#9 Creating Wealth: Investing in Common Stock, Part One
Updated: Jun 21, 2021
Creating Wealth is an in-depth conversation between Bill Taber, an experienced financial advisor, and his millennial daughter about personal finance, investing, and financial planning.
Bill Taber is President of TABER Asset Management, a Registered Investment Advisor (RIA) and fiduciary firm located in Des Moines, Iowa since 1998. For decades, Bill has provided investment management services to clients, creating wealth, building wealth, growing income, and preserving capital for each and every client. TABER offers personalized asset management, wealth management, retirement planning, financial planning, and services such as 401(k) rollovers.
His daughter, Anastasia, works in accounting at a global law firm in Washington D.C. She enjoys discussing finances and her cats’ latest antics with her dad.
Episode 9 - Investing in Common Stock, Part One: How do you invest in the stock market and what is really important to keep in mind as you do? Bill and Anastasia follow up on the Intro to Investing episode with specific questions related to how an investor should approach the stock market and how to get started. Bill analogizes his favorite sport baseball to common stock selection. This is Part 1 of a longer discussion between Bill and Anastasia.
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Anastasia: Welcome to Creating Wealth, I’m Anastasia.
Bill: Hi, I’m Bill.
Anastasia: So we started out today talking about common stock and we realized because of my dad’s expertise halfway through recording, we realized this was definitely going to be two episodes. So in this first episode that’s published today, we’re going to discuss some of the follow-up questions that people had after our Intro to Investing episode where we just go a little bit more into what that entails in terms of investing in the stock market. And then in two weeks we’re going to publish our second part of this episode which will get a little bit more into a few specific questions regarding high income earners and what they should do in terms of investing as well as continuing this theme of discussing what it’s like to invest in the stock market. So we hope you enjoy this episode. Thank you again so much for listening and submitting questions to us and we are happy to continue this journey with you guys. Please give us feedback, subscribe, help us out, get this out to people, let them know that you enjoy this personal finance podcast and if you think it’s helpful to other people, we’d really appreciate some word of mouth. Thank you again for listening and we hope that you enjoy these next two weeks!
Disclaimer: The views expressed today are our own, solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investment strategy. The views are subject to change and are not intended as a forecast or guarantee of future results.
Anastasia: So today we’re going to discuss some follow-up questions that we had gotten after our Intro to Investing episode. I think people are really curious to know more about investing in the stock market and how to get started with that. So how do people get started with the stock market?
Bill: Well, I’ll provide some general thoughts. The reason that most people consider investing in the stock market is because they want to accumulate wealth, and the building of wealth is something that is a function of two things. First, the ability to save money, which we’ve discussed in other podcasts. And the second is to then invest that money wisely to allow it to grow. One of the most important things about getting started in investing is to invest in only those things that you know and understand. Warren Buffett, a famed investor, had made a comment once that one should invest or “stay within their circle of competence”. For years, he has done investing in very solid industries that have been undervalued and made a lot of money for him. But he has never strayed out of that expertise that he understands. So he does leave opportunities on the table, so to speak, because of that. But on the other hand, he rarely gets into a company that does not work out for him. Investing in individual stocks, you don’t want to invest any money in a stock or a company that you’re not willing to have fall in value by at least 50%.
Anastasia: That’s quite a lot.
Bill: I’m not saying that it necessarily will fall 50% in value, but the important thing is that psychologically and emotionally and financially, you are in a position to be able to handle that if it does, and not feel like you need to sell or panic sell to get out of it.
Anastasia: That makes sense because I’ve asked this question before too, and you’ve always said that I need to have this pile of money ready to invest in the stock market and be able to view that as separate from what is in my savings account. You want to have a separate savings built up before you invest in the stock market, because you don’t want to put yourself in a position where you need that money quickly, in case of, you know, the financial market goes up and down. You don’t want to have to take it out during a recession, you want to wait until the value is much higher.
