How To Invest $1000 – 6 Rules For Investing Your First 1000 Dollars

Before discussing the 7 rules to follow when investing $1000 and an example of where I am investing my $1000s, I first want to ask you a question that is extremely important when it comes to making the first steps in the stock market, a question that many stock market beginners overlook.

Do you just want to make a little money on stocks or do you want to create long lasting wealth, become rich?

Let me explain the difference. Making a little money on stocks means buying Tesla’s stock (TSLA) at $178 and selling it a month later at $215.

1 tesla stock

That would give you $200 on your $1000 investment which is a 20% return. Not bad, but that’s not investing, that’s betting. Many did the same in December of 2018 hoping to make 20% on TSLA.

2 tesla stock price

Their loss, as I am writing this, is 43%. If you want to make money trading stocks, I can’t help you as I don’t have a crystal ball. Trading can make you some money, but it is unlikely it will make you rich in the long term.

If you want to invest your first $1000, in a way to develop an investing mindset that is going to create long lasting wealth for you, then I can help as there are some simple rules to follow.

A great book about how to become wealthy, financially independent, live where you want to live and how you wish to live, is the Millionaire next door. The book describes how the real millionaires are not those with flashy cars, expensive clothes, living in Belair etc. The millionaires are those that save their money, let it work for them over time, invest their time and energy to make what they know, own or manage, more efficient, avoid crazy risks and build their wealth over a lifetime.

3 millionaire next door

Source: Millionaire next door

Similar rules can be applied to investing and I am going to share 7 rules that are going to help you create a long-term, wealth-building investing mindset.

7 Rules To Become A Stock Market Millionaire Starting With $1000

These 7 rules will help you on how to invest your first $1000 to develop a long-term wealth building mindset.

  • Make your $1000 work for you

When investing, the key question to ask is what do I get as a return on my investment? Investing is not about buying a stock that goes up and down in value. Investing is about owning a business that creates some kind of value. Over the last 20 years, investors putting their money into Amazon (AMZN), have in return received the best e-commerce ecosystem in the world. Some other businesses pay large dividends like Coca-Cola (KO) has been doing for Buffett over the past 30 years. His dividend now is above 60% per year on what he invested in 1988.

Focus on what are you getting back on your $1000, it could be dividends, buybacks or it could be some new value that is being created. Then, when you know what is the return, you let it compound.

  • Let it compound

When you find something that creates value, you have to let it compound over time. The key when it comes to investing for the long-term to become rich is compound interest.

4 compound interest

Compound interest is extremely powerful, you just need the patience and right mindset to take advantage of it.

$1,000 invested at 15% per year over 40-years becomes $267,863. That is the power of compounding. Now you are going to say that it is hard to get 15% per year and I agree with you. But you will hopefully invest $1000 many times over in your lifetime and some of those $1000 investments might even hit 20% per year, some will hit 5%, but some will definitely do amazingly. Just 4 investments that compound at 20% per year, something Buffett did over 50 years, thus $4,000, would become $5,879,086 in 40 years. And let’s say you invest $1000 one hundred times in a period, 4 of those 100 investments might give you 20% per year or even more. I invest 1000 per month and I must say how I really enjoy the compounding created over time in the form of business development, higher dividends, reinvested dividends.

This is just to show the power of compounding. And I’ll also tell you the only thing that is certain, if you don’t invest you will surely not take advantage of any kind of compounding. Therefore, invest and let compounding interest do the work for you.

  • Even more important than investing is saving, so add up

5 saving money

Source: AZ Quotes

Charlie Munges is a person that says it clearly. Save, thus spend less than you make, invest it and you have nothing to worry. Invest the money in something offering a return, possibly exponential over the long term and that is it. How to find such investments? This is a bit controversial, but I’ll say go into depth.

  • Go in depth versus width

Most financial advisers and talking heads tell you to diversify. They tell you that so that they can make you listen to that talk show for longer as there is more to talk about. However, too much diversification is actually diworsification.

If you understand the risks of an investment, i.e. what can go wrong where the best thing is to think about worst case scenarios, and understand the rewards you will likely get. The rewards in the form of dividends, growth, reinvested earnings, a business model that will compound over time, then it is better to go in depth rather than width.

The key is to specialize in a few areas, I am currently researching REITs (Real Estate Investment Trusts) and if I find something interesting to follow, I’ll start learning more about the specifics of the business over the next few years. I might invest only once in 10 years in a REIT stock, but I’ll probably know it very well before investing. Knowing something very well allows you to understand the risks and rewards of an investment. This makes it much easier to invest the $1000 you have.

Give yourself time and learn about 5 or 10 things to invest in over the next decade. This is mastering only one thing, sector or investment vehicle per year. I can guarantee that when you become an expert, you will be able to find those 15% investments that others might overlook. This can be in real estate, stocks, commodities, businesses…

Over time I have built my specialism in emerging markets, commodities as from time to time Wall Street doesn’t like commodities nor emerging markets. When Wall Street doesn’t like something, prices are usually cheap. For example, something that is going to be developed over the next 3 years is usually extremely under-priced. Most investors are so focused on stock prices that they omit long-term business developments, something we can take advantage of.

  • Buy businesses, not stocks – a quick example from my portfolio, a stock to buy

The key when it comes to investing is to be a business owner. Let’s say you own a nice hotel in Paris.

