Investing in Dividend Stocks

Companies that have been paying dividends for decades and even more than a century are typically secure investments. When the economy sours, the stock market falls, and investors look for safety they typically buy companies that sell consumer staples, are in the health sector, or have amazingly strong balance sheets. These companies commonly pay dividends as well. If you have put part of your portfolio into a strong dividend stock before a market correction or crash you will typically see a bit of appreciation as other investors pile in later.

Investing with Treasuries and Corporate Bonds

US Treasuries are generally considered to be the most secure interest-bearing investment vehicles followed by AAA corporate bonds. A problem with this approach is that with increasing inflation and interest rates as low as they are today, you are saving with negative real interest rates. Your choices are to use long term treasuries or bonds to get higher interest rates or go very short term and accept extremely low rates. With this approach you will protect your dollars but not necessarily your purchasing power over time. The good part is that if the market does crash, you will have cash to pick up bargains as the market bottoms out.

Portfolio Diversification as a Defensive Investing Strategy

Many investors put their money into several US market sectors as well as abroad in order to benefit from where the growth is. Many also diversify in this manner so that investing mistakes in one sector are hopefully offset by growth in another. The best way to do this for most investors is to put your money into one or more ETFs that track the S&P 500, one or more of its sectors, and foreign markets. A problem for the average investor is that they have a “day job” that takes up the majority of their work day. This makes it difficult to adequately follow more than five or so investments. The ETF approach makes this less of a chore.

Defensive Options Trading Strategies

An approach used by professional investors, as well as options traders, to protect stock positions is to buy puts. A put is an option contract that gives the buyer the right to sell a stock at its contract price (strike price) at any time during the duration of the contract. The buyer is essentially purchasing insurance against the stock (or ETF) being taken down in a correction or crash. If the bottom does fall out of the stock price, the put buyer can execute the contract and sell the stock at the strike price even though it may have fallen ten or twenty percent. Alternatively, they can sell the contract to exit and get cash.

Three Versions of Defensive Puts

The basic defensive put strategy is to buy one more put contracts on the stock that you want to protect. Each contract is for 100 shares.  Depending on how much of a loss you are willing to accept before having the put kick in, you can pay quite a bit for the contract or not very much. Assuming that you hold a lot of the stock and that you set your strike price rather high, this can get to be expensive if you continually roll over the contracts to continue the protection. There are two approaches that make this less expensive.

Synthetic Short Stock

If you are certain that your stock is going to fall in price, you can use a synthetic short stock approach. In this case, you buy a put but also sell a call. While the put you sold gives you the right to purchase the stock, the call contract gives the buyer the right to buy the stock from you at the strike price of the contract. You set this up with the same strike price for the puts and calls and the same expiration date. The premium that you receive for selling the call contract will reduce your cost for the trade and may even leave you with a small credit. If the price goes down you can treat this strategy like a protective put and if it goes up the buyer will execute the contract and you will sell the stock for the strike price. Although this approach is cheaper than a simple put, there are a couple of issues.

Protective Collar

This approach is the same as the synthetic short stock route but it has two advantages. First, it is cheaper and second, it protects you from selling your stock due to normal market fluctuation. A protect collar sets the put and call strike prices at different levels. The put is much lower than the current stock price and the call is much higher. Since the put and call are out-of-the-money, they are cheap. Thus you can use this approach over the long term if you choose to. And, because you set the strike prices far enough apart, you will not end up selling the stock just because the market fluctuates a little and then see the market stabilize.

Defensive Investing Strategies – Slideshare Version

Defensive Investing Strategies – DOC

Defensive Investing Strategies – PDF

You may be already wondering what this question is doing on a website that provides help with investing and investments. But, there is a point at which transitioning your investments away from opportunity and risk to reduced opportunity but safer investments makes sense. We wrote recently about the silent warning from Warren Buffett in that he is finding few attractive investments these days and as a result is stockpiling cash. In a more-immediate timeframe, Jim Cramer, the former hedge fund manager-turned TV investment personality, always notes that you do not have a profit when investing in stocks until you take a profit! The Motley Fool recently published an article on the same theme.

When Is the Time to Stop Investing?

The article by The Motley Fool is entitled, Once You’ve Won the Game, Quit Playing.

Despite the stock market’s history of wealth creation over the long run, on a day-by-day basis it can be quite volatile. Heck, there are occasionally even decade-long periods when the market winds up below where it was when it started. If you still have time before you need to get at your money, you can deal with that volatility. In fact, with time on your side, a drastically down market can be a great time to go value hunting for cheap stocks.

While that risk is real, currently, we’re still benefiting from the longest bull market in history. If you’ve been invested through it, you might be looking at your portfolio today and realize that you’re ahead of where you need to be at this stage in your life in order to meet your ultimate retirement goals. If so, congratulations, you’ve won the game. For at least part of your money, it’s time to quit playing.

