Recently my seventeen year old nephew, Benjamin, asked me about buying a stock. That innocent query
turned into an ongoing conversation, over many weeks, about financial planning, investing, and the
markets. As the conversation evolved I realized that a lot of the pointers I was giving him are actually
tenets of sound financial planning that are applicable to all investors of any age, amount of experience or
net worth.
Below is a kind of open letter to Benjamin of the points I have made to him about how to approach
investing for the rest of his life and I hope, in a period of time when the market has been a bit volatile,
that it helps us all remember the reasons we buy stocks in the first place.
return of large company stocks, since 1926, has been 10.1%. That level of return is outstanding as it
means that you can save less and still achieve your goal. But remember, there is no free lunch.
The flip side of return is risk. Ibbotson also reports that, since 1928, the standard deviation of large
company stocks has been 20.1%. What does that mean? Standard deviation measures the spread of
prices around the average - the more widely distributed the spread, the higher the number. A standard
deviation of 20.1% means that, in any given year there is a 99.7% probability that the return on large
company stocks will be anywhere between 70.3% (3 deviations above the mean) and negative 50.2% (3
deviations below the mean).
How do you feel about that? Maybe ok
when we talk about $100 dropping to $50.
But how would you feel if $10,000
dropped to $5,000 or $1,000,000 dropped
to $500,000? Drops like that are rare (very
low frequency) but they do happen and
they are difficult to get ahead of fully. So
examining in advance, and revisiting often,
the level of loss that you can reasonably
tolerate is critical. It allows you to apply
realistic return assumptions, based on the
allocation of stocks and bonds that match
your tolerance, and determine the optimal
amount of savings required to meet your
goals. In the middle of a downturn,
everyones tolerance for risk drops to zero. Having a plan based on realistic expectations, before the
downturn, will prevent you from abandoning that plan when your fear of loss is at its peak.
It is not different this time.
And you may find that your tolerance for risk might expand when your biggest fear is being left behind,
if the market is doing extremely well and investors are piling in to participate in the upward swing. You
might even find yourself beginning to justify the additional risks you are taking because of the return
that is being made. And you might say to yourself its ok to take those risks because this time, its
different. Its at that moment that I want you to remember this letter. Because it is never different this
time.
When it feels like the market will just keep climbing, bounding over mediocre earnings and taking bad
news in stride, it is very likely that a price adjustment to push things back to average is on the way.
When it is selling off and it feels like it is going to go to zero because fear has gripped the hearts of
every investor, reversion to the mean is likely beginning to take shape. You must find it in you to think
like a contrarian. Buy when others are selling. Sell when others are buying. Dont follow the herd
Northstar Financial Companies, Inc, 1100 East Hector Street, Suite 399, Conshohocken, PA, 19428 Tel: 800 220 2161 www.nstarfinco.com Registered
Representative, Securities offered through Cambridge Investment Research, Inc. a Broker/Dealer, member FINRA/SIPC. Investment Advisor
Representative, Northstar Financial Companies, Inc. a Registered Investment Advisor. Northstar and Cambridge are not affiliated
because the herd is saying this time is different. Have faith in the markets long term averages and
believe in its efficiencies, despite all its emotion.
Everyones a winner
There will be many times in your life when someone, at a party or informal dinner, will regale you with
a story about the great stock they just bought and are making a killing on. Listen to what they have to
say, because being informed includes listening to opinions. However, dont get sucked into their
excitement and rush out to jump on the bandwagon. Investors think things through and ask whether a
purchase fits into the allocation that is driving their plan. Take two steps back and ask yourself will this
investment help me achieve the goals I have set without increasing the risk I am taking to get there?
The answer might be yes. It might be not right now. Often, however, the answer is no.
because nobody talks about the losers.
We all have a bias towards things that have worked out for us. We like to let our winners ride and
ignore positions that arent doing as well. We dont discuss losses, or bad choices, or even wellinformed decisions that simply havent lived up to our expectations. There is no investor that I know,
and I know quite a few, who has made money on every individual stock they bought. So realize that
every home-run you hear about was preceded (and likely will be followed) by innumerable strikes and
foul-balls.
Trading stocks is not investing.
Investors pay attention to what they are buying, because they generally buy with the intention of holding
for a long time. Find those assets that you feel can grow in value by dint of what that asset represents
superior management, innovative products, a global reputation for excellent service. Investing is
throwing your hat in with a company (or set of companies, in the case of a fund) because you are willing
to risk your time and money to be a part of the future of that company. Investing, by its nature, is about
potential.
Trading is about timing. Traders are more concerned about the nature of the market itself the
movement of stock prices and the catalysts behind those movements than with the companies whose
stocks they buy and sell. Traders are short-term thinkers by necessity because the market acquires,
interprets and reacts to a constant stream of information at a frenetic pace. Few traders hold positions
for much longer than a calendar quarter or two that is the default life-cycle of market news. This
quarters undeniable winner is forgotten by next quarters earnings call, when a new winner is found.
Trading is more exciting that investing. You get to see the results of your decision making in days,
instead of years. This is satisfying, even if when the results are disappointing, because it provides both
the thrill of anticipation and (relatively) instant gratification. Being an investor can feel boring, even
tedious, by comparison but the short-term focus of trading encourages the kind of horse-race mentality
that can inflict irreparable damage on your ability to meet long-term goals.
Northstar Financial Companies, Inc, 1100 East Hector Street, Suite 399, Conshohocken, PA, 19428 Tel: 800 220 2161 www.nstarfinco.com Registered
Representative, Securities offered through Cambridge Investment Research, Inc. a Broker/Dealer, member FINRA/SIPC. Investment Advisor
Representative, Northstar Financial Companies, Inc. a Registered Investment Advisor. Northstar and Cambridge are not affiliated
I am certain there will be more exchanges, and more bits of wisdom worth sharing. Until then, I would
love to hear of any insights you feel may have helped you make progress toward your goals. And, of
course, should you have any questions regarding your planning or your portfolio Julia and I are always
available to talk things through with you. We can be reached by email at julia@nstarfinco.com and
steve@nstarfinco.com or by phone at 800.220.2161.
Steven B Girard
President
The opinions expressed are those of Northstar Financial Companies, Inc. and are based on information believed to be from reliable
sources. However, the informations accuracy and completeness cannot be guaranteed. Past performance is no guarantee of future results.
Northstar Financial Companies, Inc, 1100 East Hector Street, Suite 399, Conshohocken, PA, 19428 Tel: 800 220 2161 www.nstarfinco.com Registered
Representative, Securities offered through Cambridge Investment Research, Inc. a Broker/Dealer, member FINRA/SIPC. Investment Advisor
Representative, Northstar Financial Companies, Inc. a Registered Investment Advisor. Northstar and Cambridge are not affiliated