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Stocks are risky when investors don't do their research

Tuesday, February 24th, 2015

A longtime client recently sent me an article from the Wall Street Journal written by Morgan Housel, “Why Bear Markets Are an Inevitable.”

It was well-written and there were many quotes from the late economist Hyman Minsky. Minsky did not buy the perception that financial crises were anomalies and caused by outside forces such as bad policy, war or, perhaps, spiking oil prices.

In 1976, Minsky wrote the report “A Theory of Systemic Fragility,” in which he argued that the crises were neither accidents nor the results of policy errors, but the normal function of our particular economy.

I have stated for many years that our economy goes through a seven- to 10-year cycle in which we head into a boom economy, which creates excesses and makes investors and bankers complacent.

That begins the bust of the cycle, in which investors and bankers no longer look at the risks, but only at the large gain that may occur.

This creates the beginning of the downfall in the economy.

Minsky stated it in a slightly different way: “Success breeds disregard for the possibility of failure.” He also stated that consumers and businesses grow increasingly comfortable taking on debt in pursuit of profits.

He said that optimistic bankers lend to dubious borrowers who stand no chance of repaying the debt, and that is when the next downfall begins.

To summarize: A period without crisis plants the seeds of the next crisis. Stability itself can be destabilized.

The writer of the WSJ column brings up some great points. Imagine if stocks were to increase 1 percent every month and never decline. No one, he points out, would ever invest in bonds, or hold cash or money in the bank.

He also points out — correctly — that stocks with a dividend yield would eventually become unattractive because as the price of the stock increases, the dividend yield will decline and make other interest-yielding investments more attractive.

So what is an investor to do?

Many people have the misconception that stocks are extremely risky and nothing more than gambling. I agree with this perception based on the 5 to 10 minutes of research people do before buying stocks. Unfortunately, many brokers do not exceed that research, either.

Most brokers do not understand investing in stocks and because of that, recommend diversifying a portfolio into other investments of which the broker has not much knowledge of, either. This is too bad, because stocks have proven time and again to be one of the best investments.

But brokers feel safe, calling it asset allocation and not putting all your eggs in one basket. They also hide behind the risk-tolerance theory. They say that if your risk tolerance is low, then you should not be in stocks and would be safer in bonds or alternative investments that do not fluctuate daily.

I have learned over my 30-plus years of investing that it is far more rewarding for investors if they are more knowledgeable about how stocks work.

You have now read about how Minsky wrote of how the economy and stocks can move. Add to that a quote from Warren Buffett: “Be fearful when others are greedy and be greedy when others are fearful.”

In other words, buy low and sell high.

It is important to extensively research the stocks you are buying. If you have spent less than three to four hours on researching a new stock, then you don’t have enough knowledge to invest in that company.

In addition to the initial research, investors must spend about 10 to 15 hours per week reviewing the fundamentals of the stocks they own and have a clear understanding of the businesses in their portfolio.

This is something that I have done for many years and it is how I have grown my client portfolio to nearly $200 million with no assistance from any other brokers — just myself meeting with individual investors.

I have been investing the same way through the tech boom and bust, 9/11 and the worst financial crisis since 1929, the Great Recession.

Through this entire period it is important understand I stayed away from all the hype stocks. In today’s stock market that would include Facebook, Netflix, LinkedIn and Amazon, just to name a few. Make no mistake: These are the high-risk stocks that in the future many investors will be disappointed by their lack of return or the losses and blame the stock market as being too risky.

Stocks are not risky; people who buy stocks with no real knowledge of what they own make stocks risky.

Do you have a question or a company you would like us to take a look at?
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