Why It Doesn't Matter Which Stocks You Buy
Editor's note: It's the most important factor in your success as an investor.
It's 100 times more important than any stock recommendation.
Ignoring this idea has ruined far too many retirements.
In today's Masters Series essay – adapted from the February 25, 2011 Digest – Porter discusses this idea... which isn't complicated, but could be the most important thing you read in 2017...
Why It Doesn't Matter Which Stocks You Buy
By Porter Stansberry
What you're going to read over the next two days is critical for you to understand.
These essays will explain the greatest weakness of individual investors and give you the two greatest secrets of professional investors.
These two ideas will enable you to make money in any market, year after year – without ever taking a loss. These ideas are extremely simple, and anyone can easily use them.
But before you begin, I have to acknowledge two things about this information...
First, you'll remember how many times I've told you trying to teach our subscribers anything is a fool's errand. Let me explain...
Based on my experience (my own learning, training dozens of analysts, etc.), I don't believe in teaching. I don't think it's possible to teach anything. Or, as I tell people, there is no teaching, only learning.
What I mean is... until you are emotionally prepared to learn, nothing about your cognitive position will change. And this is doubly true when it comes to learning new behaviors, especially when those behaviors are tied to something that is as emotionally charged as money.
As you read these essays over the next two days, know that I don't expect you to change your investment strategy. I already know you won't.
So why bother writing things like this?
Because sooner or later (hopefully sooner), some of you will make the decision to learn. At some point in the future... maybe after you've looked back over 10 years of investing only to find you haven't made anything (or worse, you've lost money)... maybe after you've suffered your third catastrophic loss in six months... you'll realize your actions aren't rational.
You'll discover what you've been doing isn't giving you the results you desire. At that point, you'll want to learn how to do better. That's when you'll go online and search for these essays. That's when you'll be ready to read them. That's when you'll learn what I'm going to explain over the next two days...
I'll offer one more warning about this information. When you read this, your most likely reaction will be to say to yourself: I can't do this. You see, if you follow the secrets I'm about to explain, you will become a truly great investor – among the best in the world.
But we all know that only a small percentage of the world's investors can do substantially better than the market as a whole. Everyone can't be a successful outlier. Investing isn't like Lake Wobegon... not every investor can be above average.
How do the markets weed out the weak from the strong? Simple: The markets challenge your emotions.
What's difficult about investing isn't getting the right facts. What's difficult is learning how to put them to work. Thus, when you read this weekend's essays, your emotions are going to tell you, "This isn't for me," or "I don't have time for this," or, most likely, "This won't be as much fun as what I'm doing right now."
Again, you must be wondering... if I don't believe in teaching and I don't believe most of you will ever put these secrets into action... why then do I continue to write the Friday Digests?Do I get some kind of perverse thrill from tilting at windmills?
No, I don't. My partner Bill Bonner told me something more than 15 years ago that's always stuck with me. He likes to say, "We can't guarantee our success. All we can do are the right things to deserve it."
I believe I have an obligation to try to make our subscribers better investors. I also believe I have a constant obligation to give you the information I would want, if our roles were reversed. If I were the subscriber and you were the publisher, I'd want you to tell me about these secrets. I'd want you to try your best to give me the information I need to be successful.
And so... I will keep giving you this kind of information. I'll keep pushing you to make these kinds of changes to your strategies. And I know... at least for some people... it will make a vast difference in their financial lives. I hope that's you. I hope this message is the one that "breaks through" and shakes you in just the right way.
So... what are these two big secrets?
The first secret will probably shock you, given our business model of selling investment research. But here it is:
On the whole, individual stock selection doesn't really matter. What really matters, over the long term, is asset-allocation decisions. It's not what stocks you buy. It's when you buy stocks versus when you buy bonds, gold, cash, real estate, etc. that matters.
Several academic studies demonstrate why portfolio allocation (how much of which type of assets you own) is far more important in determining your results than simply which stocks or bonds you buy.
