- You might be invested in growth stocks or defensive stocks, but which are best?
- The key for long term investing is knowing what your goals are and how to get there.
- An investing strategy that gives you an 80% chance of reaching your retirement goal can lead you to misery.
We all have financial goals. Some of us know exactly what we want, some are more vague on it.
Apart from knowing what you want, it’s also important to know how to get there. The vagueness around how to get there only increases when you’re not totally sure what you want. Nevertheless, I really believe that knowing what you want and developing a strategy that will get you there is much more important than what stocks to buy now or what sector to invest in.
A few days ago, we discussed how the market is very much under the influence of sentiment which means that what’s going on now, with the tech sector leading the pack, might not be the next trend. As our investing goals are usually long term, it’s extremely important to take a step back and get a helicopter view on what to expect from various investment strategies.
Jumping from one hot strategy to another can lead to disappointments and that is something you don’t want in your financial life. Let’s take the example of Apple (NASDAQ: AAPL) and how its past growth isn’t really appreciated anymore. AAPL’s revenue has grown extremely quickly since 2008, but has stalled in the last few years.
It’s impossible for a company to grow in perpetuity as more and more competitors try to take a bite of the market and it eventually gets saturated. Consequently, the company can continue to grow alongside the sector or the economy it operates in.
The current price to earnings ratio for AAPL is at 18.75 which is below the market average and shows how despite the growth shown in the past and the future potential, as soon as the growth stalls, investors tend to poorly price such a stock. You can read more about how to analyze growth stocks in our article about the delta of the delta and how the change in the growth rate impacts a stock. An example from the article was that if Amazon’s (NASDAQ: AMZN) growth slows down from 28% per year to 23%, its stock would probably fall 35% even if the company continues to grow at staggering rates of above 20%.
My point with this example is that even if the market seems to take for granted that the economy and the top stocks will continue to grow, at some point, the growth will stop and fundamentals will kick in. Now, I’m not saying that you shouldn’t be invested in growth stocks, on the contrary, but what I am saying is that investors who want to reach their investment goals have to understand the long-term risks of their strategies and be properly diversified.
A Growth Stocks Strategy
At this point in time, the next recession will send many growth stocks to extremely low levels even if the companies continue to grow through the recession. Therefore, assign a percentage of your portfolio to stocks that can take a 70% or even larger hit. Don’t forget that to cover for a 70% decline after year 5, you need a 25% yearly growth rate in the previous 5 years. Given that the growth period is going into its 9th year, you might want to rebalance a bit.
A Passive Income Strategy
A growth strategy is usually applied in order to build sufficient capital and consequently create a passive income strategy. However, it’s important to note here that a passive income strategy is also a growth strategy if the dividends are reinvested.
For example, Realty Income Corporation’s (NYSE: O) price went from $25 in 2008 to $55 today. O paid a dividend of $0.13 per month in 2008, which has grown to $0.21 per month now which results in an approximate 5% yield over time. If I calculate the return on investment by reinvesting the dividend back into O each month, the returns aren’t bad and can easily be compared to AMZN’s 10-fold growth in the same period.
From a quick back of a napkin calculation, the return from O would be around 400% over the last 10 years with all the dividends reinvested which isn’t bad given the lower risk. Therefore, the point of all this is that you should really dig deep into the risk and reward of what you’re holding and compare it to the financial goals you have for yourself.
The stock market and investing are pretty efficient over the long term and one can really estimate well what to expect. Therefore, it’s important to properly divide a portfolio into risk buckets in order to eliminate the possibility of large losses because it takes a long time to recoup a loss of 50 or even 70 percent.
The Sustainability Of Your Investing Strategy
The stock market can really be exciting. Stock prices are always moving and trading can lead to nice returns in no time. However, an important question is whether or not such a strategy is sustainable for you.
Your life situation may change and it’s easy to forget that we are in a nearly 9-year bull market that will eventually end. This is why it’s extremely important to have clear investing/financial goals, and by clear I mean having a precise number you want to get to. Second, it’s even more important to have a strategy that will get you there 100%. It might be tempting to risk a bit more to get there sooner, but the possibility of not getting there should also be taken into consideration.
I see a lot of people who are miserable in their retirement because their investing strategy didn’t work out as they had planned. Investing in a risky stock is one thing, but putting one’s financial future in a risky strategy is something I wouldn’t advise anyone do.
Keep reading Investiv Daily as we’re always discussing where to find good strategic investments for a well-diversified global portfolio in addition to discussing the macroeconomic environment and risks.