Bill: A good example of what you are talking about is a question that I sometimes get from young people that have saved a certain amount of money towards a down payment for a house, their first house, but yet they need to save a little longer to be able to come up with what they need. And so in the process of saving, they ask, “Is there something I can be doing with this money other than just having it in a low interest savings account that would allow me to earn more?” And it’s very important to understand that if you put it into a common stock, it has the potential to grow, much more than what you get from a savings account, but also it has the potential to drop, as we just discussed, it could drop as much as 50% or more at a time that you would actually need all of those dollars for a down payment on a house. And so you want to cord off those funds for things that you’ll need and keep them out of something that could potentially go down in value.
Anastasia: Yeah, so if you’re building your savings for a down payment on a house, you’re saying it’s probably not best to invest it in common stock because of the volatility?
Bill: Exactly. And they ask, “Well, how long do I need to wait?” And I say, well I’ve heard conservatively some people say five years--don’t put money into stocks that you’re not going to need for five years. Throughout my career, I’ve found that two to three years is a workable time frame for doing that.
Anastasia: Two to three years is a workable time frame for doing what?
Bill: Another way of saying it is just don’t invest in the stock market if you’re going to need the money for some other purpose within two to three years.
Anastasia: Okay, so would you say if you want it in five years, it’s safe to invest in the stock market, or would you push that number out?
Bill: The word “safe” is problematic.
Anastasia: (Laughs) Why is it problematic?
Bill: Well it gets to the length of investment cycles. Investment cycles can last anywhere from three to ten years, or even longer. And so it just depends on where you are in the cycle, and unfortunately you won’t really know in most cases until after it’s cycled up or cycled down as to where you’re at (laughs).
Anastasia: After the fact?
Bill: After the fact. So for that reason I tell people two to three years and conservatively other people say five years.
Anastasia: Well, that makes a lot of sense because I think when they’ve got their emergency savings fund built up maybe, and they start saving for a down payment on a house, or whatever it is, their first big goal, I think it is a natural impulse to be like, “Well how can I grow this money faster? I’ve heard about the stock market. I know that you can get way better returns than this paltry return I’m getting from my tiny little savings account at “whatever” bank. How do I grow this money? I’ve heard about it. How do I do this?” So I think what you’re saying makes a lot of sense. You want to make sure that you don’t need this money anytime soon and that will take out the danger of, “Oh, I need this money but we’re in a recession, so it’s going to be worth a lot less than what I could have had if I had waited a few more years.”
Anastasia: So what do investment managers actually do?
Bill: Investment managers assemble a portfolio of company stocks with the objective of earning a rate of return that’s consistent with the person’s personal tolerance for risk with that price volatility that we just talked about. And it’s axiomatic that the higher the potential return, the higher the potential risk. Good portfolio managers have a system that allows them to consistently buy and sell through up and down market cycles which can last between three to ten years plus. A consistent systematic approach helps you avoid getting into something near the top of that investment cycle, or selling out of something near the bottom of an investment cycle. It’s important or helpful to remember that you will make mistakes in choosing companies for investment. What I’ve found is that for every ten companies that I research and feel have potential, two of them will do fabulously well, that over time they’ll go up three, five, ten times plus in value; six of them will do okay, meaning that they’ll make some money; and two of them will be companies that you wish you’ve never heard of.
Anastasia: (Laughs) What’s an example of one of those companies?
Bill: Oh, American Airlines? (Laughs)
Anastasia: (Laughs) Everyone’s upset who owns their stock right now. That’s totally fair.
Bill: The key to making money is to have a system or process, and what a good investment manager does is, for example, has a discipline that allows them to continue to stay invested in the companies that are going up a lot so that they don’t sell their winners, they allow their winners to become bigger. But then on the other side of those two companies that you wish you’ve never heard of, that you have the discipline to sell out of them in a relatively short period of time. Perhaps they go down ten, twenty, twenty-five percent or something and it’s not going in the right direction, and you basically say, “Whoops, made a mistake, cutting the loss, getting out of it. And then look for another potential winner to put back in the portfolio.”