6 paris hotel

As an owner, would you constantly watch real estate prices to see whether you made something? Or, as a real owner investors do, you would not have any intention of selling such a property and the only thing you would care about is how to increase prices or occupancy rates and manage costs.

The downside to buying stocks is that there is a price that changes every second. However, what you are buying is a business that develops and grows over time.

Let me give you an example. I am a happy owner of a company called Lundin Mining (TSX: LUN, OTC: LUNMF) because of the following reasons:

  • I am bullish on copper as I see demand for it rising due to all the electrification that awaits us, due to all the Teslas, a growing global population, especially in emerging markets.
  • The company is family owned and the owners are conservative. This means that debt levels are carefully assessed and the goal is to create a vehicle that will grow and increase dividends over time. The current yield is low at 1.78% but a buyback has been announced and they are investing in growth.
  • Large investments in the future is what Wall Street rarely focuses on until those investments start to produce cash. They have invested a lot in 2018 and will invest another $745 million in 2019.

7 2019 investments

Source: Lundin Mining

Plus, they have recently invested another billion into a newly acquired mine.

8 chapada

Source: Lundin Mining

All of the investments will likely significantly increase production over the next few years, increase cash flows and probably lead to higher dividends.

9 production profile

Source: Lundin Mining

Given the 30% expected increase in production over the next few years, I expect a similar increase in the value of the investment, be it through higher dividends or through a higher stock price. Their cash dedicated to investments will significantly decline and therefore there could be much more for dividends or more acquisitions.

I like the management and their style and therefore I am happy holding this for the very long term. My expectations on current prices is for a 12% yearly long-term investing return. I am happy with that and over the past year I have invested $1000 in Lundin twice in my portfolio where I add $1000 on a monthly basis. That is also my plan, I’ll keep buying businesses that I like

  • Invest for the long-term

Lundin Mining, the company discussed above had a market capitalization of $14.5 million in the early 2000s and now has one of $3.7 billion. Both Amazon’s and Apple’s market capitalizations were below $100 billion in 2009 with AMZN’s being below $25 billion.

10 market capitalization

Source: MarketWatch

Their current market capitalizations are around $900 billion and might surpass the trillion for good in the future. This is a perfect example of how Wall Street focuses on what will happen in the next quarter, the longest term analysts might look a few quarters or a year ahead, but few think about how will the business they own look in 10 or more years.

By thinking about how will your investment look like in 10 years, investing becomes easy. You don’t waste time on noise like the current trade war discussions that were about tax breaks a year ago or about going to war with North Korea two years ago. You focus on what is important, the acquisition the management just made, the small but constant increases in dividends, the new facility that is being build etc or you see big structural risks like declining demographics in some countries, piling government debt or trends that take of market share like e-commerce is doing for retail.

By using a long-term common sense perspective, you can eliminate the short term bets from your portfolio and concentrate it on long-term businesses with positive tailwinds. Just think about what will the worlds and the business you own look like in 10 years.

  • Compare the investments you own with the rest of your finances

Do you have credit card debt of 11% or student debt of 8%? Pay that because it is an immediate return of 8% risk free. Investing in stocks, be it just $1000 requires a clean personal balance sheet. By clean personal balance sheet, I mean:

  • You don’t need the money, ever. If you need the money in a few years or something, you might behave irrationally and sell at the wrong moment in time. Unfortunately, most investors sell in fear of seeing their investments decline further. If you know you don’t need the money and you can weather storms, you can let the investments compound over the long term for you.
  • If you have any kind of debt with a high interest rate, pay that first and invest the monthly costs you save in stocks. This gives you an immediate return and gives you also piece of mind.
  • You know your life, income etc. doesn’t depend on your investments. If it does, you are again not able to make rational decisions when investing as there are outside, or better to say personal influences that unable you to buy when others are selling for example.

Summary

If you wish to develop a long-term wealth building investing mindset please subscribe to my channel. In this article I have given you the 7 key mindset tools to use long term and an example of how I do it.

The key is to have a long-term orientation even if investing just $1000 because your long-term financial success depends on the mindset you have. A correct mindset means focusing on investing in various good businesses of which I have given you an example of a business I am invested in and finally, the key is to have your stock market investments detached from your personal finances. Sounds easy when written like this but very few adhere to that. The result of not following such simple rules are terrible investment returns.

The average investor did 1.9% per year over the last 10 years even if all other classes did much better. If you have $1000 to invest, start building a vehicle that will make you rich in the long term by having the correct mindset.

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How To Invest In REITs – Pros, Cons And Simon Property Group Example Analysis

Content:

How To Invest In REITs – Pros, Cons And What Are REITs
Introduction – REITs have been the best investment over the last two decades
What impacts REITs as investments – dividends and capital appreciation
Pros and cons of investing in REITs
The pros of REITs
The cons of investing in REITs
Simon Property Group REIT analysis (NYSE: SPG)
SPG company overview
Densely populated areas and high demand lead to positive lease spreads
Dividend is just 65% of funds from operations but still yielding 5%
Self-funded growth and investments
SPG’s debt
The retail environment in the coming years

This article is about the general pros and cons of investing in REITs and about Simon Property Group (NYSE: SPG), used as an example to show what to look at when investing in REITs.

