What Makes a Good Investment?
This is a question we often ask ourselves of so many potential purchases. Whether it be a new home, a new degree, or a stock, we take on these decisions daily. In the case of the home or degree, we can probably list pros and cons to each outcome, helping us figure out the answer to this question. But what about stocks?
There are many theories of what makes a stock a good investment. Some adhere to the growth style, in which price comes second to future growth prospects. Value investors, on the other hand, look for stocks that are first and foremost, cheap relative to their peers. While both of these have merit, it is important to consider the overall portfolio when choosing an investment. Hence, the “prudent investor” theory.
I’d like to put forth another theory of investing for the layman. This theory relates the value of each stock to the value one might attach to various articles of clothing. Furthermore, building a good portfolio is similar to building a good wardrobe; each piece has its appropriate place and purpose. One wouldn’t, for example, have a closet full of shirts and no pants. Good basics are essential but can be accented by astute choice of accessories. And as always, shoes round out the outfit. As with dressing for success, investing can be thought of in the same ways. I like to call it, the prudent dresser theory.
The Good Suit
A staple in everyone’s wardrobe, a fine-quality suit acts as the core or anchor in capitalist society. This should be of a dark neutral tone, and be appropriate for all formal occasions. A hint of pattern or stripe can be added, however, nothing too outlandish; this is not to be worn at time you want to stand apart from the crowd.
Just as the good suit is core to your wardrobe, blue-chip, high quality stocks should be a staple in the prudent investors’ portfolio. Many parallels can be drawn the predominance of blue chips in the marketplace and the wide array of occasions that call for a suit, for example. Not owning these is dangerous just as uncertainty in the markets can cause a flight to quality, life’s uncertainties can bring about a time when the suit is needed, and probably on too short notice to get a good one tailored. Always, always have these on hand.
It’s been long documented that good shoes can dress up any outfit. Shoes are the area where it’s easy to skimp, but always a bad idea to do so. The aim is for high-quality leather, suede or fabric that will go unnoticed in the same way as fraying seems, peeling heels are the first thing that catches the eye and ruins an otherwise great outfit.
Just like a good pair of heels or loafers, certain high quality stocks are good growth opportunities. These are the types of stocks that deliver solid earnings, year after year; always meeting expectations (therefore going “unnoticed”) and never disappointing (fraying at the seems). Though these often trade at a premium, their higher price is well justified.
This is where good judgment comes into play. Shirt styles, fabrics and patterns can vary greatly with the times. It is also one area that can draw a lot of attention so you need to be careful. Keep in mind that designer shirts are nearly always copied, so you can still be in style without spending a lot go with value here. Don’t be stuck with outdated styles that you wear only because you paid so much for them.
Items like ties, scarves, and cosmetic jewelry are the most volatile investments they might only be in style for a short period of time, but can provide a lot of bang for the buck just like Internet stocks. My advice with these don’t be afraid to spend, but be prepared to trade often.
Value, Growth or Core?
One might ask, why not just pick a style and stick with it? Over the long term it will eventually come back into favor. Well, that is true but can leave you looking very foolish while you wait. Yes, those plain white shirts and sensible shoes got you far, but you will look boring and out of step when colored shirts and spiky heels are the current look of success. The lesson here is, be willing to change.
When to trade?
Prudent investors should never jump on a trend without understanding the underlying fundamentals, nor should a prudent dresser jump on the latest styles. Wait for the trend to develop (i.e., better proof of returns!). It is never good to be first if you’re wrong. So the best advice I can give you is, let a trend gain a little momentum and then go along for the ride. Get off when you see the smart people exiting the strategy.