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As I See It

Jackson’s own Vector Money Management has been ranked one of the “World’s Best Money Managers” by Nelson Information. Vector scored at or near the top in several investment categories. Our congratulations to Vector.

Many, if not all, of the rules of investing seem to be changing. Vector is experimenting with investing in the “new economy” and, apparently, doing quite well. With statistics indicating that about 50% of all Americans own stock in one form or another, all of us need to be challenging our conventional wisdom of investing.

The 25% annual investment gains of the S & P 500 over the past few years are a tough act to follow. Our mindset has changed from happily accepting 10% annual returns to expecting 20% or more from our investments.

Let’s look at the basics of investing for a moment. Investors buy stock expecting that the company will prosper. With prosperity comes earnings, which belong to the stockholders. A portion of those earnings are paid out as dividends while the remainder is retained in the corporation to finance operations, expansion, etc. The value of the stock depends on earnings — both current earnings and investor assessment of future earning potential.

Stocks have traditionally outperformed bonds and certificates of deposit, which are loans and pay interest to the creditor. Investors have been willing to accept lower earnings from bonds because their value is more stable than stocks and they serve as a portfolio balance. Traditional wisdom holds that one’s portfolio should be composed of roughly 50% stocks and 50% bonds. The percentage mix varies depending upon the investor’s risk tolerance for the ups and downs of the stock market.

Since bonds only yield around 6%, it is unlikely that a portfolio composed of half bonds and half stocks is going to produce a 20%+ annual return. So, to achieve these meteoric returns, investors must desert bonds and go all stocks. A risky proposition if ever there was one.

Not only must bonds be cast aside, but traditional “blue chip” stocks must also be shunned since historically they only generate about 10-12% annual return. This leads us to the current scenario. New, untried high-tech stocks are blowing the doors off the stock market while traditional stocks languish.

Many, if not most, of the new high-tech stocks have never made a penny of earnings. The Mississippi Business Journal made more money last year than Amazon.com and most of the other high-tech newcomers. Why, then are investors bidding these stock prices higher and higher?

The answer is that the investing public expects extraordinary things from the new generation of high-tech companies. Their prices are based on anticipation of future earnings rather than a track record of past performance.

No doubt, some of the new guys will be very successful. Some will fall by the wayside. For you to ride this wave to the pinnacle of financial utopia, you must pick the right company. You must rely primarily on luck since there is no historical record to analyze. Winners will proclaim victory exuberantly while losers will quietly slip below the surface.

For those who are depending on their investments for important purposes like retirement, children’s education, etc. I suggest a modicum of conservatism. The basic rule of successful investing has always been diversification and it continues to be sound philosophy.

Some bonds, some “blue chip” stocks, and some high-tech stocks will provide participation in the market surges while adding some stability in the market drops. This approach will not produce the high returns of the past few years, but neither will it leave you with a sack of worthless stock certificates from a company who got upstaged by a newer newcomer whose product was faster, longer, cheaper or something like that.

Ultimately, it all comes down to earnings. New, untried companies are living on the edge. Some will make it, many will not. I suggest you keep a few of the “old-timers” in your bag of tricks as insurance against a total wipeout. I suspect that the folks at Vector would agree with me.

THOUGHT FOR THE MOMENT

But everyone who hears these words of mine and does not put them into practice is like a foolish man who built his house on sand. The rain came down, the streams rose, and the winds blew and beat against that house, and it fell with a great crash.

— MATTHEW 7:26

Joe D. Jones, CPA, is publisher of the Mississippi Business Journal. His e-mail address is cpajones@mbusiness.com.

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