Financial Fortress - Stocks
Once you have adequate cash to invest and insurance coverage, the next level in the Financial Fortress is investing in some paper assets. These include stocks, bonds, shares in Master Limited Partnerships and retirement accounts.
I will cover each one in a separate post.
Stocks
In my view, it's much better to own 100% of a business, such as a small company that manufactures and/or sells products, a consultancy or a real estate property investment and management business. This is because you have total control over all the business decisions, the risks that are taken and you also enjoy all of the profits (and unfortunately also suffer all of the losses). Sometimes, however, owning less than 100% of a company can be a nice way to participate in a great business without having to spend the time managing or making a huge cash investment. Even better if that ownership interest can be bought and sold instantly in a highly liquid stock market.
There are two main types of stock: common stock and preferred stock. In many ways, preferred stock is a lot like debt - it has a liquidation preference, which means that in the event the company goes bankrupt, preferred shareholders receive their money before common shareholders. Also, preferred stock typically pays a mandatory dividend that is usually higher than the common stock dividend. Preferred stock may also be convertible into common stock (similar to some types of corporate debt), but unlike common stock does not allow the holder to vote on corporate matters.
Common stock shares in the profits and losses of a company, usually has voting rights and can also receive a dividend, if declared by the company.
I'm not a huge fan of buying stock mutual funds with taxable money or self-directed IRA's. You may not have a choice with your 401(k) but you do with your taxable funds and self-directed IRA. Why pay someone who probably isn't any smarter than you are to pick stocks? They make money on their management fee whether you do or not.
Instead, pick a few companies in industries you know or understand and wait for the stock price to reach an attractive value to purchase. I'll never forget a story about a stock broker who recommended buying Lowe's just prior to the Great Recession, when the individual really wanted to buy Costco, being a regular shopper there and seeing first hand what a terrific company it is from the perspective of a customer. She relented to the broker and ended up being very unhappy with the Lowe's investment since it performed very poorly as people stopped doing home improvement work as the value of their homes plummeted, while Costco did especially well during the recession with shoppers gravitating toward low prices and value.
Similarly, who would have thought that throughout the Great Recession, people would have to have their latte's and techno-gadgets (simple pleasures?), which allowed Apple and Starbucks to prosper during the worst downturn since the Great Depression? Stock brokers have also at various times recommended selling shares of Apple in order to be more "diversified." If you own a a few companies and don't have all your wealth in stocks, you don't need that kind of diversification. If you sold Apple, what would you do with the money anyway, besides pay taxes?
Here are a few other thoughts on diversification:
Warren Buffett says, “Diversification is protection against ignorance.”
Peter Lynch has referred to diversification as “deworsification,” especially when it came to companies diversifying into non-core businesses.
Charlie Munger says “Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.”
Bottom line: take the time to do the research and make your own decisions. Pick a few good companies and stick with them. I also don't recommend a large percentage of your assets in stocks. If the stock market suffers a 50%+ loss, you don't want to have the same thing happen to your investment portfolio. Stocks that pay a dividend are great, but be careful because the dividend can always be cut. The dividend yield may look attractive, but it may be short-lived.
Related articles
20 Things You Can Do to Weather the Next Big Financial Crisis
What is the True Meaning of "Diversified Investment Portfolio?"