You do not need to take all of your money out of the market and you should not be just holding cash. But, as we have written, there are ways to invest without losing any money. Taking advantage of long term treasuries, AAA corporate bonds, and a ladder of CDs insured by Federal Deposit Insurance at your bank(s) can be a good idea. Just as you will balance your stock portfolio, you can balance the maturity dates on bonds and treasuries so that money is always coming available as you need it.

What Do You Lose if You Stop Investing?

If you stop investing in strong companies with the prospects for continued growth, you will lose money by pulling out. But, if Trump’s trade war with China worsens and throws the world into a recession, it could take ten or twenty years of steady growth to come back to where we are today. If you have not invested in stocks with strong intrinsic value, they may never recover from a financial downturn and market crash.

What Do You Gain if You Stop Investing?

If you have already won, as noted by The Fool, you will gain a good night’s sleep every night as you worry and fret less about your investments. As we noted at the beginning, we are not talking about getting out of every investment and holding cash. Rather, we are talking about taking some money off the table and following Cramer’s advice about not having a profit until you take a profit. There are still conservative dividend stocks that are excellent growth prospects at any time and likely to continue to keep paying dividends for decades to come.

Investment Risks of Holding Cash Include Loss of Interest Payments

When we pointed out that the Oracle of Omaha is sitting on a pile of cash, we do not mean that he is stuffing bills into a really huge mattress. From bank deposits, CDs, and money market accounts to short term bonds, there are many ways to hold cash, make a little money (even at today’s low interest rates) and have ready access to your money. When we wrote about how to invest without losing any money, we talked about how Federal Deposit Insurance now protects bank deposits. And, with bank CDs or Treasuries, you can set up “ladders” where money is always turning over and available for short-term needs. The rate of inflation is low today but it still eats away at the purchasing power of you hidden home cash. When investing in stocks, holding cash until you find the right investment is not a bad idea. And, when you will need your money for things like buying a house or sending a child to college, don’t stay in a risky market. But, over the long term, you are missing out on interest payments when you stash cash.

Investment Risks of Holding Cash Include Missing Out on the Next Market Rally

The reason that many investors are staying in the ever-older bull market is fear of missing out on the next big surge in prices. The rationales are that Trump will fix the trade war, earnings will continue to soar, and high employment will continue. Add a possible cut in interest rates to the picture and you can see why many folks are hesitant to get out of an ever-higher market.

The problem with this line of reasoning is just why long term successful investors like Buffett are holding so much money out of the stock market when they (Buffett especially) have described the US stock market as the best place for your long term investments.

The counter-argument is that folks like Buffett pick companies that will in all likelihood make strong and steady profits into the far distant future. With this idea in mind, they are willing to wait out a market downturn in the belief that that stock prices will recover and continue to climb. This approach was borne out when investors stayed with strong companies through the Financial Collapse and Great Recession.

The Investment Benefits of Holding Cash

When the markets melt down, cash is king. Time and time again, stocks and real estate have taken hits and folks with cash in hand have moved in and used the concept of intrinsic stock value to pick investments that are very cheap only to see their investments grow and prosper over the years.

We see no problem with holding cash so long as you have a plan for how to use it. But, don’t find yourself with hidden cash at home that loses its value slowly but surely as inflation eats away at it.

What Are Investing Metrics and Why Should You Care?

As noted by Investopedia, investing metrics are quantitative measures used to assess current performance and predict future performance. The key to using metrics is choosing the right ones to watch and then learning how to read them. For example, the P/E ratio is generally considered one of the best ways for value investors to assess the value of one stock compared to others. Unfortunately, stock prices can be manipulated on a short term basis with stock buybacks. And, financial statements can be manipulated to make earnings appear greater than they really are. This does not mean that you should throw out the P/E ratio as a useful metric. Rather, it means that you should use more than one metric to assess your investments.

Investing Metrics You Should Pay Attention To

We write again and again on this site about using intrinsic value as a guide. This approach seeks to determine the forward-looking income stream of a company. Smart long term investors only invest in companies that have products and services they understand and a clear way that their business plan will make money for years to come. Success depends on the company, its products and services, and management. And, it depends on the economy. No matter how great a widget a company makes, it won’t make any profits if no one has the money to buy those widgets.

The Global Macro Monitor blog has some interesting comments in this regard in their post, How Far Can the Stock Market Run?

Our predisposition to the market is always anchored in time tested valuation metrics, which are hard to manipulate.  That is why we like market capitalization deflated by some macro variables, such as nominal GDP or wages.

Micro measures, such as Price-to-Earnings are way too distorted by buybacks and can be easily manipulated by CFOs, who play around with variables such as depreciation or loss reserves.

Our two favorite are 1) market cap-to-GDP, which, according to Warren Buffet is, “the best single measure of where valuations stand at any given moment.”   Take a look at the following chart and you will understand why the Oracle of Omaha is sitting on a record $122 billion stockpile of cash,  2) the number of hours of work needed to buy the S&P500, not a perfect valuation measure but does track our other favorite quite well.  The average person, making the average salary is not a big holder of stocks but the metric does give a heads up when the stock market becomes divorced from the underlying economic trend.

This is the first chart he refers to.