Introduction – REITs have been the best investment over the last two decades

REITs (Real Estate Investment Trusts) have been the best performing asset class in the last 20 years with an average return of 9.9%. This much better than the 5.6% return of the S&P 500 and even better than gold or oil.

investment returns.PNG

Source: Raymond James

The most important point to note is that despite the S&P 500 returned 5.6% per year, the average investor got a return of 1.9%. This really emphasizes Graham’s statement:

“The investor’s chief problem — and even his worst enemy — is likely to be himself.”

Buffett always suggests to read chapter 1, chapter 8 and chapter 20 of Benjamin Graham’s book The Intelligent Investor (full summaries in the links) to avoid making the mistakes average investors usually make, which is to buy high during exuberant times and sell low in panicky times. I know some that sold in March of 2009 and bought back only in 2015. Nevertheless, this is not a story about investment mindset on which you already have the links to Graham’s book above, this is a report on whether it is smart to invest in REITs now and whether we can expect a similar performance in the next decade or two. In this article we will discuss:

  • Why did REITs do that good
  • What impacts REITs as investments – dividends and capital appreciation
  • Pros and cons of investing in REITs
  • Put all into perspective by analysing Simon Property Group (NYSE: SPG)

The goal of this article is to check whether it is smart to invest in REITs now, compare the possible rewards to the risks and avoid being the average investor, as average investors will again underperform almost anything else over the long term.

Why did REITs do that good over the past 20 years?

The main reason REITs did good are interest rates. In 1999, from when the previous chart measured performance, interest rates have gone mostly down.

interest rates REIT.PNG

Source: Raymond James

In 1999, you would get $6,000 on $100,000 in a normal savings account while during the last years, you would get less than $1,000.

However now, some cash investments accounts do generate around 2% as interest rates increased. Consequently, REITs did extremely well up to 2016, then as interest rates started going up, then there was a bit of a pause due to the FED making a few hikes, but since Powel capitulated on higher interest rates, REITs resumed their growth.

reit investment returns

Source: iShares Core U.S. REIT ETF

The above clearly indicates that REITs are interest rate plays. If you can get a 6% return on government guaranteed savings, you are going to expect a much higher yield from various real estate investments that are always risky.

However, real estate investments, unlike bonds, offer inflation protection as the value of the properties might go up in the future and you can increase rents, thus some REITs should even deserve a premium. Additionally, REITs usually borrow money to acquire real estate or mortgage backed securities and thus interest rates play two roles. One comparative for investors that we just explained and the second for their margins as the higher the interest rate spread, the higher the profits of the REIT. The interest rate spread is the difference between the interest the REIT is paying on the loan and the yield on the mortgage backed security it bought, for example.

The iShares Core U.S. REIT ETF has a yield of 3.5%. If investors would suddenly expect a yield of 7% because of a higher interest rates environment, the value of REITs would probably half.

4 reit yield.PNG

Source: iShares Core U.S. REIT ETF

One might look at the above 3.5% yield and say no way because it is too low, but we don’t invest in markets or indexes, we invest in individual businesses and therefore we must look at individual opportunities. Plus, REITs are not only about dividends.

What impacts REITs as investments – dividends and capital appreciation

Many focus on dividends as the only return metric for REITs. However, investors can expect returns in the form of capital appreciation too. If you can increase rents, the value of the underlying real estate will probably go up in the future. Plus, as the targeted inflation rate is above 2%, we can add a minimal 2% yearly dividend return that we can expect from capital appreciation.

This is also what I am going to focus on while researching REITs:

  • First, we have the dividend that is paid out of the REIT’s funds from operations (FFO).
  • Second, if the dividend is smaller than the FFO, it means that the REIT has space to self-fund its growth, that should add too to the investment picture.
  • Third, given the huge money printing over the past decade and likely increase in the future, I think there is a high chance of high single digit inflation where owning good real estate comes in handy.

Let’s summarize the pros and cons of investing in REITs and start this REIT overview by looking at the largest position of the USRT REIT, Simon Property Group (NYSE: SPG). The stock is close to its 52-week lows, offers a 5% yield, so it looks like a good start to understand the sector better.

1 spg stock.PNG

Pros and cons of investing in REITs

The pros of REITs:

  • You can own real estate without the hustle of repairing toilets

Real estate investment trusts are internally self-managed or externally managed vehicles that take care of real estate for you; collect rent from tenants, pay expenses and give you what is left in the form of dividends. There two main types of REITs; equity and mortgage REITs. Mortgage REITs invest in mortgage backed securities while equity REITs invest directly in real estate.

Further, you have many various specialized REIT like land REITs, apartment, senior housing, single family, hotels, retail, commercial, offices, healthcare, storage, data centres, industrial, timberland and many other specializations. There is a REIT for practically anything related to real estate and those that do more are called diversified REITs.

  • REITs have to pay out at least 90% of income through dividends and pay no income tax

REITs are especially attractive to income seeking investors as more than 90% of income has to be paid out in the form of dividends. If not, a REIT might lose its REIT status which also brings the benefit of no corporate income taxes. Therefore, payments to shareholders can be substantial, especially over time.

Finding the REIT that manages to grow, have a higher yield from the invested properties than the cost of capital and thus the capacity to increase dividends, is the holy grail of investing in REITs. We are going to do out best to find REITs that have the potential.

  • Real estate usually appreciates in value and offers inflation protection

Apart from the above-mentioned dividend and income, REITs can offer huge returns from capital appreciation. If there is inflation and you own real estate while you have long term debt with fixed interest rates, you would be in REIT heaven. (we already used the holy grail anecdote so heaven is better here). REITs can simply increase rents or hotel room prices if there is inflation. Of course, if the property offers quality.

