The Temple Columns
Products:  choosing the right investment products

We have seen elsewhere on this website that the stock market provides the best long-term wealth-creating vehicle for the individual investor (stocks for newbies).  And that this will be where you place most – if not all – of your investable cash.  We’ve also seen data that prove mutual funds are not great investment vehicles for personal investors (mutual fund myth).  Moreover, in the foundation section of the Investment Temple we learned that the investor should choose the type of portfolio (i.e., asset allocation) model depending on their interest & the time they can devote to maintaining their ‘temple’.  

This column section of the Investment Temple will outline the variety of investment products that we can deploy in our drive towards long-term investment wealth.  

A word on diversification
(i.e., your need for multiple columns)

Just a reminder, a temple needs more than one column or the roof will likely collapse.  Ideally, the temple will have at least three columns to provide the beginnings of portfolio diversification.  As we shall see below, adding an ETF as an investment product will provide more than enough ‘column support’ for any robust investment strategy & long term goal.

There has been much research done on the benefits of diversification.  Diversification simply means that you do not have all of your eggs in one basket.  Years ago, I worked for Enron.  Yes, that Enron.  When it went bust in 2001, I lost not only my job, but I lost quite a bit of value in shares and stock options.  Fortunately, my 401k equivalent (I was a UK employee at the time) prohibited us from investing our pension monies in Enron stock as well.  Alas, my US colleagues did not have such protection and many lost all of their life savings in a flash.  Paper millionaires nearing retirement realized that they would have to work for the rest of their lives as their retirement savings, stock investments and jobs all vaporized on that dark day in late 2001.  This lesson taught me the hard way the benefits of diversification.  

Elton & Gruber, two professors who have written extensively about modern portfolio theory, conducted a study on the impact of diversification and found that most ‘bang for the buck’ of reducing portfolio risk by holding multiple stocks took place between 10 & 20 stock holdings.  Check out their analysis results on Wikipedia.

The bottom line is that choosing several columns (diversification) is as important as what you put in your ‘stock columns’ (see below).  But don't worry too much about this as one good ETF provides all the diversification you will need.

Column (Investment) Choices

There are many investment products available to the individual investor, ranging from individual stocks (common and preferred) to bonds (fixed income), options and commodities.  Whereas the sophisticated investor can profit quite handsomely from options, the novice investor should stick to basic financial products like stocks and, possibly, commodities (e.g., gold and silver).  For reasons mentioned elsewhere bonds are not to be covered in this current ultra-low interest rate environment.  That may change as macroeconomic conditions change in the future.

1. Stocks: equity shares are the best wealth-creating vehicle for the investor with a long-term time horizon, bar none.  For this reason and this reason alone, stocks should make up 75-80% of your Product columns.  

In order to capture the power of compounding you’ll want to make regular investments into dividend paying stocks.   Here is some proof that dividend paying stocks are the way to go.  And you’ll want to ensure those dividends are reinvested in purchasing more of the same stock.  

And the best way for the long-term investor to invest in stocks in via a little known program called the DRIP.  Click here for more information of the DRIP.

2. ETFsexchange-traded funds are low cost investment vehicles that trade like ordinary stocks.  They are a fantastic tool to provide diversification in a low-cost, tax efficient way.  Add one or two ETF columns to your Stock columns for a well diversified equity portfolio. Depending on the number of stock columns you have, an ETF column representing 10-20% of your portfolio may be appropriate.

3. Commodities: whether you realize it or not, commodities have been the investment column of choice for mankind much, much longer than other more modern-day products like stocks (which only started trading on Wall Street in 1792).

Commodities can mean a lot of different things to different people – so what I mean by it in the context of New Investor Tool Kit is gold and silver.  Precious metals, in other words.  

The small investor has been buying and storing away gold and silver for millennia.  There are many sophisticated well-known investors, like Warren Buffett, who eschew investing in precious metals as it costs money to store and, to compound the problem, doesn’t generate any income or yield (unlike dividend paying stocks or interest paying bonds).  And the astute reader will remember the returns from gold over a long period - ho hum.

Still, in our modern day environment where numerous governments are seeking to devalue their paper currencies to be able to better compete in international trade, a prudent investor may create a commodities column in order to provide some level of portfolio value insurance coverage.  And there are companies offering investing services that is consist with our automated paying ourselves first disciplining mechanism.  More details regarding the what, how & who are covered in the Top Tips section.

4. Exotics: for now I’ll lump all other investment types into the Exotics column (represented by some nice exotic birds to the right). These investment choices are only appropriate for the Hobbyist investor who has gained some level of sophistication.  

The Exotics column can include options (calls, puts, etc), warrants (long-term equity call options) and smaller capitalized equities (small caps) which usually offer higher than market returns but with increased risk due to the smaller size of the company. 

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