(Global Macro Monitor)

The commonly used micro investing metrics are these.

• Price to Earnings Ratio
• Price to Book Ratio
• Debt to Equity
• PEG Ratio
• Free Cash Flow

The commonly used macro investing metrics are these.

• GDP
• Market Cap to GDP Ratio
• Average Number of Work Hours Needed to Buy the S&P 500
• Bonds yields (e.g. inverted yield curve)

Using Investment Metrics

Micro metrics are useful in evaluating individual stocks. Macro metrics are useful when deciding when it is time to pull your investments out of the stock market and hold cash. Depending on the status of your macro investing metrics, you will choose to stay with your current investments or consider how to invest without losing any money by sticking with investments that will not crash when the market does.

As noted in a recent CNN business article, investors are “holding their noses” and buying stocks because “there is no alternative.”

TINA (There Is No Alternative) has become a popular mantra on Wall Street. It explains why stocks are near record highs despite concerns about trade tensions with China and what’s expected to be another round of lackluster corporate earnings next month.

Not even a huge surge in crude prices Monday following an attack on Saudi oil facilities over the weekend was enough to dampen investor enthusiasm all that much. The Dow fell a little more than 150 points, or about 0.6%, Monday. That’s a pretty tame drop, especially when you consider that the blue chip average had gained for the prior eight trading days.

It appears that investors are holding their noses and buying stocks because of the TINA trade. With the Federal Reserve expected to cut short-term interest rates again at its meeting this week, stocks could get another boost.

We recently wrote about investment risks related to the inverted yield curve. While an inverted yield curve is a reliable predictor of a coming recession and market correction or crash, it also tells bond investors that interest rates on bonds will remain low for years to come. While the prospect of lower interest rates for years to come makes bond investing seem less attractive to many investors it also makes stocks more attractive to others. For those who see stocks and bonds as their only investment choices, the TINA (There Is No Alternative) view to investing makes sense. However, from our viewpoint, this is a short-sighted defensive posture that is full of risk.

What Are Your Investment Alternatives?

When many folks think of investing, they think of stocks, bonds, and cash. There are alternatives. Some are so-called alternative investments like real estate, commodities, derivatives contracts, managed futures, hedge funds, and arts/antiquities. When choosing alternative investments, the same principles of intrinsic value should be applied to make your choices as to investing in stocks. Other “investments” that make a lot of sense are paying down your credit card balance or paying ahead on your mortgage if you have a locked-in high rate.

Real Estate Investments

Your first real estate investment should be your home. The mortgage interest rate deduction makes this an attractive investment for anyone. And, over the years, you will not only pay less on your mortgage than if you are paying rent but will also have a home to live in free and clear of debt in the end. For most Americans, their home is their greatest financial asset when they reach retirement.

Second homes can be a good real estate investment as well. However, recent changes in the tax law have taken away the mortgage interest deduction on second homes. Thus, any investment in a second home, vacation home, other property will need to stand on its own merits.

Alternative Investments in REITs

According to Investopedia, REITs (Real Estate Investment Trusts) allow investors to “buy shares in commercial real estate portfolios.” They then receive income from a collection of properties such as apartment complexes, health care facilities, hotels, data centers, energy pipelines, cell towers, warehouses, and even timberland. There are equity REITs, mortgage REITs, and hybrid REITs. The Investopedia article has useful descriptions of each of these alternative investments.

Commodity Investing: Gold

Unless you have the background and expertise to predict changes in the live cattle, pork belly, wheat, corn, or soybean markets, these investments are best left to the folks with the skills, experience, and resources to do this sort of trading. However, many investors choose to invest in gold as a hedge against inflation or as a bet on the market taking a downturn. Some investors choose to purchase gold bullion as bars or coins and store the gold themselves in a safe deposit box. Those who choose to purchase substantial quantities can find insured gold deposit facilities. Gold mining stocks often go up in value faster than gold in a bull market and Gold ETFs allow one to participate in an upward swing of gold and get out in a timely manner. We have written at length about the benefits and risks of long term gold investing.

Hedge Funds as Alternative Investments

Hedge funds attempt to multiply the profits of normal market movements through “hedging” strategies like holding both long and short positions in markets. These alternative investments are commonly in stocks. When you invest in a hedge fund you trust the skill and timing of the fund operators to make you a profit in excess of what your own market investing would provide.

Practical Investment Alternatives to Today’s Stock and Bond Markets

There are basic and safe ways to invest outside of the stock market and bond market and there are risky ways. Paying down your credit cards, paying ahead on your home mortgage, or investing in a well-managed REIT are practical ways to invest outside of the stock market. If you have money that you want to invest for the long term and are willing to wait, practical alternatives include US farmland and offshore investments in developing economies.

And, many smart long term investors are perfectly happy with investments that do not lose any money, such as long term bonds, Treasuries, and CDs at your local bank. This may not be a bad approach when you are unsure where the stock market is headed and if another Financial Crisis is around the corner!

What Is an Inverted Yield Curve?

Investopedia discusses the inverted yield curve.

