In June I described a high-level framework for planning including three broad categories. Today I will get more in depth on the topic of offense, specifically stock and bond investing as that is what we do at Elevate. Real estate is another proven way to build wealth, but I will leave that discussion to the real estate professionals.
Much has been written over the years about investing in stocks and bonds, some of it is valuable and some of it is garbage. Knowing how to identify and act on the worthwhile ideas and how to ignore the garbage will dramatically improve your results as an investor.
Let’s first differentiate between trading, speculating, and investing.
Traders seek short-term profits by buying and selling securities based on short-term price movements. Traders watch stock charts very closely, a discipline known as technical analysis. They may also follow market trends or momentum to make their buy and sell decisions. Trading is generally risky and not recommended for long-term wealth building.
Speculating aims for high returns by betting on future price movements usually in the short to medium term, ranging from days to months. Speculators often buy options to leverage their returns in particular market sectors or individual stocks. Much like trading, speculating is risky and not recommended for long-term wealth building.
Investing, in stark contrast to trading and speculating, aims to build wealth over time by buying great businesses at reasonable prices and holding them for a long time. Determining what makes a great business, and a reasonable price to pay for it, is what we do at Elevate. Characteristics of the best businesses, in no particular order, are:
Strong Competitive Advantage (Economic Moat):
These companies possess durable advantages , such as brand loyalty, patents, network effects (how difficult is it to leave Apple’s ecosystem once you are in it?), or cost leadership, that protect them from competitors. This moat ensures sustained profitability and market share.
High Return on Invested Capital (ROIC):
Top performers efficiently allocate capital to generate high returns, often exceeding their cost of capital. This reflects disciplined management and profitable reinvestment opportunities, as seen in firms like Microsoft, which consistently achieves high ROIC through its software dominance.
Consistent Revenue and Earnings Growth:
Businesses with steady, predictable growth in revenue and earnings, driven by market demand or innovation, outperform over time. For instance, companies in growing sectors like technology or healthcare (e.g., Amazon or Johnson & Johnson) often show resilient earnings growth.
Robust Cash Flow Generation:
Strong free cash flow allows companies to reinvest, pay dividends, or reduce debt, enhancing financial flexibility. Firms like Procter & Gamble generate reliable cash flows, supporting long-term stability and shareholder returns.
Solid Balance Sheet and Manageable Debt:
There are two kinds of good balance sheets. The first is when a company has more cash than debt. The second is when a company has more debt than cash on hand but earns enough income to cover its debt-service obligations. Companies with manageable debt levels and strong liquidity are better positioned to weather economic downturns. For example, firms like Alphabet maintain low debt-to-equity ratios, reducing financial risk and supporting bondholder confidence.
Capable and Shareholder-Friendly Management:
Effective leadership with a track record of strategic decisions and capital allocation (e.g., share buybacks, dividends) drives long-term value. Warren Buffett’s Berkshire Hathaway exemplifies management that prioritizes shareholder value, even though good ol’ Warren has only paid a dividend to shareholders one time, in 1967, which he described as a mistake, humorously noting it happened when he was briefly out of the room during a board meeting😊.
Adaptability to Market Changes:
Businesses that innovate or pivot in response to technological, regulatory, or consumer shifts maintain relevance. Netflix’s transition from DVDs to streaming is a prime example of adaptability driving sustained performance.
Scalable Business Model:
Companies with models that scale efficiently, such as software or platform businesses (e.g., Salesforce), benefit from high margins and expanding markets, leading to superior returns over time.
Dividend Consistency (for Income Investors):
For bond or dividend-focused investors, companies with a history of stable or growing dividends (e.g., Coca-Cola) provide reliable income, enhancing total returns.
Favorable Industry or Macro Trends:
Businesses aligned with long-term trends, such as cybersecurity, artificial intelligence, and healthcare innovation often outperform due to structural growth opportunities.
Stock investing has been, for decades, a wonderful hedge against the falling value of the US dollar. The chart below details the decline in the dollar vs. the gain in the S&P 500 over the last 30 years.
Source: Charlie Bilello, Creative Planning
Staying invested in stocks, even as you reach and make your way through your retirement years, has historically been a very effective way to maintain purchasing power. At Elevate, we are believers in investing in stocks and managing risk through position sizing and trailing stops. Simply put, we invest smaller percentages of a portfolio in higher volatility stocks and higher percentages in lower volatility stocks. To preserve capital, we will exit stocks, or reduce our position size, if they start acting abnormally. This is why we use trailing stops. Example…if ABC stock trades with a 20% level of volatility (it may pull back up to 20% from its most recent high before stabilizing) and we allocate 5% (position size) to this stock, we risk 1% of the overall portfolio value should we stop out on this stock.
As for avoiding the garbage ideas, hot stock tips are at the top of the list. We’ve all gotten them. Someone you know tells you “He heard ABC stock is going to the moon,” and that you should buy some right away. I suggest when this happens that you “pull a Costanza” and do the opposite. If you aren’t familiar with George Costanza from Seinfeld (or even if you are), you may enjoy this clip.