The first (Brinson) was published in 1986. And Ibbotson and Kaplan published the best study (in my opinion) in 2000. The latter looked at 94 U.S. mutual funds and several asset classes. The researchers concluded the differences in asset allocation among the funds explained virtually 100% of the variance in their returns. Differences in stock picks made virtually no difference whatsoever to total portfolio returns.
You can look these studies up and read them if you'd like. But the takeaway from these studies is simple: Asset allocation is far more important to your total portfolio return than stock picking. That's why most professional investors (like the top hedge-fund managers) allow analysts to do the stock picking, while they focus almost exclusively on the core allocation decisions.
On the other hand, most individual investors don't spend any time or effort on managing asset allocation. They're typically fully invested in stocks all the time.
Most individual investors don't even know how to buy bonds (which is a critical component of asset allocation), and they do a terrible job at position sizing, another critical component. We're going to come back to asset allocation, and I'll explain how to do it.
But first, you need to understand the second big secret...
The second secret is how to properly value a security.
In my experience, most individual investors have zero ability to calculate even the most basic measures of value in either a stock or a bond. How can you buy a stock or a bond without knowing how to value it? And yet, that is what most individual investors do every single time they buy a stock.
Believe it or not, most of the people reading this essay probably believe a $20 stock is twice as valuable as a $10 stock. It is nearly impossible to explain to them that the nominal price of a stock has nothing to do with its value.
The value of a stock can only be determined if you know the cash earnings that underlie its shares, multiple other things about the balance sheet, and the outlook of the corporation it represents.
Rather than study any of those things, most individual investors prefer to focus on changes in nominal prices. That explains why individual investors are typically much more interested in nominal-price trading systems than professional investors (though there are certainly many exceptions to this rule).
Whether you prefer to focus on nominal price changes or not, you have no excuse for failing to understand how to value a security.
If you use both these secrets together (asset allocation and proper valuation), you can become a vastly better investor.
So if you want to do a better job on asset allocation and you're ready to learn more about valuing securities... where should you start?
We don't write much about asset allocation because we need renewal income to stay in business. Even mentioning the words "asset allocation" causes people to cancel. They don't want to hear it.
The other reason we don't often talk about it is a lot of asset-allocation decisions depend on your personal position in life. Are you worth $10 million and your brokerage account is merely how you like to play poker? Then these ideas don't apply.
Or perhaps you're a 30-year-old investor with a good career, who has another 30 years of relatively high income ahead of you. Again, these rules might not apply.
We don't (and can't) provide individual advice, so you'll have to figure out how to manage your own asset allocation. But I can show you a model...
Let's assume you're a 55-year-old with $100,000 in your portfolio. (That's about average for our readership. You'll have to make adjustments based on your personal differences from this model.)
In order to build a "neutral" starting point, we also have to ignore value considerations (for now). At 55 years old, if you're in good health, your life expectancy is roughly 85. You will work full time for another 10 years. Ideally, you'll be able to save $50,000 per year for the next decade.
Given your relatively small nest egg, you'll need plenty of capital gains. But given your age, you simply cannot afford to lose anything – not even a penny.
Also, you should note, this plan requires you to save a large amount of money every year. That's life. Folks who want to become rich, but don't know how to save are hopeless. Don't be one of them.
Given this example, if you're able to earn 12% a year (after taxes) on your portfolio, you'll end up with a nest egg of $1.13 million by the time you reach 65. You won't be "rich." But you should have plenty of money to fund a comfortable 20-year retirement.
Earning 12% a year isn't impossible. In fact, it's easy. And you don't have to take any risks to accomplish it. Tomorrow, I'll show you how it can be done...
Regards,
Porter Stansberry
Editor's note: On Thursday, Porter, Steve Sjuggerud, and Dr. David "Doc" Eifrig introduced a brand-new product called Stansberry Portfolio Solutions to thousands of Stansberry Research viewers on Thursday. (If you missed it, you can re-watch the event by clicking here.)
If you've ever felt overwhelmed by how much research we publish, Stansberry Portfolio Solutions can help you take all of the "guesswork" out of investing. Learn more about this product – and how to get started on a charter membership – right here.