An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession.

Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle. A recent example is when the U.S. Treasury yield curve inverted in late 2005, 2006, and again in 2007 before U.S. equity markets collapsed.

Normally, bond investors demand a higher interest rate for locking up their money in a fixed-rate instrument for longer periods of time. Right now they are willing to purchase five, ten, and even thirty-year Treasuries at lower rates of interest. This means that these folks believe that interest rates will be lower in the future and will stay low for a long time. If the economy tanks along with the US stock market, the Federal Reserve will most-likely lower interest rates.

Japan: An Example of Long-Term Low Interest Rates

Normally, we would not think that rates in a major economy would remain low for years or even decades. But, one only needs to look at Japan. In the 1970s and 1980s, during Japan’s boom times, rates ran between 4% and 9%. By the late 1990s, their rates ran between 1% and 0% with brief periods of negative interest rates. (Trading Economics)

Will Inverted Bond Yields Cause Your Investments to Crash?

The first part of this question has to do with how often inverted yields have preceded a market crash and/or recession and by how many years. Is this really a reliable indicator?

Accuracy of Inverted Yields as an Indicator of Recession and Market Correction

Reuters writes that this is a countdown to recession.

The U.S. curve has inverted before each recession in the past 50 years. It offered a false signal just once in that time.

So, this is a pretty reliable indicator that economic troubles are ahead. But, how long will it take after yields invert before the economy and stock market tank? The yield curve inverted in 2005 and again in 2007. Although the 2007 yield curve inversion immediately preceded the Financial Crisis, the 2005 inversion preceded it by slightly more than two years. The thing to avoid here is to believe that the 2005 inversion was a “false alarm.” Long term bond investors are a cautious group. As such, they may sniff out economic trouble and make smart decisions with their bond purchases while everyone else is happy buying into a market that is ready to correct or crash. These folks are using the same sort of approach as with applying intrinsic stock value to their stock purchases. Is should be noted that before the dot com crash that Warren Buffet pulled lots of money out of the stock market because he said did not make sense. And today, he is doing the same as we noted in our article, Silent Warning for Investors.

Will Your Investments Survive a Recession and Stock Market Crash?

This is really what the inverted yield curve issue is all about. Last year we wrote about how to invest without losing any money. The argument we made in that article is that part of your investment portfolio should be in vehicles like US Treasuries, AAA corporate bonds, and bank CDS that are protected by Federal Deposit Insurance. In this part of your portfolio, you will forego growth in favor of safety. And, if today’s inverted yields are an accurate indicator of a coming recession and crash, this part of your investments will be protected against devastating loss.

That having been said, are there ways to keep a foot in the market and protect your investments?

Using Stock Options to Protect Your Stock Investments

Last year we wrote about how to use options to protect your investment portfolio. Our suggestion was to consider buying put options on stocks that you believe are in danger of a correction but still have some room to run.

Market Watch also mentioned buying puts in an article about four ways to protect your stock portfolio using options.

When you buy puts, you will profit when a stock drops in value. For example, before the 2008 crash, your puts would have gone up in value as your stocks went down. Put options grant their owners the right to sell 100 shares of stock at the strike price. Although puts don’t necessarily provide 100 percent protection, they can reduce loss. It’s similar to buying an insurance policy with a deductible. Unlike shorting stocks, where losses can be unlimited, with puts the most you can lose is what you paid for the put.

This can be a very effective strategy for those who know how to use it. That includes picking the right strike prices and options expiration dates. Successful use of this approach also includes knowing when to use it and when to avoid the repeated expense of buying new put options when the old ones expire.

In today’s world of high-speed trading and short attention spans, it might seem unfathomable to hold any given stock for years, let alone decades. But the world’s best investors know all too well the best way to consistently beat the market is to buy high-quality stocks and hold them for extended periods.

To that end, we asked three Motley Fool contributors to each discuss a growth stock they think investors could do well to buy and hold for the next 50 years. Read on to learn why they chose Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL), iQiyi (NASDAQ:IQ), and Shopify (NYSE:SHOP).

The rationale for each of these stocks is that they have the potential for significant long term growth. People who invested in American companies like AT&T, General Motors, Coca Cola, or Eastman Kodak early in the 20th century had at least 50 years of growth. These stocks grew with the US economy as phone service was extended to every corner of the land, more and more people had a car or two or three, everyone took photos, and everyone loved to have a Coke. It is useful to note that only Coca Cola has passed into the century relatively unscathed while digital photography essentially killed Kodak, General Motors lost out to foreign competition and passed through bankruptcy, and AT&T was broken up in anti-trust proceedings.