The same goes for stocks you hear about on the 6 o’clock news. By the time stocks or sectors that are hot on Wall Street reach the news, it’s likely the easy money has already been made and the stock is ripe for a fall.
Guests on CNBC and other financial shows appear to be genuine in sharing their views on stocks and markets, but they are often just “talking their book.” That means they own a given stock, go on TV and tell the world how wonderful it is and how it will continue to rise in value, then sell into the buying strength the tout generated.
Even if you manage to avoid these traps, just buying average businesses is not likely to make you much money. According to Porter Stansberry, one of our favorite financial writers, “out of the 29,000-plus common stocks that were publicly traded in America between 1925 and today, only about 5,000 survived more than 20 years. And, as you’d expect from Mandelbrot’s work and from Pareto’s Law, which I discussed on Monday, there’s a huge ‘power law’ in the stock market: most of the profits accrue to a very small number of companies. Various studies show that about 1% of stocks will create about 70% of all the wealth. And what is the most important factor? Time.”
So, finding the best businesses with long term track records and many of the characteristics I noted above and holding them for as long as possible is the simple (but not easy) way to generate wealth using stocks.
Next, let’s talk about bonds.
Investing in bonds can be a wise choice for those seeking to generate steady income. Bonds are essentially loans made to entities like governments or corporations, which repay you with interest over time. This regular interest, known as a coupon, provides a predictable income stream provided the issuer doesn’t go bankrupt. Much of the investing public has been conditioned to think that bonds are safe and negatively correlated to stocks. Meaning, when stocks fall bonds go up in value. That is not always true, as demonstrated in 2022 when bonds were down double digits right along with stocks.
Interest rate movements meaningfully impact bond returns. When interest rates fall, bond prices rise, benefiting investors. This happens because existing bonds with higher coupon rates become more valuable compared to newly issued bonds with lower rates, allowing investors to potentially sell their bonds at a premium or enjoy higher relative yields. Interest rates, on balance, declined from 1981 to 2021, marking a golden era for bond investing.
Since 2021, interest rates have generally been rising which can pose challenges for bond investors, as bond prices typically fall when rates increase. New bonds issued at higher rates make existing bonds with lower coupons less appealing, reducing their market value and potentially leading to losses if sold before maturity. Bonds with shorter maturities are impacted less by rising interest rates but usually offer lower yields, but, interestingly, that is not always true. As I type, the US government is paying 4.2% annualized return over three months and only 3.7% annualized return over three years. This is what is known as an inverted yield curve, but that is a topic for another day.
Now that you know what to look for and what to avoid, let’s talk about using market investments to build wealth. Here is a framework for building wealth in the market:
Set your financial goals
Define your purpose: Are you investing for retirement, a house, or financial independence? Your goal determines your time horizon and risk tolerance.
Determine your time horizon: Investing for short term goals dictates safer investments and longer-term goals allow for more risk taking.
Assess risk tolerance: Can you handle market dips, or do you prefer stability? We like to measure risk tolerance in terms of willingness, ability, and propensity.
Decide if you should hire someone or if you will do it yourself
Do you have enough interest in investing and markets to keep you engaged?
Do you have the time to dedicate to following markets and your investments?
Don’t fool yourself here…either commit to doing what it takes or hire someone to do it for you
Adopt a strategy called Dollar Cost Averaging
Invest regularly by putting a fixed amount (e.g., $200/month) into your account, regardless of market conditions.
This works because buying at regular intervals averages out the purchase price, reducing the risk of buying at a market peak.
Pro tip: Automate investments to remove emotion and stick to the plan. The easiest money to save is the money you never see.
Monitor and rebalance periodically
Review your portfolio a few times per year to avoid overreacting to market swings.
Rebalancing is the process of trimming positions that have grown beyond their target allocations and adding to positions that are below their target allocations.
Stay informed: Follow broad market trends but avoid chasing hot stocks or sectors.
Stay disciplined and patient
Think long-term: If you have bought great businesses at reasonable prices, you are likely best off holding them through difficult markets.
Reinvest dividends: Use dividends to buy more shares, compounding your returns over time.
Minimize taxes and fees
Look to max out contributions to tax-advantaged accounts like IRAs or 401(k)s first.
If you are investing in a taxable account, remember stocks held for over a year qualify for lower capital gains taxes.
Tips for success
Start now: Time is your greatest friend in investing. Even small amounts compound significantly over time.
Ignore market noise: Avoid reacting to daily market news or hype.
Keep learning: Here is a link to the Elevate Capital Reading List.
Next time we’ll dive into Defense. Feel free to share this planning commentary with anyone you feel could benefit from it. If you are reading this and have been managing your own investments and would like to know more about how we do things at Elevate, please feel free to arrange some time to get acquainted by clicking this link to my calendar here.
Ken Armstrong, CFP®, RICP®, ChFC®, CLU®, CASL®, CLTC
CEO & Senior Wealth Management Advisor
Elevate Capital Advisors
Legal Information and Disclosures
This commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Elevate Capital Advisors, LLC (“Elevate”) has no duty or obligation to update the information contained herein. This information is being made available for educational purposes only. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elevate believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Elevate. Further, wherever there exists the potential for profit there is also the risk of loss.