Sunday, April 26, 2015

The Stock Market is a Giant Distraction

“The stock market is a giant distraction to the business of investing.” - Jack Bogle
Earlier this week, I was thinking back on my baseball card collecting days as a kid and how each month my neighborhood friends and I would get a copy of the Beckett price guide and check the value of our favorite cards.

The prices went up, went down, or stayed the same, but a monthly quote was sufficient.

I can only imagine how much of our childhoods we would have wasted had there been a live quote feed for card prices...

"Barry Larkin went 3-for-4 with two RBIs last night; his 1987 Topps card is up five cents today in heavy trading..."

As silly as that sounds, we have no problem doing something similar as adults with our stock investments, spending time on our smartphones and computers watching green and red real-time price quotes that tell us next to nothing about how the underlying business is performing.

As long-term, business-focused investors, of course we want to know when the market is offering attractive prices for good companies, but there are ways to keep up without being glued to the quotes screen.

My favorite way to do this is to set up price alerts on your favorite financial website. Yahoo! Finance, for example, has a tool that lets you receive an email whenever a stock reaches a certain price point or rises or falls by a certain percentage.

The stock market is a wonderful instrument that matches buyers with sellers in a very efficient manner, but it's important to remember that it is a means to an end and not the end itself. It's a tool for us to use to our advantage when we need it. The more time we spend researching businesses and the less time on watching the quotes screen, the better off we'll be in the long-run.

Related posts
Stay patient, stay focused.



Saturday, April 25, 2015

How to Invest for Your Kid's Education

After posting some investing advice for my new son a few months ago, a number of readers contacted me to ask how I planned on investing on his behalf - in particular, how I planned on investing for his education.

Frankly, I didn't have a great answer to give, so I contacted my buddy Ryan Vogel, CFP® at Private Wealth Management Group to get his opinion. 

Ryan and I started our careers at Vanguard on the same day and we've remained good friends ever since. Not only is he one of the nicest guys in the business, he's also one of the most trustworthy - a valuable commodity in the finance world. Decent golfer, too. 

Rather than keep Ryan's responses* to myself, we thought it made sense to share them with you, too, as they address most of the questions I received. (This is somewhat of a U.S.-centric discussion, but non-U.S. readers should still get something out of it.)

TW: There are a lot of education savings vehicles out there for parents to consider - 529s, Education Savings Accounts, UGMA/UTMAs. Which is the best vehicle for minimizing taxes for the parents and making sure the kids get the most out of the savings plan and financial aid?

RV: While saving money on taxes is important, it should not be the primary consideration on how to invest your money for education.  The first consideration should be the goals you have for your money.  What is the purpose of this investment?  How much control do I want to retain?  Each account has their pros and cons.

529s - I deal with these the most with my clientele.

  • Tax free growth
  • No limitations based on earned income
  • Very high limits on contributions
  • Potential state tax deductions (depends on state, in PA you get a deduction for amount contributed regardless of what plan you choose).
  • 5 year averaging for gift tax avoidance
  • Can transfer money between beneficiaries that are siblings or even cousins (ideal for grandparents)
  • Can only trade once per calendar year
  • Limited investment options
  • Must be used for post-secondary education costs. 
ESAs are a better fit for saving for high school education.  However, the contribution limit is only $2,000 and there are income limitations.  This means that if you earn too much you can’t contribute.  You have a much greater choice of investment options in this type of account and the money grows tax free.

UTMAs are taxable custodial accounts.  You have complete investment flexibility but you receive no tax benefits. 

I didn’t address the financial aid part of the question because I really don’t have experience in this area.  Most of the clients I work with have incomes too high to qualify for any aid.  Also, colleges and universities have become much more detailed in vetting the finances of applicants. 

TW: Which states have the best 529 plans? How should parents evaluate them and their fund options? 

RV: Nowadays there are plenty of good options.  Ohio, Michigan, Utah, New York, Kansas, etc.  Since 529’s have trading restrictions, the best thing to focus on is costs.  What are the administrative fees?  What are the expense ratios for the underlying funds in each plan?  What funds are included in their age based option?  What are the asset allocations used in the age based options?  How about the options available other than age based?  

Then there are other aspects such as administration.  How user friendly is their website?  Is it easy to setup auto withdrawal/deposit?  Personally, I chose Ohio.  I like their aggressive age based asset allocation and the funds and administrative costs are low.  The funds are mainly Vanguard and now DFA, which I am happy about.  Their website is just OK, but I don’t go on except for when I make ad hoc contributions.  Mostly I just stick with my monthly contribution and increase the amount whenever I get a raise.