Anastasia: For you, when does that become clear, when a stock is trending downward? Because I’ve heard you say that you should sell when others are greedy and buy when others are fearful?
Bill: Unfortunately nobody rings a bell (laughs) and says, “This is not the time to be in this,” or “You should get out of this.”
Anastasia: (Laughs) That’s so rude, people should definitely ring a bell! (Laughs)
Bill: (Laughs) Yeah, but it gets to the fact that when you purchase a stock, you should think, “What is the main reason that I am purchasing this? What is the main premise for me to believe that this company will continue to grow and get bigger?” And one way to limit your downside risk is to follow the company, the actual results of the company, how they’re doing financially and how well management is handling things. And if that reason that you picked the company in the first place is no longer valid, then you should sell it immediately. That’s the discipline that a professional manager will bring to the process.
Bill: In choosing stocks, it’s also helpful to think of it as a process similar to baseball. You know that baseball is something that is near and dear to my heart.
Anastasia: Dad really loves the baseball analogies.
Bill: (Laughs) For those that are not steeped in baseball history, the greatest hitter in the history of the game was Ted Williams, who I had the fortune to meet at a baseball game once. He was a cool guy.
Anastasia: Super fan (Laughs).
Bill: And his lifetime batting average was .400, which means that for every ten times that he came up to bat, he got four hits. Now, the reason that he was able to hit that well was because he had trained himself only to swing the bat at the ball when it crossed through the strike zone at a spot which he knew that he was more likely to hit the ball. In other words, when it crossed in his sweet spot. Stock selection is like that. It’s just another way of saying, “Stay within your circle of competence.” Does that make sense?
Anastasia: Yeah, so if you work in a particular industry, that gives you inside knowledge to companies who are involved in your industry and whether or not they’re worth investing in? If you know something about something then use that knowledge and incorporate it in your sphere of competency.
Bill: Yes. And you know some people ask, “Well you’re talking about investing in say, ten different companies. I have some money and I want to get a faster return and I want to put it into one stock or one company.” So people ask me, “Is that advisable to do that?” And my response to that is only if you know just about everything that there is to know about the company. Like you say, you may work in the industry, you understand a lot of the trends and the cues that cause companies to have better or worse results, but you truly do understand the company and follow it on a regular basis. Not so much the stock price, but the actual operating results of the company. And by investing in a large sum of money in just one company, to use an old analogy, you’re putting all of your eggs in one basket. And even Warren Buffett has said that putting all of your eggs in one basket is okay, you just need to watch it very, very closely. A reason that he’s been successful is that he studies companies well enough to say, “I don’t mind at all having at least 10% of my total financial net worth in this company.” And the approach that he takes is that once he buys it, he never intends to sell it. So that research and that willingness to invest in a company, a substantial amount of your own personal wealth in that company, keeps you hyper focused. (Laughs)
Anastasia: You watch that basket very closely.
Bill: Yeah, and there’s been sources of great fortunes that have been created by doing that. In my career, I’ve seen individual clients that I’ve had that work for their company that have done very well because the company was doing well. A public company example of that is Microsoft, which Bill Gates today is still probably in the top ten wealthiest people in the world simply by virtue of having Microsoft stock. But on the other hand, owning just one company can be a source of great pain. If you had the the unfortunate situation of being an employee of Enron--
Bill: --Or World Com, back in the early 2000s, you learned after the fact, after the company went bankrupt, that they--
Anastasia: Were cooking the books!
Bill: --were cooking the books, exactly!
Anastasia: I watched that documentary about Enron: The Smartest Guys in the Room.
Bill: Really, really, really bad accounting. (Laughs)
Anastasia: (Laughs) Yeah. So in that case it would be good to diversify?
