The Royal Road to Riches

December 14, 2006 by  


By Bob Wood

How’s that for a catchy title? As much as I would like to take credit for coining it, I was beaten to the punch by Richard Russell, who writes the “Dow Theory Letter,” an online website and an excellent source of market information. What he describes as the surest way to make money over time seems far opposed to today’s conventional thinking, though.

Russell has been writing about stock markets for almost 50 years, and, at age 82, he seems to have seen everything about investing in stocks. And the way he suggests for getting rich in stocks is doing what so few investors today seem able to manage. Russell contends that making money in the markets takes time. How many patient investors do you know?

When he says that it takes time to earn wealth from investing, he refers to decades, not years. But planning so far ahead seems to make little sense in our attention-deficit culture, which is made all the worse by stock market promoters who recommend which stocks to buy and where, in their estimation, the short-term, up-side price target is.

When was the last time you heard a broker, advisor or stock analyst praising a favorite stock, based on its expected returns over the following 10 years? Yet hasn’t Warren Buffett famously told us that his favorite holding period for stocks is “forever?”

Russell is one really smart guy, and his ideas about smart investing take a cue from another really smart guy, Albert Einstein. Einstein called compound interest the “eighth wonder of the world.’’ Maybe you have wondered why some investors prefer dividend-paying stocks like those boring utility shares. Here’s why!

In a recent daily commentary, Russell said:

Funny, I was thinking about this over Thanksgiving. In our current, highly-taxed, overpriced world, what are the two things or items that I have found most valuable? Here they are —

To own your own business, so you don’t have to take orders from anyone else. And when you own your own business it helps you to be in charge of your income and expenses. My advice –if you can own or build a business of your own, do it. It’s a lot of work and it can be risky, but it also comes with a lot of advantages.

The second item on my most valuable list is time–repeat TIME. Time allows you to compound your money, and the longer the period that you have to compound your money, the more your assets will grow.

I know that investors tend to spend most of their time trying to pick out the right stocks, the hot stocks, the stocks that will appreciate and build profits. In contrast, those who follow the compounding road spend their time in picking the safest highest yielding stocks. And I’ll let you in on a secret–it’s a lot easier to pick 100 safe, high-yielding stocks than it is to find one stock that’s going to outperform over the coming year or so. Compounding requires patience and discipline. Stock picking requires ingenuity, hard work, imagination, courage, and–a lot of luck.

I have a two-word answer or excuse that I use for myself when I buy a great stock and sell it too soon when I should have held on to it–or when I buy a house and sell it when I should have held on to it. My two-word excuse is–WHO KNEW? Listen, I’m the guy who bought Berkshire Hathaway at 250 and sold it at 500. I’m the guy who bought my first house in La Jolla for $55,000 and later sold it for $85,000. I’m the guy who bought a second house in La Jolla for $90,000 and sold it later for $110,000. Both houses are now worth well over a million. And the Berkshire stock that I bought at 250 is now selling for over $100,000 a share.

But I keep compounding. Muni bonds, preferreds, utilities, closed-end funds, gold stocks bought five years ago, an item here, an item there (they must pay dividends). It all adds up over the years–thanks to accumulated interest and dividends plus the miracle of compounding.

Sure I should have put all my money (and borrowed a lot more) into Berkshire at 250. But damn it–WHO KNEW?

However, I do know this–a dollar compounded at 5% over 10 years will be worth 1.62 (more if compounded quarterly).

And a dollar compounded at 6% over 10 years will be worth 1.79.

A dollar deposited periodically at 6% over 10 years will add up to 13.180.

A dollar deposited periodically at 6% over 15 years will add up to 23.27.

You want to be a millionaire? Or if you’re too old, then do you want to make your kids into millionaires? Then buy a book of compounding tables, and sit down for an hour or two and study those tables. Then act on them. It’s the royal road to riches. I’ve been preaching this “method” ever since I started writing Dow Theory Letters. This is a method that works. It works as surely as 2 + 2 = 4 or 1000 + 1000 = 2000. Compounding works–guaranteed.

As you can see, Russell espouses the power of time and compound interest. But maybe he omitted something from this discussion, possibly in the interest of saving time and space. What we can add to the benefits of time and compounding is the positive effect on investor behavior that conservative investing allows.

How many conservative investors have lost money over time? How many had investments ravaged by imploding technology or other speculative stocks? I have heard of no conservative investors who took long-lasting beatings in the stock market. I have, however, heard about many aggressive investors who suffered large losses when volatility and downside risk left only a very few of them profitable.

Too many look for the fastest roads to riches, following the constant hype offered by the Wall Street marketing operation that encourages trading based on hot tips or technical chart reading. Others simply disregard caution when hearing tales of rapid gains by others involved in the current hot trend in stocks.

Too few look at what may be their most profitable investment ever, their homes. And holding real estate, no doubt, has taken many years to show the gains that others hope to achieve overnight.

To me, Russell’s “Royal Road” is also “The Less-Traveled Road” by investors. If you doubt this, simply open today’s newspaper to the business section and look at the list of most actively traded stocks. As of Friday, December 8, the five most actively traded Nasdaq shares are Microsoft, Sun Microsystems, Intel, Oracle and the Nasdaq 100 ETF, known as the QQQQs.

As you look at today’s paper, do you see any of the same stocks appear on the most active list? Sure you do! They are always there! And over the past five years, these same shares have humbled investors over and over again, since the list never seems to change!

Helping the wrong-headedness are today’s attention-deficit hedge and the mutual fund managers who play the ‘’beta trade’’ game. They buy the most volatile shares, since these tend to rise most in a rising market. But how has that strategy worked over the past five years or at any other time in the past?

To find out, I just built a chart on Yahoo’s “Finance” website, comparing two ETFs. This chart compares the highly traded Nasdaq 100 ETF, QQQQ, with the ETF for the utility sector, IDU. I had trouble finding that one on the actives list, since it trades in far fewer amounts each day than the more aggressive technology basket.

As you can easily see by building the same chart, the conservative utility shares have performed much better over the past five years. And since investors are far more likely to get spooked out of really aggressive investments at just the wrong time, as they buy high and sell low again and again, the ability to stay invested makes the conservative investing option more viable. Time most likely aids in the maturation of those holdings, with dividends re-invested over time and effective yields rising steadily.

Perhaps you should consider a more conservative approach to your investing and leave the hyper-trading fund managers to compete for those slim gains in stocks–with more risk than reward potential. And think of the money you’ll save on antacids!

Have a great week,
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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