Reasons to Invest in Alphabet Stock

The rationale for investing in Alphabet is that they are using the dominance of the world of internet searches to fund their expansion into multiple, potentially very profitable arenas. Today eight of their products have more than a billion users each. These are Google Play Store, Gmail, YouTube, Android, Chrome, Google Drive, Google Search, and Google Maps. With their restructuring, they are now active in self-driving cars with Waymo, lifespan extension with Loon, drone delivery with Wing, life science products with Verily, and high-speed internet with Fiber. This “multiple bets” approach takes advantage of the huge number of smart people working for Alphabet and positions them for further growth in markets that are not dependent on the original internet search focus. This strategy will, hopefully, help them avoid the fate of Kodak whose business model became extinct, AT&T which was taken apart by anti-trust action, or General Motors whose product line came under unceasing attack from foreign competition.

Reasons to Invest in iQiyi

iQiyi is a Chinese company that was spun off from Baidu a year ago but which maintains a close relationship. The company is referred to as the Netflix of China. They aim to make premium subscription videos their core business. Right now they serve 20% of Chinese households compared to the 70% of American households that use Netflix. Considering that China has 1.3 billion people compared to 311million in the USA, the company has a lot more room to grow. Additionally, they are in video games and working on virtual reality. Right now the stock price is attractive because of the trade war between the USA and China. But, this is a Chinese company doing business in China and, would seem to be a Chinese company safe from tariffs. This company can be compared to Netflix, Microsoft, Apple, and other tech stories or to the early to mid-twentieth century stories of General Motors, AT&T, Coca Cola, and Eastman Kodak.

Reasons to Invest in Shopify

The rationale for investing in this company is that they appear to be well-positioned to take advantage of an expanding market in e-commerce. They are the “pick and shovel” approach when everyone wants to dig for gold. That is to say, Shopify assists businesses both large and small in selling their services and products online. This business niche is expected to grow to $25 Trillion by 2025. This company has a nice growth story but not the same sort of story as Alphabet or iQiyi when it comes to a fifty-year investment.

Is There a Safe Fifty-year Investment?

As we noted at the beginning, the Motley Fool article with its three suggested investments brought us to ask the question, is there a safe fifty-year investment? We write about the concept of intrinsic stock value so much that our readers can be forgiven if they get bored with the idea. Nevertheless, the best stocks to invest in are almost always ones that do well in intrinsic value analysis. However, this sort of fundamental analysis needs to be repeated on a routine basis. That is simply because the fundamentals change over time. New technologies replace old and Kodak goes from being the king of film, process, and printing photos to a footnote. Antitrust actions catch up with AT&T and break it up. The development of container shipping to support the Vietnam War effort brings cheap foreign products to America and undercuts American businesses including General Motors. The point is that in order to pick a safe fifty-year investment you need to be able to see into the future. What sort of investments will still be paying off half a century from now?

Your Home Is a Safe Fifty-year Investment

This is another point that we bring up every time that we write about how to start investing. You need a place to live and it is cheaper to own than to rent. The federal tax break for mortgage interest is unlikely to go away in the next fifty years. It is popular on both sides of the political divide and serves a good purpose of societal and financial stability. So, is there a safe fifty-year investment in home ownership? You bet there is and you should be taking advantage of that as early in your investing life as possible.

Are Investments That Don’t Lose Money Really Safe Investments?

We have written about how to invest without losing any money. Over the duration of a US Treasury, Bank CD, or AAA Bond, these are safe investments. You give up the potential for larger gains in return for protection against financial loss. But, over a fifty-year time span is there a safe investment in this arena? The problem with long term bank deposits, Treasuries, and AAA Bonds is that they may barely keep up with inflation or may even fall behind. As such, you will preserve your dollars at the same time that your dollars inflate and become less valuable. The closer you are to needing your investments in retirement the more you will want to be invested in this manner but over a fifty-year timespan, you need an investment that grows faster.

Dividend Stocks for Long Term Investing

In our article about dividend stocks, we provided a list of companies that have been paying dividends for more than 120 years. To keep paying dividends for this long the company has to be making money. Over the years, dividend stocks tend to outpace the market. As such, a safe fifty-year investment might come from a list of dividend stocks.

Technology Stocks for Long Term Investing

Is there a safe fifty-year investment in the tech arena? The telephone, automobile, and the film camera were “high tech” at the beginning of the 1900s. Companies that got in early and performed well dominated American business for nearly a century. And then they didn’t. The risk with tech is that you need a company that can “think on its feet” and not “rest on its laurels.” IBM comes to mind as a company that dominated the computer world until they missed the boat with small computers. Their mistakes allowed companies like Apple and Microsoft to become giants in the ever-evolving computer world. In this regard, we like Alphabet as much because it is diversifying and hedging its bets as for its dominance of internet search.

Safe Fifty-year Investments Are Ones That You Keep an Eye On

The bottom line for picking long term investments is that you need to choose wisely and, more importantly, you need to stay in touch with your investments. Whether your choice is an ETF that tracks the S&P 500 or an individual stock like Alphabet, you need to know why you choose that investment and you need to keep track to make sure that the investment still meets your criteria.

Investing in a Prolonged Trade War

Fortune just published an article about how to invest during a trade war. They start by looking at Amazon versus Apple.

Goldman Sachs gave its take early last week, forecasting that services-oriented companies (think Amazon, Google, and Microsoft) that are “less exposed to trade policy” will likely have an easier time than goods-producing companies (such as Apple, ExxonMobil, and Johnson & Johnson) that are more vulnerable to trade headwinds.

