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What the Average Loser Doesn't Know About StocksBy
Friday, January 20, 2012
In some recent DailyWealth essays, my colleague, Dan Ferris, covered four key ideas that wealthy, sophisticated stock investors know... that average frustrated investors do not.
As he explained, wealthy investors know how to identify a great business and buy it when the price is right. They know they can safely ignore both the past price action of the quality stocks they buy... and what the rest of the market is doing.
But the "king" of investment ideas... the goal of every wealthy, sophisticated investor, is the end product of these great, "smaller" investment ideas.
This idea – this goal – is to compound wealth over a long time period.
As the great advisory writer Richard Russell once said, compounding is "the royal road to riches." If you're not obsessively focused on safely compounding your capital, it's unlikely you'll ever be a successful investor. You should close your brokerage account and just stick your money in the bank.
So... what is compounding? Why is it the "king" of all investment ideas? Why are wealthy people so concerned about it? And how can you begin using it to make a fortune in stocks?
The aforementioned Richard Russell (at www.dowtheoryletters.com) has popularized what might be the most powerful example of how compounding over time works. It goes like this...
Investor A starts investing in an IRA account at age 26. He deposits $2,000 into his IRA each year. He invests this money in a portfolio of safe stocks that pay 10% dividends. He continues these contributions until he retires at age 65.
Investor B starts investing in an IRA account at age 19. He also deposits $2,000 each year and invests in the same 10% dividend portfolio. Investor B only makes seven contributions. After age 26, he makes no more payments.
Their stock portfolios show no share-price appreciation. They just crank out 10% dividends each year. On their 65th birthdays, the two investors compare the balances in their accounts.
Even though Investor B only made seven contributions, he ended up with more money than Investor A, who made 40 contributions. The trick is, Investor B started seven years earlier than A. So on the day Investor A made his first contribution, Investor B had already accumulated $22,959, and his portfolio was throwing off $2,296 a year in dividends.
As you can see, time is the most important ingredient in compounding. The more years you give it, the more your money mushrooms. That's why this strategy is used by wealthy, sophisticated investors... They always think five... 10... and even 20 years down the road. They don't care about tomorrow or next week. They know the power of compounding is proven over time. They are patient.
But the amateur, habitually unsuccessful investor doesn't care about compounding. He's typically too busy watching CNBC, looking for hot tips and "get rich quick" ideas to care about compounding. He's impatient and always looking for action. Compounding doesn't have enough sex appeal for the loser. So he ends up gambling his money away.
Dan wrote this series of essays because I challenged him to detail what wealthy investors know about investing that amateur investors don't know. Each essay is important, but I can sum them all up with this: Wealthy investors are patient and focus on compounding. Amateurs are impatient and do not focus on compounding.
The best way to compound in the stock market is not to worry about what "the market" is doing... or what a business' share price was eight years ago... It's to buy elite businesses at great prices and let the reinvestment of dividends snowball your money.
If you're interested in building long-term wealth in the stock market, I encourage you to concentrate on compounding. Review the four ideas Dan covered in his earlier essays. When you keep these ideas in mind... with the goal of long-term compounding... you'll have the mindset of a wealthy, successful investor. Time will take care of the rest... and you stand a very good chance of getting rich in stocks.
Good investing,
Brian Hunt
Further Reading:
Read Dan's series on what wealthy, sophisticated investors know... that average, frustrated investors don't:
If you're struggling to make consistent returns in stocks, keep this in mind...
"When you understand this concept, you'll understand why we have a fantastic opportunity today to buy super-high-quality stocks."
If you take this lesson to heart, Dan says, "you're virtually guaranteed to make money over the long term."
Over the long haul, one group of companies beat the market while exposing you to less risk...
Market NotesGOT A STRONG GUT? WE'VE GOT A TRADE FOR YOU... Price action in the broad market has been so strong over the past month, even the "down and out" steel sector is making headway...
In late August, we noted how companies that produce steel to build skyscrapers, cars, bridges, and power lines are among the greatest "boom and bust" assets in the world. They soar and crash as the global economy fluctuates. The thin profit margins these companies sport add to their extreme volatility.
Today's chart displays the steel sector's volatility and sensitivity to investor sentiment toward global economic growth. It shows the past two years of trading in the world's largest steel producer, ArcelorMittal (MT).
Like most all assets, MT was hammered in late 2011. Shares fell from their summer level of $35 to $15 (a 57% haircut). But the broad market action has become more bullish... and MT has bounced off its lows. It's now close to staging a multi-month upside breakout. Should the world simply "not end," volatile ArcelorMittal and the beaten-up steel sector could stage a big "bad to less bad" rally... and gain 50% in the coming months.
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