
Billionaire investor Warren Buffett famously avoids companies with esoteric business models. During the “tech bubble,” he was widely derided as out of touch. But Buffett’s unwavering focus on buying businesses whose fundamentals he thoroughly understands has resulted in undeniable success.
Complicated businesses can be great investments if you have specialized areas of expertise. For example, if you’re a professional chemist, you may be better positioned to under-stand the merits of a new pharmaceutical stock than someone with a layperson’s knowledge. However, you probably don’t want to invest only in one market niche. Your Lenox Advisor can help broaden your knowledge base and assemble a diversified portfolio of investments that make sense for you.
IN FOR THE LONG TERM
Buffett is a well-known proponent of another piece of classic investment wisdom: Find great companies and hold them for a long time. As he once put it, “our favorite holding period is forever.” of course, the trick is to be able to distinguish the great companies from the not-so-great. Try to tune out the daily noise in the markets and instead look for companies with dominant competitive positions and strong, sustainable business plans. Generally, you want to keep these names in your portfolio, reinvesting any dividends and letting compounded growth work for you. That said, there are valid reasons for selling securities that once met your criteria. Changing economic and market conditions, and factors such as a company’s management, product lineup or competitive profile, may all be good excuses to sell.
Reading about tried-and-true investment concepts is one thing. Applying them effectively is another. This is where your Lenox Advisor can be a significant asset — both as a sounding board for your own ideas and as a source of investment advice that can bring you closer to your goals.
MAKE YOUR PORTFOLIO AN EMOTION-FREE ZONE
It’s natural to experience emotions in response to market volatility. But anxiety, excitement and fear shouldn’t guide your investment decisions. To avoid the consequences of rash acts, consider enrolling in an automatic investment plan. Offered by many financial institutions, these plans allow you to invest set amounts of money at regular intervals. By investing on a schedule, you can avoid the temptation to buy and sell at inopportune times, and actually buy larger quantities when prices are lower.
It’s also important to develop an individualized wealth management plan. Your Lenox Advisor can help you determine the appropriate asset allocation for your age, goals and risk tolerance. Be sure to record your goals, making them as specific as possible. Then stick to your plan, regard-less of what’s happening in the market.
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