Bill: Yeah, and I think that’s the approach that they like to take and I like to take which is to have minimal diversification.
Anastasia: Minimal diversification?
Bill: Meaning maybe own ten companies, perhaps a few more than that. Never own more companies than what you can track what they’re doing and understand what they’re doing. And when I’m saying you in this case, it’s either you or your professional advisor. I mean, you don’t have to do this personally, if you find someone that you trust that knows how to do this, then that’s just as good as doing it yourself.
Bill: But if you have an advisor or you know what you’re doing, you can get a better return from investing in a few different companies by getting that minimal diversification. Meaning that if one company does poorly, that it won’t have an outsized impact on your entire account. And that concept of minimal diversification allows you to get a better return with little more risk than what is extremely popular today which is index funds, ETFs (which are exchange traded funds) and even open and close-ended mutual funds in which your money gets invested in a piece of anywhere from 100-500 different companies. I mean, it really makes it difficult to get an above average return if you’re invested in a piece of that many companies.
Anastasia: I think ‘we’re going to have to have a separate follow-up podcast where we go more into those options.
Bill: Mhm, sure. So that’s the general approach to getting started. Either you’re willing to do that yourself, you’re confident that you have the ability to do that yourself, or you find someone that can help do that for you. And then we’ve talked about the three Ts.
Bill: The time, talent, and temperament. That plays a key in this too. It takes some time to do this. So if this is kind of a hobby for you, that’s great. If you have a lot of other things going on, and you just don’t get around to looking at it very often, maybe you shouldn’t be making these types of individual stock investments yourself. The second T is the talent piece of it, and the talent is, first of all knowing how to value companies. What company is currently selling for a price less than what it’s worth, what company is selling for a price more than what it’s worth? And also having some sort of sense, and this maybe comes from your overall perspective of knowing how to choose companies that grow, as Buffett says, “companies that have a long sled ride down the hill.”
Bill: And the third element of it is temperament, and that’s again you mentioned this earlier, being able to be fearful about things when everyone else is greedy, and being greedy when everyone else is fearful.
Anastasia: Which sounds simple but it’s actually hard to practice. (Laughs) Because when everyone is running scared in the other direction.
Bill: Yeah, what’s the term? If you’re really into social confirmation, don’t invest in stock. (Laughs) I think historically they’ve talked about lemmings. A lemming is some sort of animal that tends to follow another animal off the edge of a cliff.
Anastasia: So if you think you’re a lemming, which I don’t think anyone would think of themselves as a lemming, then maybe don’t invest in stocks. (Laughs)
Bill: Yeah (laughs).
Anastasia: Okay, so I have a functional question then--how do people invest in stocks? Where do they go to do that? I mean I know you have your process, but how does someone without a financial advisor do that?
Bill: Well, when I got started many, many moons ago, there were a lot of stockbrokers out there and so I simply went to one of those firms. Today, the equivalent would be to go to what’s considered a deep discount broker. And there are a number firms out there--the two largest ones are Charles Schwab and TD Ameritrade. And it’s gotten to the point in the industry now after about 35 years of evolution that you can do trading in quite a few stocks without having to pay any trading commissions. The models of these companies have shifted so that they can make money in other ways other than charging people commissions for buying and selling. So that would be one way to get started. There’s another thing that just came out here within the last year or two and it’s just kind of starting to proliferate now. They’ve invested some of their savings in a new form of investing called fractional shares. And fractional shares, say for example Amazon, as of yesterday was trading at nearly $3,000 per share. To buy 100 shares of that is $300,000.
Anastasia: Which is a house in some parts of the country!
Anastasia: (Laughs) In most parts of the country. Sorry I’m in DC, so…
Bill: (Laughs) Yeah. Technology-wise, they’ve now gotten this shifted around so that through some of these financial services companies you can buy Amazon or any other kind of stock in $5 increments and then be able to trade those without commissions, without trading costs.
Anastasia: And they do that, how?