The key is to hold those REITs that will continue to see the value of their real estate appreciate. Empty malls, ghost cities or abandoned factories are definitely not a good sign for capital appreciation.

  • Liquidity

Even if liquidity should not be a concern for long term investors, you can sell your REIT by on click on your mouse. Something you can’t do when you own real estate.

The cons of investing in REITs:

  • Interest rate risk

We already mentioned how REITs depend on interest rates as lower interest rates have been a key factor in their boom. However, if a REIT is a great business, has great properties and a good business model, you shouldn’t worry much about interest rates as lower REIT stock prices would allow you to increase your yield on the reinvested dividends and consequently your long-term returns.

  • REITs use a lot of leverage

As REITs have to pay out more than 90% on their income there isn’t much left for growth. As ‘no growth’ is practically the most hated situation on Wall Street, managements tend to do whatever it takes to keep growing which includes risky acquisitions or mergers, overinvesting in new properties even if the market is saturated and not having a margin of safety within the interest rate spread.

  • There is high competition

Investing in real estate is like investing in stocks. As would Peter Lynch say, the more stones (stocks) you turn, the number of great investments you find will be larger. You can check my video on How to invest in real estate here if you wish to hear my views on what makes the difference when it comes to investing in real estate.

However, REITs usually invest in large properties, there are usually many bidders for such projects and, especially if the property is of high quality, initial investment prices can be sky high. Therefore, by investing in REITs you miss on the opportunity to really find the best bargain in the neighbourhood or a fix-up that doesn’t really need that much work but others don’t see it. Such laser focused real estate investing allows you to make money immediately when you buy as you pay less than what the property is actually worth.

Some REITs trade below net asset value but there is usually a reason for that, it can be the management, trends, new competition etc.

  • Most people already own a home

By owning your home, you are already exposed to many of the real estate benefits mentioned, especially if you have a low interest rate 30-year fixed mortgage. Therefore, having a heavily weighted REIT portfolio alongside owning a home and maybe a rental unit, might make you too exposed to the real estate market that, as we have seen from 2009 to 2013, doesn’t always go up.

  • The dividends are taxed as income

Taxes are always personal but you have to check how will the dividends you receive from REITs be taxed or you might want to hold REITs in non-taxable accounts. This is an even bigger mess for non-U.S. investors.

  • Some real estate sectors are being hit hard, think of retail

Given the boom in e-commerce, retail is hit hard and consequently REITs owning retail stores suffer. On the other hand, REITs owning distribution centres do well, so be careful when buying REITs and either buy absolute bargains or REITs that have strong sector tailwinds.

  • REITs were created in the 1960s and boomed only in the last 30 years

The first REITs were created in the 1960 while REIT investing became really popular only in the last few decades. Therefore, you might be buying in exuberance as average investors usually flock into buying exuberantly priced assets after the low risk/high return gains have already been made.

  • The risk of a recession

When discussing almost any business, you will hear how it would be impacted by a recession. REITs would be no exception but perhaps investors still have a bit too much of 2009 in their memories. Further, as we can’t anticipate a recession, perhaps it is best to simply know your portfolio will suffer, at least temporarily, reinvest the dividends and enjoy the ride up when the recession is over. Therefore, yes, earnings might fall and dividends might get cut, but that is with every business and many didn’t invest in 2010 fearing a recession. No need to mention how they feel now.

Let’s now put all the above into perspective by analysing a very large REIT, Simon Property Group.

Simon Property Group REIT analysis (NYSE: SPG)

I want to start this REIT analysis series by analysing one of the best REITs out there, Simon Property Group (NYSE: SPG). I’ll also use it to explain what you need to know when investing in REITs:

  • The dividend yield, buyback, growth and capital appreciation return
  • The interest/lease spread
  • Funds from operations (FFO or AFFO – adjusted)
  • Focus on debt
  • Sector trends

SPG company overview

SPG owns malls and outlets in the US, Europe and Asia.

SPG REIT mall.PNG

Source: SPG – The Shops at Crystals, Las Vegas NV

I am going to focus on the key aspects of investing in SPG and avoid a purely descriptive chapter as you can learn much more about the business from their Investor Presentation. Just shortly, 79.5% of net operating income comes from U.S. malls and outlets, 11.7% from the Mills, a REIT they acquired in 2007, and 8.7% is international.

2 overview spg.PNG

Source: SPG

The key factors for SPG are the following:

Densely populated areas and high demand lead to positive lease spreads

Despite the turmoil in the retail sector, SPG keeps increasing rents and keeps occupancy at high levels. Average leases per square foot increased from $51.59 in 2016 to $54.18 in 2018. If a company can increase rents and keep a high occupancy rate, it means their customers aren’t really in that much trouble.

The lease spread is the difference between the new lease in comparison to the lease of the previous tenant.

3 leases going up.PNG

Source: 2018 Annual Report

SPG is considered a high-quality REIT, with great assets and therefore it can increase leases.

Dividend is just 65% of funds from operations but still yielding 5%

Funds for operations (FFO) is a crucial metric when it comes to analysing REITs. FFO describe what is left after all the expenses are paid. The management has to distribute more than 90% of net income as dividends but don’t forget that a non-cash expense when owning real-estate is depreciation. Thus, the cash flows are usually higher than net income. Therefore, SPG can self-finance its growth as it is practically distributing only 65% of what it could distribute. This leaves room for buybacks and investments on top of the 5% dividend yield.

