Investment Questions For Success
Frequently, we are asked whether Nvidia, Amazon, Google or another random stock is a good investment. The answer often frustrates as the response is “It depends”.
What does it depend on? Either it is a good company or not—right? Not necessarily.
Just like building a solid house, you have to build the framework of your investment plan. Identifying financial goals will outline your plan of attack and prepare you for the financial challenges you will face.
When we begin working with a client we run through a set of questions to determine what type of investments we hold in a portfolio.
Our first questions is, “How much cash flow do you need from your portfolio?” If you need lots of annual cash flow from investments, Amazon, which pays no dividend, might be a horrible choice. If you need lots of cash we look to investments that regularly pay interest or dividends we can count on. This is especially important for retirees.
Secondly, how much cash do you plan on depositing or withdrawing on a regular basis? If a client is going to give us an extra $1,000 a month for the next ten years then we know we will continue to have more money to work with. It also allows us to concentrate our efforts on our best ideas. Conversely, if a client is going to be withdrawing $1,000 a month from a portfolio it tells us we need to make sure the portfolio generates enough cash flow to fund withdrawals while not running out of money.
Next, we want to identify time frames for different goals. If your kid just got accepted to Harvard and the first tuition payment is in six months, the last place we are putting college savings is the stock market. Instead, we will probably recommend something boring like a six-month CD or a money market. While it is not exciting, I don’t want to be the one to break it to your young scholar that because we gambled with the college fund, they won’t be going to Harvard.
Similarly, if we are just trying to sock away funds for “emergency” purposes we recommend it stay in money market or very short-term CD’s. You won’t earn much, but it will be there when you really need it. Again, the stock market is not appropriate for short term needs.
When considering these issues, remember one of Warren Buffett’s favorite sayings: “Investing is not like Olympic gymnastics—there are no extra points for an increased level of difficulty.” There is beauty and efficiency in keeping it simple.
If a client can truly look us in the eye and commit to a long investment time frame (like ten or more years), then we will consider the stock market and the growth opportunities from business ownership.
Lastly, how much volatility can you withstand? This is always difficult. When the stock market is going up we are all invincible and greatly overstate our tolerance. No one wants to miss the party. However, when the stock market dips, our long-term goals can quickly turn to short term panic as we emotionally run for the door. If you don’t know what your goals are, it is easy to do—just ask anyone who sold in 2009 or 2020.
Over the past fifty years, the stock market has gained more than 50% in one year and lost as much as 37% in one year. That is a huge swing from one year to the next and helps to exemplify just how volatile the market can be over short periods of time.
However, if you look at the same fifty year time frame, but look at five year rolling averages instead, you start to get a different picture. The best five year rolling average return is more than 25% per year and the worst five-year return is a loss of only 3% per year.
Obviously, time is your friend when investing in the stock market and owning businesses.
Once you have answered these questions, you can begin to consider whether a particular investment, or investment strategy, makes sense for you.
Dave Sather is a Certified Financial Planner and the CEO of Sather Financial Group, a fee-only strategic planning and investment management firm.