Sunday, November 9

Week 175 - Gold, Apple and Your Inner Gambler

Situation: Why do many of us keep trying to make money on chancy investments like gold or zippy growth stocks? Because we think we're clever enough to make it work (even though few of us have a degree in finance or a job in financial services). I know you wouldn't be reading this blog if you didn't already know this is not a sound investment strategy but the temptation is still there. It’s the voice of our Inner Gambler. Why is that? Quite simply, we're competitive... all of us. Disposable income allows us to compete, whether in material terms or by positioning our children and grandchildren for success. Status carries with it a propensity to gamble for more status. An investor, however, measures success less by material proof and more by assets under management. An investor is unlikely to put money toward anything where the long-term Return On Invested Capital (ROIC) is unlikely to exceed the Weighted Average Cost of Capital (WACC) by at least 5%/yr. Therefore, long-term investment in life-enhancing events, such as educating one’s children, take top priority.

For today’s blog, we would like to examine how our Inner Gambler works, so as to gain power over it through situational awareness. In order to exist, gambling has to fulfill a need. But gambling differs from other addictions in a profound way: If successful, it enhances self-esteem and allows us to gain respect through the appearance of success and by helping others. In addition, we may be able to afford the trappings of self-importance and use those as a route to impressing other people.

Retirement is serious. And it’s becoming more serious with each passing year (and our government’s trillion-dollar addition to social safety net insolvency). With modern medicine, you may enjoy 40 years of retirement, if you’ve saved enough. The secret of retirement planning lies in distant gratification, not instant gratification. Most gamblers prefer instant gratification and allowing it to overcome their reasoning ability. We all know stressors arise from time to time and demand instant gratification. But we can also learn to “firewall” our key assets, such as the deed to our house, the title to our car, our wedding ring, and our retirement accounts.

Wait, how does one firewall a retirement account? You set up automatic monthly withdrawals from your checking account into your IRA and DRIPs, and divert at least 10% of your salary to your workplace retirement plan. It’s all on automatic pilot and you’d have to go to some trouble to stop those diversions, which would also result in a big tax bill.

More importantly, rules are needed that keep you from getting in a credit crisis: 1) Never buy stock with borrowed money (i.e., buying “on margin”); 2) Backup stock investments 1:1 with Treasuries unless you’re buying a "hedge" stock (see Week 150); 3) Create a budget that dedicates a piece of your monthly income to match each recurring monthly expense.

For this week's Table, we examine the two smartest gambles of the past decade: Apple stock (AAPL) and the iShares gold ETF (GLD). You'll want to know how these stack up against the lowest-cost and best-hedged mutual funds like Vanguard Wellesley Income Fund (VWINX) and Vanguard Balanced Index Fund (VBINX), as well as the lowest-cost S&P 500 Index fund, Vanguard’s 500 Index Fund (VFINX). Red highlights indicate underperformance relative to VBINX. For comparison, we include stocks that prosper in bad times: Wal-Mart Stores (WMT) and Ross Stores (ROST), as well as an intermediate-term US Treasury fund (VFITX) and a long-term US Treasury fund (PRULX). GLD did well during the Great Recession but the two recession-proof stocks did well then and have continued to do well. GLD predictably collapsed in price when the economy started recovering. Treasuries are the “steady Eddies” of finance and really shine during recessions, but fade during recoveries.

Let’s assume that you were clever and bought a lot of AAPL and GLD 10 yrs ago. But were you clever enough to sell GLD 5 yrs ago and buy VFINX just as the stock market was taking off? Or did you wait until the price of gold collapsed two years ago? And, would you have been clever enough to not sell your AAPL shares in 2012 when the price fell 20%, or in 2013 when the price fell 40%? Very few investors who bought GLD and/or AAPL 10 yrs ago would have known “when to hold and when to fold.” And, those few probably wouldn’t have acted. Why? Because that would have meant going against herd behavior. In summary, being clever is about making three smart moves (buy:hold:sell) in a timely manner, not just one, and making those moves regardless of the opinions that others may hold.

Bottom Line: In hindsight, even the best gambles carry too much emotional baggage and volatility to warrant a place in your retirement account. But Apple (AAPL) shares have been a great investment for those who studied the company carefully throughout its ups and downs and refused to sell. The problem: AAPL is so successful that naysayers abound, and they’re not just short-sellers. It is simply human nature to highlight negative factlets about successful people or enterprises.

Risk Rating: 8

Full Disclosure: I've never owned GLD or AAPL shares.

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