How Do I Invest? What is My Process?

 Recently, a friend asked me to share the process I use to invest my own retirement funds.  If you, too, are curious, or are thinking about becoming a do-it-yourself investor, this post is for you.

Most people who do not have a background in business (I have an MBA) or years of experience investing their own retirement funds (I’ve been investing for almost 40 years) will be better off having their retirements professionally managed.   However, I am a big advocate for taking charge of your own investments, especially for those who are young and have time to recover from their investment mistakes (like I did).

In addition, there are those who are retired, whose income is mainly from a pension, but who have a small portion of their retirement in an IRA and would like to manage that small portion themselves.  That can make a lot of sense.

This post will not be about what to own.  This post is not a recommendation for any particular investment. (Do your own research!)  Rather, this post is about WHERE I go to inform myself, and what tools I use to manage my portfolio.

Fundamental Concepts

First, you must understand that I take a fundamental analysis approach to investing.  Which means I consider the actual business of each company I might invest in; its profit potential, its competitive position vs. its industry, and I formulate a value for that company.  I then buy selected companies when they are “on sale”.

Fundamental analysis is different from technical analysis or momentum analysis.  Technical analysis ignores the business fundamentals and focuses solely upon the historic pricing of the stock.  Technical analysis can be fun, and I use it to a very marginal degree.  Momentum analysis involves seeing “what’s hot” and piling into those securities while they are rising and exiting when they are declining.  Again, this can be fun, but this is not my focus.

Big Picture

I feel it is important to understand where we are in the business cycle. I make my own guesses as to how close we are to the next recession.  This informs my decision as to what types of securities to own in my portfolio.

I also consider where I believe interest rates are likely to go in the future.  Interest rates represent the cost of money.  High interest rates indicate that money is dear and borrowing is costly for businesses.  In a high-rate environment, a business must overcome a much higher hurdle to justify borrowing to grow their business.

I’m a big believer in the concept of ‘reversion to the mean’.   Here is a great example of how I use this principle.

Source: Advisor Perspectives.com

As you can see in the chart above, from a historic perspective, the price investors are willing to pay for companies in the S&P 500 Index are quite inflated, as compared to their historic average.  This graph tells me that stocks are expensive today.  So I must be extremely selective about which stocks I buy in the current environment.  This is also an indicator to me that we are close to a market top and nearing the end of a business cycle.  That’s my opinion.  I look at these and other charts from Advisor Perspective frequently, to keep my perspective on the marketplace.

Source: Advisor Perspectives.com

Here’s another informative snapshot (above).  This single graph gives us volumes of information, but let’s focus on the blue line.  Interest rates, as measured by the 10-year treasury yields, have been in a long-term decline since the early 1980’s.  Currently 10-year treasury yields are just over 2%.  Money is cheap!  How low can yields go?

These two graphs give us the big picture.  But there is an even bigger picture.  What is going on in the rest of the world and how might it affect the U.S. market?

One source I use to stay abreast of world events is Geopolitical Futures.com  (https://geopoliticalfutures.com/welcome-to-geopolitical-futures/).  For a nominal fee I receive daily e-mail briefings on events of the world.  Another source I use is found at SeekingAlpha.com (https://seekingalpha.com), where many gurus of the financial world come together to share their views.  Each guru specializes in their own unique field. Here, for example, is an entertaining and thought provoking author, Mark J. Grant, who purports that we can expect interest rates to continue to decline, even below zero!  (https://seekingalpha.com/author/mark-j-grant#regular_articles)

So these are examples of some of the sources I use to gain a big-picture perspective, which informs my decision-making.  I am constantly looking for additional sources; looking for contrary opinions to my own.  I’m always asking myself, “What if I’m wrong?”  Years of investing experience have taught me to be humble and open-minded to new and contrary ideas.  My methods are constantly changing as a result.  It makes me a safer investor.  And it helps me identify opportunities.

Concepts of Investing

 Portfolio Diversification and Balance.  You have heard the saying, “Don’t put all your eggs in one basket.”  Depending on my age, my financial circumstances, where we are in the business cycle, and current interest rates, I change the mix of assets in my portfolio and how many securities I hold.  As an example, here’s what my portfolio looks like today:

I’m invested in over 60 securities, none of which represents more than 4% of my portfolio.   At some times during the business cycle I have fewer securities and weight the portfolio more toward high-dividend stocks.  But right now I’m looking to reduce my exposure to stocks and increase my exposure to fixed-income securities.  My portfolio is an ever-changing creature based on the factors I listed above.

