Investing Rules from an Old Guy

Let’s say you bought a stock for $100 and after 1 year you sold it at $105 for a gain of $5 or 5%. How do you determine whether this was a good or bad investment?

Rule #5

Performance is measured against all the other financial choices you had.

Let’s compare the $100 investment with some other things the money could have been used for:

• You could have paid down your credit-card balance. Your credit card charges 18% interest so after 1 year you would have saved $18 in credit card interest charges. Since saving $18 is better than making $5, paying down the credit card would have been a much better investment. [Note: ALWAY, ALWAYS, ALWAYS pay off your credit card balance every month because finding a better investment is nearly impossible.]
• You could have paid down your mortgage principle which is a loan charging 4% interest. After 1 year you would have saved $4 in mortgage interest. Although saving $4 is not as good as making $5, the difference is not much. [Note: Since there is not much gain for the amount of risk incurred, NEVER use a personal or home equity loan to buy stocks.]
• You could have done nothing and left the $100 as cash for a gain of $0. Your investment gain of $5 is clearly better than holding cash.
• You could have put the $100 into a Savings account paying the national average rate of 0.1% for a gain of $0.10. Again, your investment gain of $5 is clearly better.
• You could have bought $100 of SPY, the S&P500 ETF, and assuming it returned the 40 year historical average of 9.4% it would have gained $9.40. Although a $5 gain is nice, a $9.40 gain is better and buying SPY would have been a better investment.

Rule #6

The metric I use to track market performance is the S&P500. There may be other better metrics like the Russell 3000, but the S&P500 is more readily available. The corollary to this is you can ignore the Dow Jones Industrial average IMHO.

So, if your investment does better than the S&P500 you have beaten the market, and that’s a good thing. Note that there will be many situations where your investment will be down, but if you are down LESS than the S&P500 that is also is a good thing.

Rule #7

It’s all about % gain/loss/change

Say your stock went up by $5. How does that compare to another stock that went up $50? Well it depends. If your stock was at $100 and went up by $5 that is a 5% gain. If your other stock was at $5000 and went up by $50 that is only a 1% gain and is not as good.

Related to this is # of shares and share price which don’t mean much. What matters is the market value of the stock investment which is the (# of shares) x (share price). When one has invested $1000 in a stock (does not matter how many shares) and you know the price went up 5%, then you know your investment went up by 5% or $50.

But is 5% good or not? If the 5% change was greater than the % change of the S&P500 over the same time period, it was a good buy. [Note: When I buy a stock, I track the S&P500 on the same timeline so I can compare the performance of that stock relative to the S&P500.]

Although gaining 5% is good, if it is less than the gains of the S&P500 you could have done better!

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