Check Out These Super Market Tips on Investing
If individual investors bought stocks the way they buy breakfast cereals, they’d dramatically improve their returns.
Or so says Craig Ueland, president and chief executive of Russell Investment Group in Tacoma, Wash. His point: People will stock up when a cereal is on sale, and pass it by when the price shoots up.
“If you go into the supermarket and Cheerios suddenly cost $8 a box instead of $4, what do you do? You look around and see what else you’d like for breakfast,” he said. “But when people are buying stocks and they see that some company has doubled in price, instead of saying, ‘What a rip-off,’ they say, ‘It’s on a roll! I’d better get in before it goes to $20.’ ”
That type of thinking has cost investors a bundle, he said, and there are data to back that up. During the last 20 years, when stock mutual funds posted average annual returns of 13.2%, mutual fund investors earned average returns of 3.7%, according to estimates by Dalbar Inc., a Boston-based firm that tracks money flowing in and out of all types of mutual funds.
The reason: Investors “chase the trend”: selling when the market is down, and buying after it goes up, Ueland said. That’s the opposite of the trite but true market axiom: Buy low, sell high. And it’s exactly the opposite of what consumers do at the supermarket.
Chasing the trend can be costly. A person who invested $10,000 in 1985 would now have $119,379 if he or she simply matched the average fund’s return and reinvested annual earnings. By comparison, that same $10,000 would be worth just $20,681 today if the performance matched that of the average mutual fund investor.
“The granddaddy of all mistakes in mutual fund investing is chasing returns,” said Jim Peterson, vice president of mutual fund research at the Schwab Center for Investment Research in San Francisco.
How should investors put the right stocks -- or mutual funds -- in their baskets? Here are a few shopping tips:
Quality counts. Ueland believes that investors are willing to overpay for stocks simply because they don’t understand what they’re buying in the same way that they do when buying consumer products. But whether it’s stocks or cereal, the value is in the quality of the product.
When buying stocks, you’re buying a piece of a company. The quality of the company is generally measured by growth in sales, earnings, assets, cash flow and stockholders’ equity. The stronger and more consistent the growth, the better.
Check the price. Both cereal and stock prices can bounce around a bit, but there is a normal range. To find that normal range with a stock, check the Value Line Investment Survey for the company’s historical price-to-earnings ratio.
Value Line books, which examine thousands of public companies, are generally available in public libraries or through brokerage firms. The price-to-earnings ratio, or P/E, is a measure of how the company’s stock price compares with its per-share earnings. A company that earns $2 per share annually and sells for $20, for instance, would have a P/E of 10.
To estimate where today’s market price should be, look at the company’s current annual earnings and multiply by the historical P/E in Value Line. In other words, if the company earned $1.62 a share and has a historical P/E of 15, you’d figure the company should now be selling for about $24 a share.
If nothing dramatic has changed -- the company hasn’t bought or sold a major component of the business or hasn’t changed strategies -- but it’s selling for much more, it’s the equivalent of a $4 box of cereal being marked up to $8. If today’s market price is much lower, it’s a sale. It might be time to stock up.
Consider the expense ratio. When investing through mutual funds, pay close attention to the fees, Peterson advises. The cost of running the fund -- having a professional pick stocks or bonds for you -- is measured by the expense ratio, and it is expressed as a percentage of assets. If you have a $10,000 fund and the expense ratio is 1%, for example, you would be paying $100 in annual fees. Those expenses are deducted from fund returns, so the bigger they are, the less return that’s left for you. Over time, even seemingly small differences can add to a fortune, Peterson said.
Remember the vegetables. Picking individual stocks or mutual funds that manage to outperform the market is the fun part. But what keeps a portfolio healthy is diversification, which means having assets in a wide variety of investments that suit different goals, Peterson said. Every investor ought to have some big company stocks, some small company stocks, some bonds, some cash, some international securities and some real estate. How much of each will depend on the investor’s age, assets and ability to tolerate risk.
Like different foods on a plate, different investments provide different benefits, whether that’s safety of principal, growth or income. Having them all keeps a portfolio in balance.
Be consistent. According to a Dalbar study, the miserable returns that most mutual fund investors received was the result of bingeing: loading up on stocks when they were rising, and dumping the whole portfolio when prices fell, said Louis S. Harvey, president of Dalbar.
The company’s data show the devastating effect that the 1987 crash had on investors as they pulled billions of dollars out of stock-based mutual funds as the market tanked -- and then waited to reinvest in stocks long after stock prices had recovered, Harvey said.
Just the simple effect of investing the same amount each month through a 401(k) or other automatic investment plan seems to help, according to Dalbar data. Investors in automatic investment plans didn’t shift their money as frequently and consequently didn’t lose as much by bailing out at market nadirs or buying at the top, he said. Over 20 years, their returns averaged 6.5% annually.
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Judging returns
Research firm Dalbar Inc. maintains that the average mutual fund investor earned just 3.7% annually over the last 20 years, while the average stock mutual fund earned 13.2%. Those who invested through automatic plans such as 401(k)s earned 6.5% on average. Here’s a look at how $10,000 grows over time at those average rates.
*--* Average annual return 3.7% 6.5% 13.2% 5 years $11,992 $13,701 $18,588 10 years $14,381 $18,771 $34,551 20 years $20,681 $35,236 $119,379 30 years $29,741 $66,144 $412,470 40 years $42,771 $124,160 $1,425,138
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Sources: Dalbar Inc., Times research
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Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For previous columns, visit latimes.com/kristof.