Each of these asset types must be researched in a different way.  I find it helpful to follow the research done by experts in these various asset types.  My list of experts is constantly changing over the years.  Currently, for equity securities I use two main sources:

Equities.

Brian Bollinger produces research on equities, with a focus on measuring the safety each stock’s dividend at https://2.simplysafedividends.com/home.  His service also provides an excellent portfolio management system that allows me to see the big picture of my portfolio, with the ability to drill down to each security for an in-depth analysis.

Here’s a snapshot of a small portion of my portfolio:

The amount of the dividend and the safety of the dividend are extremely important to me, since I live off the dividends.  This brings me to a concept I follow, which is that — I try to live entirely off the fruit of my portfolio and avoid cutting down the trees.  That is, I don’t sell stocks to fund my living expenses.  Rather, I try to live on less than the income from those stocks’ dividends (and interest from my bonds).

Why does dividend safety matter?  Because, if I’m confident in the safety of the dividend, I can sleep well at night when the price of the stock goes down in a recession.  So long as the company can continue to afford to pay its dividend, I can live my current lifestyle.  Whereas if my strategy were to sell stocks each year to fund my living expenses I would end up destroying the trees that grow the fruit each year (dividend).  Eventually I would have sold all the stocks in my portfolio and would become a pauper. Not good.  So Bollinger’s dividend safety score at Simplysafedividend.com is very helpful to me.

Another source of research I use for selecting equities is found at FastGraphs.com (https://www.fastgraphs.com/trial/).   Here, Charles Carnevale has created an amazingly simple way to view the current value of a company, its dividend history, its forecast earnings, etc.  Here’s a snapshot of one of my holdings using FastGraphs:

This graph tells a story to those who learn how to read it.

Finding bargains in equities is how I grow the value of my portfolio. But my portfolio income is generated from high-yield equities (utilities, MLPs, REITs, BDCs) and fixed-income securities.

Fixed-Income Securities

If you believe that interest rates will continue to decline (and that’s a big, big question), then fixed-income securities (preferred shares, baby bonds, bonds, closed end funds) become attractive because they not only produce a good yield, but they can also increase in value as interest rates decline.

Again, it really helps to have specialists in these fields ferret out bargains that pop up on occasion.  With their recommendations I can do my own research to pick what I like for my portfolio.

SeekingAlpha.com is a source of two such gurus that send me ideas to consider every week, sometimes every day.  These are Rida Morwa of High Dividend Opportunities, and Stanford Chemist at CEF/ETF Income Laboratory.  I enjoy sorting through their ideas and appreciate their ability to find potential bargains.

Strategy

In my experience, successful investments are typically found where most people are running away from a security.  For example, currently investors are running away from shopping mall REITs (Real Estate Investment Trusts).  Brick and mortar retail sales have suffered from too many malls in the United States. Plus there is the ‘Amazon affect’, a significant growth in on-line sales at the expense of brick and mortar store sales. But not all shopping malls are created equal.

Photo by Heidi Sandstrom. on Unsplash

The highest-quality mall REIT stock prices have suffered along with the low-traffic malls REIT prices.  Hmmm. Are there bargains to be found here?

Another example of potential bargains can be found in correction facility REITs.  These companies build and manage facilities for state and federal prisons.  Recently, while Democratic candidates have been on the campaign trail, there has been much discussion about prison reform.  As a result, investors have run away from correction facility REITs.

Photo by Larry Farr on Unsplash

Hmm. Are the bonds issued by some of these REITs safe?  How likely is it that congress would come together to make significant prison reform? Would they likely release millions of prisoners?  Or would they make some less-dramatic, cosmetic change that would appease liberal voters?  Is there a bargain here?  These are tough judgments that an investor must make in order to find true bargains.

If you want a decent yield and/or a great potential for an increase in your portfolio value, you must find these bargains.  It sometimes feels like running into a burning building while everyone else is running out screaming.

I hope this post has given you a taste of what it’s like to invest for your own retirement.  My methods are unique to me.  There are as many methods of investing as there are investors.  I love to do my own investing and sleuthing to find bargains, while continually staying alert for alligators.  It’s the great game of life for me.  If you want to chat, I am always, always happy to enjoy a conversation about the fascinating adventure of investing.

— Clay