4 distribution.PNG

Source: 2018 Annual Report

In February 2019 SPG announced a new $2 billion dollar buyback program for 2019 and 2020. If they spend all the available $2 billion on buybacks, that would add a 1.7% yearly buyback return to the dividend as the market cap is currently $57 billion. This would put the expected investment return to 6.7% already. But that is not all, there is still room for growth.

Self-funded growth and investments

The company is building new developments and refurbishing existing malls.

5 investments.PNG

Net operating income growth was 3.2% in 2018 and 4.2% on average over the last 4 years (this includes inflation). Even if we put a conservative 3% growth rate on net operating income, the growth should increase income by 80% over the next 20 years that should consequently add another 3% to the return from SPG.

Summing up the 5% dividend, 1.7% buybacks and 3% growth, the expected yearly return from SPG could be 9.7% over the next decade or two.

SPG’s debt

When it comes to debt, SPG is as good as it gets with A credit ratings. This means that whatever hits the economy, SPG should not have trouble to service its debt payments.

8 debt.PNG

Source: Investor Presentation Q1 2019

The only thing that is concerning a bit but it might also be a management decision, is the shorter debt maturity. This is necessary to keep the same interest rates as the cost of debt went up over the past years, but longer fixed interest rates are always nicer.

9 credit profile.PNG

Source: Investor Presentation Q1 2019

Logically, SPG has most of its debt on fixed interest rates.

10 fixed.PNG

Source: Investor Presentation Q1 2019

What is really interesting are the interest rates in Europe. The Noventa di Piave designer outlet close to Venice, where I have been once when returning from a visit to Venice and Padova, has a fixed interest rate of 1.95% maturing only in 2025. This implies SPG might easily grow in Europe as interest rates are ridiculously low.

11 europe.PNG

Perhaps there will be other acquisitions. As long as the net operating income is higher than the cost of capital needed to service the acquisition debt, it pays to growth via acquisitions. This might add another percentage point to the returns over the long term.

6 presenation.PNG

However, there is always a catch.

The retail environment in the coming years

This is the main question to answer when it comes to retail REITs, are these outlet centres going to still be interesting to consumers in 5 to 10 years? Or, will we be so entangled into virtual reality that a visit to an outlet or mall will be considered a waste of time?

The answer to the above questions is unknown, some may be more or less convinced but the reality is nobody knows what the future brings. As investors we have to think about what can happen and then put it into an investing perspective.

Things could continue as those are now, thus SPG should continue to pay a 5% yield that should probably grow between 3% and 5% per year, the company should continue to do buybacks and the expected return should be close to 10% per year.

E-commerce might even boost SPG’s growth as omnichannel might lead online sellers to open stocks in high-end locations.

However, if there is less interest for malls and outlets, revenues might stagnate and consequently eliminate the additional 3% yearly return coming from growth. SPG owns class A malls and outlets while market specialists predict closures for class C and D malls. Mall bankruptcies might even increase the number of visitors for SPG.

Another risk is always interest rates, if interest rates go up, SPG’s spreads might decline.

I think the above described uncertainty is what the market is pricing in because if not, you wouldn’t find a high-quality REIT like SPG offering a 10% total yearly long-term return.

I am going to continue to look at REITs and at the end of the sector analysis we are going to compare what is out there and perhaps find something to watch or even invest in. The fact that one of the largest REITs in the U.S. possibly offers 10% is encouraging for further REIT research.

reit comparison dividend.PNG

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Stock Market Crash, Economic Recession – My Plan, Portfolio, Cash and Stock Market Investment Strategy for Return Maximization

Contents:

  • Stock Market Crash Plan
  • My portfolios
  • Lump sum portfolio – 100k – crash strategy
  • 3 Stock Market Crash Investing Factors
  • Margin of safety
  • Focus on the business return
  • Don’t forget the dividends and takeovers
  • Model portfolio Stock Market Crash Strategy
  • Portfolio Strategy
  • Stock Market Crash Scenarios
  • Non-Linear Markets
  • Stocks crash all the time
  • Market timing
  • A crash can be inflationary + currency collapse
  • Conclusion

Stock Market Crash Plan

Whenever I do a video related to stock market crashes, views explode. This means investors worry about crashes and recessions. I think I can help with that.

The best thing if and when a stock market crash, economic collapse or recession come, is to have a strong plan. In this article I’ll share my plan and perhaps you will find good tips for your investment strategy so that you can increase your long term returns and lower your risks. 

I’ve been investing since 2002 when I took advantage of the post dot-com period and I also took advantage of the 2008 financial crisis. That experience is embodied in my plan but things are not that easy.

Let me:

  • Show you my portfolios and their crash/recession preparation
  • Discuss the most important things when it comes to recession proof investing
  • Show how crashes happen all the time and how take advantage of that

By the end of this article you should know enough to maximize your long-term investment returns by actually taking advantage of stock market crashes. It is extremely important to know ahead what might happen in order to act decisively when others sell in panic. 

My portfolios 

I have two portfolios that I manage that make things official as things are done publicly. On my Stock market research platform, I have a 100k lump sum portfolio launched in January 2019 and a model portfolio started with 10k plus 1k added every month launched in May 2018 when I also launched my research platform. I’ll discuss the strategies for each portfolio as those differ because one is a lump sum portfolio, thus no money will be added while the other is a portfolio with constant additions that makes risk management easier.

