When is the best time to invest?
Sir John Templeton is one of the founders of Franklin Templeton Investments. When he speaks, listeners often ask, "When is the best time to invest?" He invariably replies, "Whenever you have the money." While past performance is not a guarantee of future results, history has borne him out so far.
Here are some of the reasons many investors have avoided the stock market over the past 75 years:
Assassination of President Kennedy
All-time-high interest rates in early 1980s
Terrorist events of 9/11 and the war on terrorism
High energy prices
If you look hard enough, you can always find a reason to stay away from stocks. However, we believe an intelligent investor gives more weight to long-term trends than to the current events that make headlines.
When you invest in any kind of security, you do face risks. The most obvious is loss of money. But there are other kinds of risk as well — risks that affect all investors and all non-investors — like the loss of purchasing power. Obviously, putting your money under a mattress, or in a CD, may not even keep up with inflation — to say nothing of the additional erosion by taxes.
Why do most investors fail to meet their investment goals? We believe there are three main reasons:
They have no plan.
They select the wrong funding vehicles — investments that don't outpace inflation and taxes over long periods.
They let their emotions influence their decisions.
The secret to investing is not timing the market, but time in the market.
By investing the same amount of money at regular intervals, you can avoid the temptation to time the market. This powerful long-term investment technique is called dollar-cost averaging. It helps you buy more shares when prices are low, fewer when prices are high.
Dollar-cost averaging in itself doesn't ensure a profit. If you have to sell your shares at a time when their price is lower than the average price you paid for them, you'll have a loss, but dollar-cost averaging can reduce the price you have to get to break even. Before starting such a program, you should consider your ability to continue buying at periods of low prices.
As mentioned earlier, you can always find a reason to stay away from stocks. Again, past performance does not guarantee future results — but over the long term, the stock market has risen, and it has preserved and enhanced investors' purchasing power.
When buying bonds, quality counts
One of the reasons you invest in bonds - perhaps the main reason - is the interest payments you'll receive. So, naturally, you'd like these payments to be as large as possible. However, chasing high rates may not always work out in your favor. But when buying bonds, you can hardly go wrong when you look for quality.
As you may know, there's a direct, and inverse, relationship between a bond's quality and its interest rate. To attract investors, the lowest-quality bonds typically pay the highest interest rates. Conversely, high-quality bonds pay lower rates.
But what does it mean to say that a bond is of high quality? Essentially, it means that an independent rating agency, such as Moody's or Standard & Poor's, has evaluated a bond and found that its issuer, a corporation or a municipality, is unlikely to default on its payments. And the higher-rated the bond, the less likely a default.
Before buying a bond, then, check out its rating. Moody's ranks "investment grade" bonds (the highest quality bonds) from Aaa down to Baa-1 or Baa, while Standard & Poor's ranks these bonds from AAA down to BBB. If you see a bond with a rating below these, it is considered "speculative," "highly speculative" or in default.
Is it smart to chase higher rates?
It's not hard to understand why high quality is desirable when choosing bonds; after all, you'd like to be fairly confident that the issuer is going to continue making interest payments throughout the life of your bond. But what may be more difficult for some people to understand is why they can't sacrifice some quality for higher rates. After all, in times of low interest rates - such as the present - higher-return bonds can look attractive to people who rely on their investments for income and to those who are looking for the best return on their money. So why not buy lower- quality bonds that carry higher yields?
For one thing, while it's true that lower-quality bonds generally pay more than those with higher grades, the difference is no longer as great as it once was. Why? Because, in the declining-rate environment we've been in for several years, yield-hungry investors have aggressively sought ought lower-quality bonds. Consequently, the increased demand for these bonds has caused their price to go up, relative to higher-rated bonds. And because interest rates move in the opposite direction of bond prices, the "quality spread" - the difference in yields for bonds of different quality - has narrowed.
In plain English, this means you are probably not getting paid enough, in terms of yield, for taking on the risk of buying lower-quality bonds. So chasing higher yields, and sacrificing quality to get them, may not work in your favor.
Rather than pursuing higher yields in today's marketplace, you'd be better off by creating a bond "ladder" composed of bonds of varying maturities. When rates are rising, the proceeds from your maturing bonds can be used to invest in new bonds at the higher levels. When market rates are falling, you'll continue to benefit from the higher rates offered by your longer-term bonds.
But in any case, stick with quality bonds. They may not always give you the top interest rates, but they can still be quite rewarding.
Various definitions of earnings confuse
Evaluate diluted earnings based on GAAP
Have you ever wondered why a company's stock fell after reporting apparently stellar earnings numbers, or a stock held steady or even shot higher after announcing a massive loss?
Sometimes these situations are a simple matter of stocks trading in one direction in anticipation of news and then reversing course slightly when the actual report is released—the old Wall Street adage "buy the rumor, sell the news" playing out.
But other times you may start to wonder if other investors/traders are looking at different earnings numbers than the ones you're seeing, and you find yourself asking: aren't earnings for one company the same as earnings for the next company? Unfortunately, the answer isn't an unequivocal yes or no.
Over the years, stock analysts and corporate finance professionals have concocted numerous definitions of earnings. You may have heard of basic earnings, diluted earnings, cash earnings, core earnings or any of the alphabet-soup variations such as EBIT, EBITDA, OIBDA, ATOI, etc. When evaluating your investments, the gold standard to look for is diluted earnings based on GAAP—the generally accepted accounting principles set by the Financial Accounting Standards Board. Any other variety of earnings is referred to as "pro forma."
Pro forma earnings are usually used in an attempt to show how much money a company earned, or would have earned, if certain expenses for non-recurring items or transactions were ignored. This type of analysis can be useful when certain expenses aren't part of a company's normal course of business and/or they obscure the company's true earnings generating capacity. However, presenting earnings on a pro forma basis has been so prone to abuse that Investopedia, an investment-oriented educational Web site, calls them "everything-but-the-bad-stuff earnings."
I would never suggest completely disregarding all non-GAAP measures of profitability. However, when looking at a company's pro forma earnings statements, it is critical to use your own common sense to assess the assumptions behind the earnings adjustments. Always ask yourself: Are the item(s) being excluded truly non-recurring? Are they truly not related to the company's normal business operations? If the company has taken similar or identical charges in the past, it is fair to question management's claim that the expenses are "non-recurring." Just because something occurs infrequently—such as an inventory or goodwill write-down, or an unusual spike in bad-debt expense—doesn't render it irrelevant.
Some industries are highly vulnerable to rapid inventory obsolescence or customers not paying their bills, so those types of events should be considered when a firm's long-term profitability is measured.
Merger and acquisition transactions provide one of the most legitimate reasons for companies to publish pro forma earnings statements. The expenses directly related to closing the transaction are inarguably "non-recurring," and pro forma financials can help investors estimate the combined company's future earnings power. However, many of the biggest accounting frauds that have been perpetrated in the past have involved companies that did frequent merger and acquisition transactions and buried regular operating expenses in their charges for one-time merger expenses. The greater the number of merger and acquisition transactions, the closer you should examine the financial statements.
Recent legislation such as Sarbanes-Oxley and changes in GAAP guidelines have attempted to curb the inappropriate use of pro forma earnings. But, even if a company reports its earnings in accordance with GAAP, with no pro forma modifications, you should still scrutinize the quality of the earnings. Banks, for example, have great latitude in the timing and amounts they place in their provision for bad loans, so a bank's earnings should be considered of "low quality" if they are boosted by under-reserving.