TW: What about setting up trusts for the kids' education?

RV: Setting up trusts just for education can be costly and in some cases unnecessary.  If you own a 529  you still retain control and ownership of the assets regardless of age (even though the contribution is considered a completed gift for tax purposes).  

I find education trusts are used mainly as an incentive as part of someone’s estate plan.  Basically, the trusts state that the student “go to school and graduate” or they don’t get access to an inheritance or other gift from their family.  Another aspect to keep in mind with trusts is that if you don’t have someone to act as trustee and need a corporate trustee, the trust needs to be large enough (usually at least $750k) for a corporate trustee to want to assume liability.   

TW: How should parents think about asset allocation for their kids' education funds? How should we think about making adjustments as the kids approach college?

RV: Be aggressive.  Education inflation is averaging 6%.  In order to retain purchasing power you will need to take risk.  Risk tolerance is important to consider, since you don’t want to get scared and sell at the wrong time, but investing in a stock heavy asset allocation makes sense.  

As you approach college or any goal where you know the money will be needed, you will want to become more conservative.  However, remember that you don’t need all of the money on the first day of college.  The four years (or more) will go fast, but that doesn’t mean you need to be 100% bonds and cash on the first day of school.

TW: What's the best type of account to use if I just want to buy a few stocks for my kids to teach them about investing and help them build non-education related wealth?
RV: UTMAs are the best in this situation.  There are no investment restrictions and the money can be used for anything. Just be careful how much income is generated so as to avoid paying any “kiddie tax.”

*Please note that Ryan's answers are only highlights and are not all encompassing or to be construed as specific advice.

How do you invest for your kids' education? Please let me know in the comments section below or on Twitter @toddwenning. (I ended up going with the Ohio 529 plan and started with the Wellington Fund option. I also plan on buying him a few stocks - the subject of a future post.)

Stay patient, stay focused.



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Tuesday, April 21, 2015

Weekly Reading List 4/21/2015

What I've been reading & listening to - April 21, 2015
  • Placing constraints on yourself as an investor - Ben Carlson (A Wealth of Common Sense)
  • Value Matters - Wally Weitz via ValueWalk
  • Barry Ritholtz's recent interviews with Charley Ellis and Rick Ferri - (Bloomberg - audio)
  • Why individual investors do so poorly in the markets - Charles Sizemore
  • Thoughts on Neil Woodford's Patient Capital Trust - Richard Beddard
  • It's always calmest before the crash - Monevator
  • What Jeff Bezos and Neil Woodford have in common - Total Return Investor
  • Activity v. inactivity in investing - Jeff Saut via Market Folly
  • Similarities between Joel Greenblatt and Stanley Druckenmiller - John Huber (Basehit Investing)
  • Exceptions to the rule can make for valuable investments - Matt Brice (Sova Group)
  • Howard Marks interviews Joel Greenblatt at Wharton (below)

Stay patient, stay focused.



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Saturday, April 18, 2015

Investing in Your Best Ideas

One of the things I struggle with the most as an investor is knowing how much capital I should put behind each of my investments.

Indeed, the biggest mistakes of my investing career haven't been those where I've lost a little money, it's been the ones where I haven't invested enough in my top ideas.

Case in point, in the summer of 2010, I started researching TradeStation, an online brokerage company here in the U.S. that I thought was significantly undervalued. I did a lot of due diligence, spoke with the CFO, users of the product, etc. and thought the odds were favorable that I'd make money on the investment. It was the best idea I'd had in some time.

Feeling confident in my thesis, I bought some shares for my portfolio.

Fast-forward eight months and TradeStation gets acquired, producing a 60% gain on my investment.

Good news, right?

A 60% gain is nothing to sneeze at, of course, but the problem was I only put 1% of my portfolio behind my idea. While the investment had a positive impact on my returns, it also didn't have a very meaningful impact. It was akin to getting the proverbial "fat pitch" only to lay down a bunt instead of taking a full swing.

What I took from this experience was that you need to invest enough in your best ideas that they can have a meaningful impact on your long-term performance, up to the point where you start to lose sleep over the size of the position.

This will vary by each investor's ability to handle risk. Some investors don't mind putting 20% or 30% behind a single stock while others will blush at a 5% position. Either way, it's important to give your best ideas a chance to make a difference.