While that’s a largely accepted view, equity and investment strategists who spoke to Fortune noted that it’s a little more complicated than that.

“The key questions to ask are: what’s priced into the market right now, what’s the direct earnings and [price-to-earnings] multiples impact, and what’s the long-term impact?” according to Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch.

Has a Trade War Been Priced into the Stock Market Already?

The first issue to consider with any investment is how much has a prolonged trade war already been priced into that investment? The fact that the market fell in response to the recent tit for tat increases tells us that not all of the risk of a trade war had been priced into the market! But, to the degree that companies have adjusted their supply chains and where they are trying to sell their products (not in China), those investments will better weather the coming storm.

Which Stocks Will Be Hurt the Most by Higher Tariffs?

In general, service companies like Google, Amazon.com, or Microsoft will tend to have fewer problems than companies that sell tangible things. These would include ExxonMobil, Johnson & Johnson, and Apple. Obviously, companies like 3M that are highly diversified to all corners of the globe will do better than companies that are trying to focus entirely on China.

Safe Haven Investing in a Trade War

Are your investments safe from tariffs if the companies only do business in the USA? Here we are talking about utility stocks, real estate investments like REITs or home builders who work exclusively in the USA. Health Care is another promising sector despite the Medicare for all possibility being talked about by Democratic candidates for president. Defense stocks are another possibility for safe haven consideration, especially if trade tensions spill over into heightened military threats.

Investing without Losing any Money, Trade War or Not

Are you investments safe from tariffs when both the USA and China seem to be digging in for a prolonged fight? How do you handle your risk when a single tweet by a Twitter-obsessed president can send stocks dramatically up or down? In the context of investing in general we have written about how to invest without losing any money. The first answer is to put money in an FDIC insured account at your bank, preferably a ladder of CDs. Next, you can buy US Treasuries, again laddered. AAA corporate bonds come next. There are only two US companies that have this rating, Microsoft and Johnson & Johnson. And, the fourth choice in our article was to apply the concept of intrinsic stock value as well as you can to this situation and your particular investments with the idea of investing for the very long term. And, in the cases of bank CDs, Treasuries, or AAA bonds, they should be held to maturity. Of course, in the case of Treasuries or AAA bonds, interest rates could plummet and suddenly make them profitable to sell.

How Long Could the Trade War Last / How Badly Could It Hurt Your Investments

Trump, and many others in the USA, are tired of funding the rise to power of China. China is viewed as not only an economic threat to the USA but an existential threat to the democracies of Europe, the Americas, and elsewhere (India especially). The trade war, according to Trump has been going on for decades and the USA has been steadily losing. However, there two previous major power issues that bear on the current trade war. One is the cold war between the USA and the Soviet Union. The other is the rise Japan as an economic power and its near collapse. The common thread in how these situations worked out has to do with money and debt.

Winning the Cold War by Driving the USSR Farther and Farther into Debt

During the 1980s the USA ramped up its “Star Wars” missile defense program forcing the USSR to spend money that it could ill afford to spend. When social unrest in Eastern Europe became overwhelming, the USSR essentially told the leaders of its puppet Communist states that there was no money to support them, keep the borders policed, or send in the tanks, such as was done in Hungary and Czechoslovakia years before. Today the USA has put sanctions on Russia to ramp up the pressure and is also playing the money and finance card with China.

Japan’s Economy Collapsed Due to a Huge Debt Load

This is the other example that comes closer to why the USA is pursuing a trade war with China. Japan was rising towards dominance as an economic power. Although they were and are US military allies, they were an economic threat. What happened to Japan was not orchestrated by the USA but it was instructive. Japan had a mountain of debt, much of it “off the books” as deals between private parties or hidden debts within the banking system. When this debt situation collapsed, almost 30 years ago, Japan went into a period of economic stagnation from which it has still not recovered.

Applying Japan’s Collapse and Cold War Strategy to China’s Threat to US Dominance

China has a stronger economic system that the USSR had but they have a mountain of debt and it is increasing. Their economic miracle has been funded by borrowing, manufacturing, selling to the world, and then borrowing more. In recent years, their debt has accelerated. The risk to China is that their entire financial system will collapse, taking their social contract with the people along with it. The fact of the matter is that people in China are not in love with the Communist Party leaders unless the economy is growing. If the financial system in China collapses there is a risk that the social system will collapse as well. Thus, the Chinese are digging in to protect the dominance of the Communist Party at the same time that their largest customer is putting tariffs on their products.

All of this having been said are your investments safe from tariffs? Our point in this discussion is threefold. This could be a long trade war for it has to do with basic national interests. It could become even nastier. And, you need to consider how to arrange and protect your investments as it plays out.

How Can You Diversify Your Investments?