Bill: Well, as I said it’s an evolution of technology and I think it gets to perhaps investing apps allow you to--
Anastasia: Like Acorn.
Bill: --You know, I’m not aware of all the different entities that are doing that at this point, but I know that the biggest ones out, whether they be Vanguard or Charles Schwab, etc, are rapidly moving into this area, because they see it as a way basically to help--
Together: Get the millennials
Bill: --Into the market.
Anastasia: (Laughs) And the Gen Zs!
Anastasia: Yeah, there’s several different apps, honestly if you just google investing apps, you’ll run into some. But what do you think of the practice of doing this? Do you think it’s worth it?
Bill: Again, if you are willing to put the time into it and you’re willing to make mistakes, that’s probably the thing that you have to admit upfront is that you will make mistakes. I use an example of calling it the “cost of tuition”. I mean, when you go to college you pay tuition to sit in classes, and when you’re investing like this and you don’t have any experience and you’re doing it on your own without a professional’s help, you’re going to pay tuition. (Laughs) There’s no way around it. But the important thing is that you study the mistakes that you make and learn from those mistakes and attempt not to make the mistakes again in the future. And over time you’ll get better at it. In general, I find that it takes about ten years of investing to experience most of what you can experience within the stock market, because that in the last probably twenty years is how long those up and down cycles are taking.
Anastasia: That’s really interesting. It kind of goes along the lines of Malcolm Gladwell’s theory that it takes 10,000 hours to become an expert in anything. You’re saying it takes ten years. And not necessarily being an expert because I imagine at that point you’re just proficient in it.
Bill: It takes ten years for some of the exogenous factors that happen to affect the markets for you to learn from them. I mean, I’ve been in this career now for forty years, I’ve gone through four different recessions. I thought that the ‘08-’09 downturn was one of the most severe in the last 100 plus years, only to be exceeded by the Depression in 1929-1931, which fortunately I wasn’t around for. But the pandemic, this could be another one of those things that is a real learning experience for investors. And it’s interesting to me that I’m hearing of some first-time investors that are putting small amounts of money into companies that have really gone down in value, like for example, American Airlines, and some of the other airlines that obviously are flying at 5-10% of their capacity at this point, and the stocks have gone down to super cheap levels. And these first-time investors are looking at it and saying, “Wow, that’s a stock that in the past was maybe selling at $40 or $50 per share, now it’s down to less than $5 per share, that’s really cheap I’m going to buy it and it’s going to go back up.” But what experience will teach you, is that what goes down doesn’t necessarily have to come back up again. And the airlines have declared bankruptcy at least twice in the last thirty years, leaving any investor in their common stock “up a tree without a limb”.
Anastasia: (Laughs) Yeah, I’ve never thought about it before, what happens when you own stock in a company that goes bankrupt.
Bill: The stock goes to zero and you lose all of your money.
Anastasia: But then they were bailed out, right? They went bankrupt and--
Bill: They were bailed out by the government at some point in the past. They reorganized themselves, they reissued new stock, and people began to buy that new stock.
Anastasia: And then?
Bill: When they went bankrupt again then the same process happened all over again.
Anastasia: So why would you ever invest in them?
Bill: Well Buffett once said that Orville and Wilbur Wright have destroyed more financial capital than any industry in history...
Anastasia: (Laughs) Alright, so I’m starting to feel like this will probably end up being two episodes.
Anastasia: So continuing on the next episode we will follow up with more questions about investments.
Bill: Great, thank you!
Anastasia: Thanks Dad.
Anastasia: Thank you for listening to Creating Wealth! If you liked our podcast, please subscribe and consider recommending it to your friends or leaving us a review on your podcast app. We would love to discuss your questions. You can email them to us at email@example.com. You can also find full transcripts of every episode on taberasset.com. That’s Taber with an “e” not an “o.” Thank you for joining us on the path to financial abundance. We’ll see you next time!