Lump sum portfolio – 100k – crash strategy

With 100k as a start and no additional investments, the key is to always manage your risks and have enough cash to take advantage of the opportunities arising when a stock or the whole market crashes. 

I am comfortable with a max of 8 positions because it is enough to eliminate individual catastrophic risk but it still leads to long term return maximization. 

However, on the cash position, I am currently 75% invested with 7 positions and 25% is in cash. 

The cash is 30% of the initial invested amount of 100k where the portfolio is now already at 111k but that I attribute mostly to short term volatility as the portfolio was launched just 5 months ago. 

Long-term I will be comfortable with a 20% cash balance with this portfolio. However, stocks are so volatile, especially individual stocks, that my cash balance will also be volatile. The most important thing is that you need to have a strategy when it comes to crashes and my strategy is the following:

  • 80% invested when I can find investments that will lead to 15% long-term average yearly business returns, have a margin of safety and are generally good value investments. 
  • I’ll increase my exposure to 90% when there are businesses that offer 20% yearly long-term business returns at acceptable risk.
  • I’ll increase my exposure to 100% when there are businesses that offer 25% yearly long-term business returns at acceptable risk.
  • I’ll increase my exposure to 120% through margin where there are businesses that offer 30% and higher yearly long-term business returns at acceptable risk, the dividend is more than enough to pay for the margin interest and there is no way to get a margin call.

The point of this all is not that I’ll do something because stocks crash, there is a risk of a recession or something. The point is that I’ll simply buy things when I can get value on the cheap, when the average cycle adjusted business return is high. The cheaper you can get value and returns, the better protected you are in case of a crash.

Plus, having a clear plan makes you unemotional when it comes to stock price movements, a crucial factor when it comes to investing.

Let me show you the business value I own because I think it will be extremely educational.

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I own a lot of the energy, mining, food sector because it is something I can understand well and I feel it is something that will do well over the next decade. Plus, it is cheap at the moment as you can see from the 3rd column the average PE ratios around 10. 

If you look at dividends, price to book ratios and debt to equity, you will see that there is no fixed level as I mostly invest in the long-term business outlooks and those things are not reflected into fundamentals yet.

Price to book values are all over the place but that depends what you are buying and whether the value is tangible or future oriented in the form of future cash flows. However, I believe all of the businesses I own currently trade below intrinsic value. This gives me a margin of safety. 

3 Stock Market Crash Investing Factors

I have three things that I believe make investing easy, no matter the economy or stock market:

  • A margin of safety
  • The business yield
  • Dividends and takeovers

Margin of safety

As said, I believe all of my positions offer a margin of safety in a form or another. This means that if those stocks fall, I’ll be happy to buy more. A real investor is happy when stocks decline because he can simply buy more of the things he owns.

All my businesses have high cash flows or strong balance sheets which means it is unlikely those will ever go bust that gives me another margin of safety.

Focus on the business return

As said earlier, what makes investing easy is to focus on the business yield and not on the stock price. I try to find businesses that offer long term returns of 15% and above. This involves a lot of work to find such investments, understand them across the cycle and then buy when the risk is low and reward high.

I’ll explain what I mean by using the S&P 500. The current earnings/business yield of the S&P 500 is 4.72%. At the current level of 2,856 points for the S&P 500, the business earnings are134.8 points. 

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Source: Multpl

An earnings yield of 4.7% also means that expected long-term investment returns will be around that number, likely a bit higher due to inflation and economic growth. So, if you wish for safety and are happy with a 5% return, buy the S&P 500. 

If you know stocks are volatile and there could be a crash coming, they you can manage your lump sum portfolio by putting portfolio exposure thresholds depending on the yield you require.

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Such a strategy will allow you to be happy if stocks crash as you will be able to buy more of what you already like at a lower price. The portfolio exposure allocation depends on your personal preferences, required long term investment returns and also investing knowledge.

The most important thing when having such a strategy is that you buy more when stocks become cheaper. Thus, you will do the opposite of what most do. Stock prices will be all over the place over time, but if you know what your goal is, what are your capabilities, having such a simple plan will make investing easy and no matter what happens you will be happy.

Don’t forget the dividends and takeovers

As dividends don’t come often in most cases, dividends often seem irrelevant when compared to the daily stock market volatility of a few percentage points up or down, many disregard them. However, dividends are crucial for long term investors. If we look again at my portfolio, you can see that the yield on the whole portfolio even with the cash exposure will be around 4%.

pastedGraphic_3.png 

This means that every year I’ll get at least 4% to reinvest. If stocks crash, that 4% reinvested will be of incredible importance as the returns on that will be huge. Compound that long term and you will be amazed.

Takeovers happen often and you might suddenly have 15 to 20% of your portfolio in cash. Don’t rush it, wait for good businesses to offer you the required business yield and invest when that happens.

Model portfolio Stock Market Crash Strategy

On top of the above discussed lump sum portfolio, I have a model portfolio that I started with 10k in May 2018 where I add 1k per month. 

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The monthly additions cumulate over time, which means the portfolio will grow and grow no matter what happens in the market. You will also see that the cash position is much smaller at just 7%. This is because I’ll be adding 1k per month for the next 19 years and that is all the risk management I need.

