No. of Recommendations: 32
Hi mattyfatbags!

Here is a copy of a response to a younger investor over on Income Investor that you may find useful:

Hi Dan!

Thanks for posting!

While I'm not a certified financial or investment anything....nor, as a Home Fool do I speak for planning assumption for average "market returns" for the next 10 years is 6-7%.

That being said, "average market returns" don't mean much to me, since my investing revolves around/is driven from a long-term financial plan.
If you don't have one, get one....and THEN derive an investing strategy that fits it ( versus trying to "maximize your returns" or to "beat the market".

A post that might shed light on my approach:

( Here is the linked post in its entirety, since not all subscribe to II )

"IMHO, the very first thing one needs to develop such a disciplined approach ( and some investing peace of mind ) is a long-term financial plan, showing how many conservatively estimated, inflation-adjusted dollars they will need until expected death. From this and the amount of current/future investing dollars/assets available, one can calculate what CAGR is needed to meet said needs. That CAGR can then be tested for "reasonableness" ( i.e. if this exercise says one needs a CAGR of 15% for the rest of one's life, I would suggest cutting back expenses, working longer/saving more...or being real lucky...because most investors can't achieve this level of return over that long a period ).

Once a "reasonable" plan is set, then one develops an investing strategy to meet it, with the least possible risk ( risk being defined for me as the probability of running out of money before I die ). Special note: I am NOT trying to "maximize my returns"; just to meet my plans needs with the least risk.

In my case, a CAGR of 7.2% pretax is needed, so my investing strategy revolves around trying to meet 100% of my inflation-adjusted expenses by the time I turn 70 ( about 5 years from now, when the "new investing money" from a business sale back in 2004 stops coming in ) from a combination of three elements:

1. A somewhat inflation-protected dividend stream from solid balance sheet, dividend payers, whose products have the pricing power to offset inflation via dividend increases, and who have demonstrated this ability through thick and thin. No more than 5% in any one company; no more than 20% in any one sector.

This is the biggie in my strategy set, so safety of dividend is key; at the slightest hint of a cut/departure from a company's historical dividend strategy, I'm usually gone...plenty of good candidates about.

2. Social Security payments, delayed until the maximum ( 70 1/2 ) to coincide tax-wise with the end of the "new money" payments above.

3. A very small defined-benefit pension from a company I worked for back in the 80's.

Now, other important tenants of my strategy are as follows:

1. Annual review of the financial plan ( income/expenses/projections for life ) and investing strategies versus goal; adjusting if necessary by major event changes ( for example, I got married this year) ;-)

2. So long as I have new money to invest ( any source, money above annual expenses ), I set a price on desirable dividend payers and then wait for my price. If it doesn't come, that's OK...always another stock "bus" coming by.

3. While I wait for my price to come, I sell puts at strike prices I would buy the stocks for any way, especially during "panic times, when the market ( or sometimes a specific company, if it is a non-long-term business case event ), is in panic-mode. If the option is exercised, my stock at my price plus the option premium. If it is not exercised, I get the equivalent of way better than current interest rates on my cash.

4. On the flip side, I establish prices at which any stock would be gladly sold ( way overvalued ). In times of euphoria, I sell covered calls. Similar to the puts above, if the calls are exercised, I sold the stock at my price; if not, I just created an extra "dividend" for that stock.

( What these two options tactics do is find a way to make volatility my friend; and finding a way to make money both ways )

5. Keep my bond % way below what modern portfolio theory says ( currently around 20-25%, versus the 65%+ recommended). I saw my Dad wait until tax-free munis were up in double digits back in the 70's, and will up my bond percentage when rates eventually explode. Besides, I can get much better than bond yields from AAA balance sheet companies ( there are about 4 of this left in the US ), and bonds will get killed by rate increases, while core dividend stock are growing their dividends.

Net/Net: I see the risk of bonds getting decimated by interest rate increases in the next 10+ years as far greater than that of good dividend payers cutting their dividends/going out of business. Thus, once I stop being a net buyer of stocks, the absolute price of the dividend stocks becomes relatively immaterial, so long as the dividend is paid/increasing to offset inflation.

6. Use limited hedges ( outright shorts/option strategies from TMF services ) to make short-term money on down-drafts...still learning and evolving here....but will not commit more than 5% of investable assets because I'm a novice at it...and it can compete for funds needed to build my core dividend stream.

7. Given the strange financial times in which we live, I placed about 5% of total assets in gold/silver-related investments in 2003-2004. I just think of it a form of panic insurance. Maximum position size is 10% of portfolio.

8. Maintain a small portfolio for deep value and other non-core strategy investing ideas ( SPOPS, HG, ALPHA, RB ) to continue to learn, essential to my emotional survival. Note that certain positions in these portfolios can fit into my dividend-stream strategy.

9. Don't try and "time the market"; instead try and "time" specific desired stock prices. Wait for YOUR price, whether buying or selling.
( The only exception here is that in #8's non-core portfolio, I sometimes use a broad index as shorting vehicle, in times of "irrational exuberance ). ;-)

10. Don't put any money in the markets that I will need for the next 5 years; always keep at least one years expenses in cash.

All of the above ( and more that I left out because this post is getting WAY too long ), gives me great piece of mind. Indeed, so long as I am a net buyer of equities, I rejoice at big market me a chance to build my dividend stream faster/cheaper.

Now that I think about it, I began to really think of myself as an "investor" when I realized that I was sad when the market went up and visa-versa. Like Warren Buffett says, the stock market is the only one he knows where customers run out of the store when prices for great "merchandise" goes down.

All those talking heads and pundits ( multiplied by high-frequency trading algorithms, etc.) make for greater "herd-like" movements in both directions. Rather than "curse the darkness" of that junk, I "light some candles" by profiting from it. ;-)

Lastly, please note that while the above approach may make sense for me, it may be wrong for others. Most folks spend tons of time trying to find the "right" way to invest; IMHO, what they should spend their time on is finding the right way to invest....for them."

I might add, that had I taken this approach ( centered on good solid balance sheet dividend payers/growers ), when I was 25 ( versus starting this at age 57 ), my net worth would be many times what it is right now.

My advice to all but the most sophisticated of investors is simply to not swing for the fences so much...rather concentrate on hitting single after single...and you'll score a lot more runs. ;-)

Home Fool
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