There are some basics to sound investing that set the stage for diversification. After paying off credit card debts and putting enough money in a bank account to cover expenses for three months, it is time to consider investments. For the vast majority of people, owning their own home is the best investment of their whole life. It is cheaper over the long run to pay off a mortgage than to pay rent and for many people, their largest asset becomes the home they live in. So the first investment is in your home.

Investing and having your taxes deferred until retirement is a huge benefit that you can get from a 401 (K) at work or from an IRA. You may be able to invest these by yourself or may need to pick one of several options offered by work with the 401 (K). Whichever is offered, you should take advantage of the tax-deferred aspect of these opportunities and they should be your second routine investment.

A common and time-tested approach to investing is to treat part of your investments very conservatively so that you do not lose money. Last year we wrote about how to invest without losing any money and focused on bank CDs, US Treasuries, and AAA corporate bonds. As you invest over the years, part of your investment portfolio should go into such safe investments.

The U.S. stock market is generally considered to be the best way to make money over the long term for the vast majority of people. The S&P 500 has appreciated by 10% on the average since its beginning in the 1920s and that includes making up for the 1929 Stock Market Crash and Great Depression. U.S. stocks should be part of your investment diversification routine. And, those stocks should be diversified as well.

Diversifying a Stock Portfolio

Some people simply bypass this issue by investing funds with Fidelity or Vanguard in one of their mutual funds or in an ETF. The difference between an ETF and a mutual fund is that the ETF passively tracks a stock sector or even the entire S&P 500 while a mutual fund is managed and charges you for that service. Investing in stocks this way is easy, passive, and takes very little of your time. But, as we mention in our article about picking the best stocks to invest in, smart investors only invest in companies when they know what the company does to make money and how that business plan will continue to work for the long term future. This approach requires that you limit the number of stocks that you hold to those that you understand and have time to follow. But, even if you have all of the time in the world, can you diversify your investments too much? Yes, you can and here are a couple of opinions on the subject.

How Many Stocks in a Portfolio Are Too Many?

In the book, A Random Walk Down Wall Street, the author makes the point that with an efficient stock market, an investor could randomly purchase enough stocks (ten large-cap stocks or 40 small-cap stocks) to reduce risk and outperform many active investors.

By “diversifying in this way, the investor lets the market take over and generate profits. But, there is a point of diminishing portfolio risk reduction compared to market risk.

If one simply picks large-cap stocks and small-cap stocks at random, one’s portfolio risk is the same as market risk by 25 stocks. Holding more stocks does not provide more diversification benefit but it does increase the work needed to manage the portfolio.

A Market Watch article writes about the exact number of stocks one should own. The point they make is that in order to “beat the market” you need to be invested in stocks that you understand and have time to follow and that does not work very well when you have too many stocks to keep track of.

Is there such a thing as too much diversification? Yes, in fact, there absolutely is, according to Phil Fisher, an influential stock picker whom Warren Buffett BRK.A, -0.54%  credits as a major source of inspiration.

“Investors have been so oversold on diversification,” Fisher said many decades ago, “that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others which they know nothing about.”

Sean Stannard-Stockton, president and chief investment officer of Ensemble Capital, agrees, saying that while diversification is critical in mitigating risk, active market participants should be mindful of just how much diversity is ideal.

“Too much of anything can be bad for you and diversification can be taken too far,” he wrote in a post on the Intrinsic Investing blog. “But the level at which ‘too far’ kicks in is surprising to most people.”

In the article, they show the graph from The Random Walk Down Wall Street. Their advice for active investors is to stick with stocks that they know and not “randomly” add new investments in the name of diversification.

Investopedia also warns about the dangers of over-diversifying your portfolio. They start by noting why it is that an investor should diversify.

Most investment professionals agree that although diversification is no guarantee against loss, it is a prudent strategy to adopt toward your long-range financial objectives. There are many studies demonstrating why diversification works – to put it simply by spreading your investments across various sectors or industries with low correlation to each other, you reduce price volatility.

This is because different industries and sectors don’t move up and down at the same time or at the same rate. If you mix things up in your portfolio, you’re less likely to experience major drops, because as some sectors encounter tough times, others may be thriving. This provides for a more consistent overall portfolio performance.

But, they make the point that just buying twenty stocks is not true diversification unless the stocks are chosen to be in different sectors. And, they emphasize that you can diversify your investments too much and crowd out your most promising stocks. They end by quoting Warren Buffett. “Wide diversification is only required when investors do not understand what they are doing.”

(U.S. Securities and Exchange Commission: Define Your Goals)

The best returns on investment over the years come from routine stock investments.

Investing in Stocks

Investing in stocks needs to be part of your total financial strategy. Before you start putting money into the stock market, pay off your credit card debt. A typical interest rate on credit card debt is 24% per year. You are not likely to get this rate of return as a novice investor, so pay off your credit cards before investing in stocks. And, put three months-worth of expenses in the bank so that you are not continually selling your stocks to cover routine living expenses! Now you are ready to consider how to invest.