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When I discount all the future additions to the portfolio with a 10% discount rate for the next 19 years, the actual present value of the cash to be added is 100k. This means that the current portfolio allocation is just 20%. Therefore, if you are an investor that will still be adding money to one’s stock market portfolio, you should actually beg for a crash because your money additions, alongside the reinvested dividends, will allow you to buy more and consequently increase your long-term returns. 

Portfolio Strategy

So, my strategy is simple, with the lump sum portfolio, I own assets where I am happy with the business yield and if the business yield increases, i.e. stocks crash, I’ll simply increase my exposure. I’ll talk about timing the markets in a moment.

On the portfolio with monthly additions, as long as you still add cash to your investments, you should not worry about a crash, but simply add money and take advantage of crashes.

Stock Market Crash Scenarios

Extremely important topics related to stock market crashes are the following:

  • The markets are not linear
  • Stocks crash all the time
  • Market timing
  • A crash can be inflationary + currency collapse

Non-Linear Markets

Stock market crashes are not linear, something crashes while other things go up. It is enough to compare the Shanghai Composite Index with the S&P 500 Index over the last 5 years.

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Source: Bloomberg

Over the last 5 years the Chinese stock market has experienced two bear and three bull markets while the S&P 500 was constantly in a bull market. The message is simple, stock market crashes happen all the time. Therefore, if you are diversified you can take advantage of them by buying where and when others panic. 

What is also important is that not everything crashes at the same time. The S&P 500 has been down 2.6% over the last month but some stocks have jumped 26% at the same time. 

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Source: Bloomberg

So, don’t focus on the general picture, focus on the individual positions, something will go up, something will go down, just be prepared and if something is a much better bargain, buy more of the bargain.

Stocks crash all the time

If I look at my portfolio, the average decline from 5-year peaks is 41%. I would call that a crash.

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Crashes constantly create opportunities and crashes are always around us. I wish I could time the market but all I can do is focus on the business. Market timing is dangerous.

Market timing

I’ve been listening to stock market crash scenarios since 2002. “You are crazy to buy stocks now” is the sentence I mostly heard in 2002, 2009 and 2012 (European crisis) when I was buying stocks heavily. However, those that stayed away from the markets, lost a lot of money on opportunity costs.

My message is that if you focus on businesses, and on the business returns and keep a strategy like we discussed where whatever happens you are fine, you don’t have to worry about stock market crashes. This is because, let’s say you own a business that has a 15% earnings yield and the stock growth at 15% when things are going good.

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Even if a recession happens every 5 years and the stock drops 30%, you will still be well ahead over 10 years. Plus, no stock will behave so linearly and you would sell when others are greedy and buy when others are fearful. Thus, your returns would be even higher. If I would have listened to recession predictions in 2018:

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Source: Time 2018

I would have never bought a copper miner in 2018 because copper prices are very sensitive for economic development. However, I though that a miner was of great value and that even waiting 5 years for that value to unlock itself was a good deal. A recession didn’t happen, the stock got bought out and I did ok, despite all the doom and gloom around me.

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A crash can be inflationary + currency collapse

A risk few discuss is an inflationary crash. Something not unlikely given the huge budget deficits most governments run. So, it is possible that we have an Argentina stock market scenario in the future. Something you can be prepared against only if you own value.

The Argentinian Merval index is up 34 times over the last 10 years while the peso is down about 93% against the dollar over the same period. So, $1,000 invested would now be around $2,450, something better than the S&P 500 did since 2008.

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Conclusion

For me it is very simple as it has been rewarding me for the past 18 years. Simply buy value, good businesses, great assets and enjoy the returns while being patient.

I’ll keep looking, learning and constantly comparing in order to create the best maximizing return portfolio within my circle of competence.

The more I work, the more I am confident things will be ok. Any kind of crash would actually improve long-term returns even if it might look bad on my relative performance. However, I have no boss that can fire me based on a quarterly or yearly performance so I don’t have to fear that like most money managers have.

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Trying to Explain Nassim Taleb’s Views on the Economy and Markets

Nassim Taleb just had an interview on Bloomberg discussing the latest topics in finance:

1 nassim Taleb

Modern Monetary Policy – Monetary Policy 3

Trade wars

Budged deficits

Market risk

How to invest

It is a great interview but as often with such interviews, things are not explained in depth. I’ll try to add facts to Taleb’s thinking and you will see how that affects your investing!

The biggest risk for Taleb – Deficits and no skin in the game

Let’s start with deficits, from the Wall Street Journal:

2 budged deficit

In an environment with full employment, thus with the economy doing great, budged deficits are increasing!

3 unemployment

Unemployment rate US, Source: FRED

With a strong economy, the logical thing should be to have budget surpluses so that when a recession or slowdown eventually comes, you have the room to increase government spending. If you check below, during the late 1990s, the budget had surpluses but it seems now most politicians think that debt is something not to worry about now.

4 budged deficitis

Source: FRED

Accumulating deficits mean higher government debt. Total public debt in the US had doubled in the last 10 years, DOUBLED.

5 public debt

Source: FRED

Higher debt, leads to higher interest payments. Despite historically low interest rates on government lending, interest payments have skyrocketed due to the large amount of debt.

6 interest payments

Source: FRED

The US government has to pay $550 billion in interest per year, and to do that, it simply borrows more as the deficits are now at almost $800 billion and expected to hit $1 trillion soon.

