Drug Dealers, of all shapes and sizes, prey on the weak and the needy. But before they can sink their claws into their cash cows, they need a drug and an addict. They need that addictive thrill and thrill seeker to exploit.
I believe the financial media in this country has turned into a Drug Dealer, they’re giving you a short-term thrill and ruining your (financial) health in the process. Here’s why, and what you can do about it.
Like a Drug Dealer, the financial media has you trapped in a vicious, destructive, cycle
There’s a dangerous cycle that starts the moment investors tune in to financial network “news” and watching their investments too closely, it goes like this.
1. We tune in to CNBC (or Fox Business, etc.) way too frequently, which makes us track the short-term performance of our stocks too frequently
2. As stocks gyrate up and down the financial media looks for reasons to explain why, when often there are none. We can’t get enough of this. We let these “stories” and headlines evoke fear and greed inside us.
3. We then proceed to buy (high) and sell (low) at the absolute worst time, because that’s what the TV is telling us to do. The “Experts” also start to convince us that we can miss every correction and cash in on every rally by chasing technicals and trading frequently.
4. Then, we the individual investors proceed to underperform the market by more than 7%.
The numbers back it up, over the past twenty years; the market has gained in excess of 10% per year while individual investors have earned a meager 3%. And it’s all because we gave in to mankind’s oldest addiction: trying to predict the future and rationalize the past.
Like a Drug Dealer the financial media tries to make your risky behavior seem acceptable
So much has been made of diversification in recent years. The financial media tells you that you’ll achieve safety through buying many “safe stocks.” I don’t see it that way.
The truth is a “dividend stock” or a “safe stock” is a stock that has little or no upside, while still having the same risk all individual stocks have—it can go out of business. Owning many companies that fit this bill isn’t safe. I understand the merits of diversification, but why, in the age of ETF’s is anyone still looking for diversification through buying individual stocks which carry unlimited risks?
The Rehab Portfolio
Ok fellow Fool, to get clean the first step we need to take is at least matching the market averages. I truly believe that the individual investor loses to the market because they get spooked (thanks to headlines) into selling they’re stocks at the absolute worst time. So why not commit half of your funds to well diversified ETF’s or Index funds that will match the markets return?
The reason is simple; an Index isn’t going to go bankrupt (barring an asteroid or alien invasion) so you can contribute to it each month without selling. I prefer Vanguard MSCI Emerging Markets ETF (NYSEARCA:VWO)’s because their fees are miniscule; here are a few you should consider.
Why not consider Vanguard Dividend Appreciation ETF (NYSEARCA:VIG), which has a 2.17% yield, and only a .13% expense ratio? If you’re interested in having diversification and dividend exposure, this is a great place to be. The fund holds business like Wal-Mart Stores, Inc. (NYSE:WMT), The Coca-Cola Company (NYSE:KO), The Procter & Gamble Company (NYSE:PG), and more with good dividends and growth prospects to increase them even more.
Want even more safety and diversification? Well, Vanguard FTSE Emerging Markets ETF can get you the international exposure needed for a truly diversified portfolio. The fund invests in companies like China Mobile Ltd. (ADR) (NYSE:CHL), Samsung, Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM) but you’ll skip the risk of investing in individual firms in companies whose rules you’re unfamiliar with. The fund offer a 2.4% yield with only a .18% expense ratio.
And to offer some upside with your diversification, I’d recommend Vanguard Small-Cap ETF (NYSEARCA:VB) the fund has an expense ratio of just 0.10% and tremendous upside. It’s bounced between a 52-week range of $69.43 – $91.72, a 42% variance. The fund owns small, cyclical, stocks so if you’re buying into it consistently you know that you’ll catch some of that upside—but again—it won’t go down to zero, so you shouldn’t get spooked out of it.
Step 2: Only buy stocks that have a chance to drastically outperform the market
Is it just me, or is “safe stocks” a lot like saying “safe skydiving?” It’s a complete oxymoron, stocks are inherently dangerous, and the only thing that outweighs the risk is reward. So step two to your Rehab Portfolio should be to choose stocks that are either a). drastically undervalued, b). provide tremendous upside, or c). offer both.
In fact, the only safety you should be looking for can be answered in one question—will the company go out of business?
One stock that offers such upside, is Cliffs Natural Resources Inc (NYSE:CLF)
Cliff’s has been a perennial grower–with revenue growth of 22% annually over the past five years–but finds itself in the investment dog house. What’s funny is that over the past year, while the stock has slumped, revenue has grown even faster. In fact, the company actually made Fortune’s list of the fastest growth companies last year.
Analyst’s worries over costs and demand for iron ore have legitimacy. But if you’re looking only for stocks that can outperform the market, it’s hard to beat one that traded nearly three times higher this year, and it’s still growing.
Cliffs Natural Resources Inc (NYSE:CLF) just reported a nice earnings beat, $0.60 vs. expectations of $0.34. Again, there are concerns, cash has decreased and debt has increased while demand has waned. But if this recent quarter was a sign that the ship is stabilizing, there could be tremendous upside amidst a relatively flat market. The stock is still trading just above $20 per share and was at $100 a share not long ago.
The stock has been rebounding recently due to some of the positive factors previously mentioned, but it’s very volatile—so I’d wait for a slight pullback before rushing in.
The most important step to rehab: tuning out the noise
In 2009, after receiving enormous acclaim for “predicting” the crash of 2008 famed economist Nouriel “Dr. Doom” Roubini “predicted” that the bear market would continue for years.
Ditto for 2010, 2011, and 2012. In fact, throughout one of the greatest bull markets in history (2009-2012) this guy was a perma-bear, the only time he’s been bullish on stocks is, well, right now with the market at record highs.
But he didn’t lose speaking opportunities, even as you lost money from taking his advice. The same goes for Jim Cramer and all of the bulls of 2007 and 2008, they’re still solvent even though you may not be.
The point is that listening to these guys is hazardous to your financial health. Not because they don’t know what they’re talking about—they do—but because nobody can “predict” what the market will do next.
In fact, the most important lesson from the crash—and the rally that followed—is to tune out the noise and stay invested. If you would have just contributed, each month to a diversified index fund you would have outperformed the market by a mile. I strongly feel this, along with picking a few stocks that have multi-bagger potential, is the way to go.
But for this to really work, we need to give up the most powerful drug of all: trying to guess what will happen next.
It’s a thrill, but a costly one.
The article Stock Pundits Are Drug Dealers: It’s Time for Portfolio Rehab! originally appeared on Fool.com and is written by Adem Tahiri.
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