Stock Market or Market of Stocks

When it comes to investing in the public markets, is it a stock market? Or a market of stocks? And if it is a stock market, what defines that market? And how do you and I determine value? As in, what do we buy, and why?

The Indices

Data purveyors and market analysts have attempted to capture market results using indices. The three most popular retail indices are the Dow Jones Industrial Average, or DJIA or Dow, the Standard and Poor’s 500, or S&P 500, and the NASDAQ 100, though many more exist.

At the moment, there are more than 5600 publicly traded companies in the U.S. with a total market cap of roughly $65 trillion and total revenue of more than $28 trillion. So, can a particular index capture the entire market? The Wilshire 5000 index comes closest. And it has three versions, one of which is an equally weighted version. We believe this to be the best proxy for overall market performance.

Why?

But is your, or my, or our investing goal simply to “beat the market”, however we choose to define it? For some yes, that’s the goal. In my experience, those who have this goal are generally men rather than ladies, and those men are typically of the Type A or High D variety. This isn’t a good or bad/right or wrong analysis. Simply an observation. My personal and professional experience suggests that this approach can create significant angst and in almost all cases, isn’t a good long-term approach to investment decision-making.

Graham On Investing

Benjamin Graham, an economics professor at Columbia (among many other accomplishments), wrote Security Analysis with David Dodd, which was published in 1934, he wrote The Intelligent Investor in 1949, and he was Warren Buffett’s professor at Columbia. Graham had an outsized influence on public markets investing and was a proponent of value investing. A simple layman’s explanation of his investment philosophy regarding expected returns? He expected returns of 4% annually attributable to dividends, 2% annually attributable to revenue growth of the company, and 2% annually to inflation. There have been many changes over the 90 years since the first book was published. The fundamentals remain the same. Dividends, expected revenue growth, and inflation drive return.

For a 100% stock or equity portfolio, it is our personal and professional opinion that a net 8% annualized return, measured across decades, is a meaningful target and expectation. In fact, an 8% annualized return is what I use to measure success for my own portfolio, as it is 100% equity. The minimum measuring time frame? At least five years. In fact, if I can grow my investment portfolio 8% annually, and grow my financial statement 10% annually, each year, over 20 years, I consider that a good use of financial resources and talent. Much better than simply burying the money.

Efficient Frontiers

In the 1960’s Bill Sharpe of Stanford, as well as Eugene Fama and Kenneth French of the University of Chicago Booth School of Business, did significant academic research into something called the “Efficient Market Hypothesis”. If you want to learn more, there are books upon books written about this. And from this research came the concept of the “efficient frontier”.

And what is that? The efficient frontier attempts to capture the optimal portfolio design for any particular person or situation, which maximizes return without the owner of those assets giving way to fear due to market downturns and going to cash. And in most cases, financial firms and institutions attempt to capture this efficient frontier through model portfolios.

Model Portfolios?

Yes. Typically comprised of open-end mutual funds or closed-end/exchange traded funds (ETFs). And allocated to cash, bonds, and stocks. Both domestic and international, small and large company. The goal of the models? To move you toward an identified goal or retirement date, and in tune with your tolerance for volatility. Target annual returns for these models? Typically, from 2% annually when the focus is principal preservation, to something close to 8% annually, for the 100% equity models.

So Which?

Actually, we use both model portfolios, as well as the Ben Graham approach. Model portfolios are ideal for those households which are on a glidepath toward a traditional retirement. In 401(k) plans for example, the fund selection is a perfect fit for model portfolio design. And for those very passive investors in their company’s retirement plan, you may even be able to select a “Target Date” fund, meaning that fund is managed to suit your target retirement date at your age 65. With model portfolios, we are typically investing in the stock market.

Many of you are financially independent or soon will be. Or said another way, you have asset margin, meaning it’s hard to determine a scenario where you will outlive your money. Those of you in this category often have significant unrealized gain in your investment portfolio. For these situations, we utilize dividend-paying stocks. Two benefits. Cost effectiveness and tax efficiency. With the value-oriented, dividend-paying approach, we are typically investing in the market of stocks.

Questions For You

As you reflect on your own situation, why do you invest, whether in marketable securities, real estate, or businesses? Is it to outperform a retail index? To reach a future retirement date with enough funds to maintain sustainability for the rest of your life? To grow your financial statement so you can care for family or others whether you are living or not? To leave a legacy for future generations or causes you care about? To maximize the use of the gifts and talents you have been given? Those are the first questions for us to address. From there, we can determine an optimal approach for you.

When it comes to money and related financial decisions, a phrase I learned as a child comes to mind. “We have not been given a spirit of fear, but a spirit of love, and power, and a sound and disciplined mind.”

Until we see you again, wishing you only the best.

Warm regards,

Randy Brunson