7 budget deficit

Source: FRED

Such a situation is unsustainable and for Taleb, and probably for every other rational being, a huge risk that is piling up and will at some point in time blow up. If you borrow just to pay interest on your debt, you are close to a Ponzi scheme and we know how those things usually end up.

In the next recession, budget deficits will explode that will probably increase the borrowing rate and create a spiral of trouble as raising rates will cripple debt servicing. To solve such issues, government tend to print more money and you soon have hyperinflation.

Further, if you increase interest rates, the cost of debt for the government exacerbates. So, a normal option to cool the economy is something the FED can’t use at this point in time.

9 treasury

Source: FRED

A longer term increase in rates where the US borrowing cost go to 5%, where those were in 2007, would double interest payments on the debt, further increasing budget deficits.

The main problem for Taleb is that those who make decisions, like politicians have no skin in the game. What harm will Trump have from current budget deficits if those create havoc in 2029? The main problem for Taleb is that there is no accountability in the current capitalistic system.

The plausible solution to the above problems creates another huge risk.

Taleb on Modern Monetary Policy – Monetary Policy 3

We recently discussed Ray Dalio’s views on the plausible next monetary policy moves that involve helicopter money and a coordination between government spending and money printing. Taleb is against such things because of the risks that pile up where the main risk is hyperinflation.

Even if inflation has been really low over the past years and contained between 1.5% and 2.5%, Taleb mentions how inflation doesn’t work linearly and how just because it hasn’t materialized, it doesn’t mean the risk isn’t there.

8 inflation

Source: FRED

At some point inflation will ramp up, that will make things not manageable; think of Venezuela, Argentina, Zimbabwe. Taleb really agrees with Charlie Munger on this issue.

Don’t own equities

On market risk, Taleb discusses how people should not even own equities and should focus on their jobs as source of income and invest only for capital protection. He says that if you must hold equities, you have to do that and be hedged in a proper way against long tail risks. The problem is that few know how to do that, i.e. buying some puts is not the strategy because of the large cost attached to it.

But, he is clear that what is going on will at some point crash and that we should be ready for it. He also says that if there is a crisis, he will be the first to buy.

How to invest

On how to invest, he advises to avoid the middle, thus the zone where most people invest chasing income and yield and how you should invest in a barbell way where you hold most of your money in safe, wealth protective assets where he excludes equity and especially bonds.

10 barbel investing

Source: Seekingalpha

He mentions how public pensions funds need to hedge properly because if not those are doomed as they promise 7% returns and a crash would require them to reach much higher returns in the long term.

His message is that if you don’t know how to hedge for tail risk protection, you should not hold equities.

He owns some gold, land, some other financial instruments(derivatives) and avoids stocks, long term bonds – hold short term. Tail risk hedging if you know how to do it.

Morale of the story, risks are piling in the form of higher debts, hyperinflation is the probable solution and one should be hedged against tail risks. More about what are tail risks and how to possibly hedge, if we can do that in future videos.

Trade Wars

Oh, on the hot topic, I almost forgot, Taleb says how he loves to chat about things that took him 20 years of thinking to get to have something to say, so he really has nothing to say on trade wars, next year there will be something else people will chit chat about.

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You can retire by investing in the stock market – just don’t invest like everybody else in index funds

  • It is possible to retire earlier using the stock market if you focus on investing in businesses. Investing is all about business earnings and value.
  • This paper will show how historically, you can do amazing things if you think before you invest, or at least avoid the stupid mistakes others usually make. When it comes to retirement, small current mistakes are extremely costly in the long term. 
  • I’ll give you an example of a simple stock that has been paying a dividend for 89 years and will likely outperform most indexes. I’ll also add 5 stock ideas. If you find 20 of such stocks, you practically need nothing more for your retirement.

Financial independence and retiring is the goal of many investors. This booklet will cover current and future potential investing opportunities and strategies that will help you achieve your financial goals in the long term. To achieve financial independence sooner, with more certainty, one has to invest in investments that offer less risk and, at the same time, higher returns than other investments – this is called value investing.  

Financial independence topics covered are:

  • Stock market and retiring – great tool but use it smartly!
  • The economy, inflation and your financial independence
  • Real estate – the best leverage, diversification and inflation protection option.
  • A fixed vs. a dynamic investment mindset – over decades, things change.
  • Diversification, yes, but not like and when your banker advises.

In this article: 

Contents

  • Stocks can make you financially independent – but mind the valuations, value, business strength and risks
  • The value investing truth – buy businesses with value
  • PE ratio and price to book value
  • Value investing – Margin of safety
  • Current value and strong earnings example plus 5 stocks to watch
  • How can you find such stocks?

Index funds might not be the vehicle to your financial independence

The predominant investment advice you hear is to invest your money in index funds, usually the S&P 500 (SPY). Invest on a monthly basis and simply forget about it. 

That is a good advice, unfortunately it is better suited for the 1980s or 1990s than now. Nobody can argue that stocks have been an amazing investment over the past 35 years. Those that invested $1,000 in the S&P 500 in 1982, have now $26,000 and the dividend is $480 per year. Not bad on a $1,000 investment. Those that invested $100k in 1982, have now a dividend of $48k per year and a capital of $2.6 million. I would call that a wonderful retirement scenario.

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Source: Macrotrends

The problem is that back then, really few dared to invest in stocks. Even investing legends, like Ray Dalio, didn’t invest in stocks in 1982. Actually, stocks looked that bad that Dalio was betting against stocks and practically lost it all.