How do you approach position sizing? Let me know on Twitter @toddwenning or in the comments section below.

If you're going to be in Omaha for the Berkshire Hathaway meeting on May 2 and would like to meet up, please drop me a line!

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Stay patient, stay focused.



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Saturday, April 4, 2015

Signs of a Perfect Stock

Peter Lynch's chapter in One Up on Wall Street describing the signs of a "perfect stock" was one of the most influential to my early investing career because it steered my attention away from the water cooler stocks I'd typically hear about and toward underfollowed, niche companies that operated in decidedly unglamorous industries.

As I've developed my own style of investing, I've come up with my own list of company traits that I like to look for when researching a new stock. I have yet to find a company that checks off all ten boxes, granted, but if the company possesses at least two attributes, it makes me sit up and take notice.

1. Management and directors have significant skin in the game. One of the first things I check into when researching a company is how much stock management and the board members own. With smaller companies, I like to see executives and directors as a group owning at least 5% of the company, as they'll will be less likely to take undue risks with shareholder capital and more likely to think like owners because they are in fact owners. With larger companies where high-percentage ownership is less realistic, insiders should still own enough where the stock's long-term performance has a material impact on their own net worth.

I particularly like to see companies, like Sun Hydraulics (SNHY), pay their board members solely in stock grants with long-term vesting as this increases the likelihood that the board's interests will be aligned with those of long-term shareholders.

2. Its employee turnover is well-below industry average. Having to frequently train new employees is not only negative on the income statement, but the company also loses valuable institutional memory with the departure of each employee. One of the many reasons that Costco (COST) has stood apart from other retailers is that its employee turnover (6% in 2014) is far below the retail industry average. Diamond Hill Investment Group (DHIL) has had zero turnover (at least as of 2013) in its equity portfolio manager and research analyst group since the firm was founded.

3. It's headquartered in a smaller town. This may seem trivial, but I like to see companies based far outside of major financial centers as I think they're more likely to fly under Wall Street's radar, can afford to take a longer-term perspective, and have employees with a better work/life balance (less traffic, affordable housing, etc.).

4. It has a great corporate culture that reinforces its competitive advantages. See: Don't Overlook This Factor in Your Research Process

5. It makes products that can't be (easily) disrupted by technology. If a start-up in Silicon Valley or a teenager in her garage is looking for ways to challenge a company's business model, eventually they'll find a way. That's why I prefer to own companies that make products that aren't likely to change or be disrupted anytime soon (knock on wood), like Douglas Dynamics' (PLOW) snow plows or WD-40's (WDFC) eponymous oil-based spray.

6. It pays a regular dividend and pays special dividends in good years. After particularly strong years, well-run companies often find themselves flush with cash. While this is a good problem to have, it can become a bad problem if management misallocates the capital by pursuing growth-for-growth's sake acquisitions and overpaying for them. Paying special dividends shrinks management's sand box and allows them to focus on only reallocating the capital that can earn high long-term returns.

7. It approaches buybacks opportunistically. Most companies I've come across approach buybacks as a way to return excess cash to shareholders without regard to the value of the shares they're buying back. As such, I like to see a company with a cogent and disciplined buyback strategy like U.K. retailer, Next (NXT.L). Such companies should, over time, create value for long-term shareholders.

8. It prefers to grow organically rather than through aggressive acquisitions. A company that's willing to start from scratch in new markets and build the business slowly and in the manner they want shows me that they're willing to take a long-term approach.

9. It communicates plainly with shareholders. See: 5 Signs of a Good Annual Report

10. It has a meaningful recurring revenue stream. One of the best investments I've made was in a healthcare equipment company called Kinetic Concepts, also known as KCI, which was acquired in 2011. KCI makes negative-pressure wound therapy equipment for healing difficult-to-treat wounds, and the great thing about their business model was they lease or sell the equipment and sell the one-use dressing kits that needed to be changed out during treatment. The disposable product sales provided KCI with a steady recurring revenue stream that gave me added confidence to buy the stock in November 2008 at a time when the market in turmoil.

What company attributes do you look for? Let me know on Twitter @toddwenning or in the comments section below.

*I own shares of Douglas Dynamics, Sun Hydraulics, Diamond Hill, and WD-40. A list of my current holdings can be found here

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Happy Easter!

Stay patient, stay focused.



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