Investing in Stocks vs Bonds

For those who have heard the horror stories of folks losing everything in the 2008 stock market crash and financial crisis, how to invest without losing any money is a major issue. As we note in our article about investing and not losing money, a portion of your investment portfolio should be conservative. A simple way to do this is to purchase certificates of deposit at your bank. These are protected against loss up to $250,000 per depositor per bank by the Federal Deposit Insurance Corporation, an agency of the U.S. government.

(FDIC: Deposit Insurance at a Glance)

Alternatively, U.S. Treasuries are backed by the “full faith and credit” of the U.S. government and will not result in any losses if held to maturity. The next conservative investment in line is an AAA corporate bond. The two U.S. corporations with this bond rating are Microsoft and Johnson & Johnson.

But, in order to attain your goals you probably need to get a larger return on investment than with these conservative vehicles. Over the years, stocks have offered the most potential for growth.

(Fidelity: Three Reasons to Invest in Stocks)

This brings us to the mechanics of investing stocks. The best approach according to most experts is to allocate a set amount of money with each paycheck, every quarter or annually as money becomes available. Then, which is best, investing in stocks now or later, investing in stocks with dividends, letting a mutual fund do your investing for you, putting your money in index funds, or simply investing in stocks online by yourself.

Investing in Stocks Now

Once you have put your financial house in order it is time to invest in stocks. When you invest early in life you get to take advantage of the exponential growth of wise investments. The rationale is that a well-chosen investment in the stock market may appreciate as much as 12% a year on the average. When you leave this investment in place you benefit from the “rule of 72.” Divide the number 72 by your average yearly percent return on an investment. This gives you the number of years required to double that investment!

With a common stock whose appreciation plus dividends come to 12% on the average it will take six years to double your money. Start investing in stocks now when you are 25 years old and you will have seven x six = 42 years until you reach age 67. Double your investment seven times and you will get a 2x2x2x2x2x2x2=128 fold appreciation on your initial investment! The $100 that you invest in a well-chosen stock at age 25 could be worth 128 x $100 = $12,800 and that is just the $100 that you invested in one month.

The basic reason that investing in stocks builds wealth better over the long term is that with stocks you get more “doublings” over the years when you start early and continue over the years.

(Investopedia: Rule 72)

Investing in Stocks with Dividends

In our article about dividend stocks, we note that some companies have routinely paid dividends for more than a century. Not only is such an accomplishment an indication of the safety of such investments but when dividends are reinvested and added to the usual stock appreciation it makes “rule 72” work faster! Look for companies with dividend reinvestment plans when considering dividend stocks.

Investing in Stocks vs Index Funds

Although we would like to think we can pick the best investments, even experienced fund managers can have a hard time beating the S&P 500 over the years. As such, many investors choose a fund that tracks a major stock index like the S&P 500 or a sub-category of the S&P 500 such as consumer staples, consumer discretionary, energy, communication services, financials, health care, industrials, materials, information technology, real estate, and utilities. And, there are many sub-sectors within each of these categories as well. We commonly suggest that if you are picking your own investments that you should start with things that you know about as your knowledge and insights will give you an advantage over other investors.

(The Balance: Sectors and Industries of the S&P 500)

Investing in Stocks Short Term vs Long Term

Short term investing requires skill at market timing. Basically, you need to recognize an opportunity early in the game, make your investment, and then sell when the stock reaches a plateau or starts to fade. There are investors whose only method of investing in stocks is this approach. While some of these folks do very well, many routinely lose money chasing an elusive dream. When an investor repeatedly buys and sells stocks he or she incurs a cost with every transaction. Fees and commissions can eat up what would otherwise be moderate profits. This is the main reason why old, rich investing legends like Warren Buffett do not try to time the market. Rather they look for long term value and unique buying opportunities.

Long term investors know that the eventual price of a stock is determined by its intrinsic stock value. This is the value of the stock based on its projected future earnings. Successful long term investors only invest in stocks when they clearly understand how the company makes money and how their business plan will result in continued earnings into the distant future. Carrying this approach to success requires a bit of homework and patience. Imitating the investment portfolios of the most successful investors like Buffett is a place to start. Buffett himself has said that as he and his team look for clear indications of strong intrinsic stock value they end up throwing out 19 out of 20 possible investments.

The best way to start with this method is by imitation of successful investors and then add more investments of your own as you gain experience. A key factor is to keep track of what you have in your portfolio and use the intrinsic value calculation contained in our article to not only decide what to buy when investing in stocks but what to unload when the company’s business plan is no longer working!

Investing in Stocks vs Mutual Funds

Many folks have the money and want to save and invest for retirement, sending the kids to college, or being able to afford to live the life they always dreamed. These same folks may well be too busy with their work and their lives to devote sufficient time and effort to making and following their investments with the degree of skill and attention that they deserve. Many of these folks will look for someone to invest for them. One approach is a mutual fund. Fidelity explains what a mutual fund is.

Mutual funds are investments that pool your money together with other investors to purchase shares of a collection of stocks, bonds, or other securities, referred to as a portfolio, that might be difficult to recreate on your own. Mutual funds are typically overseen by a portfolio manager.

(Fidelity: What Are Mutual Funds?)

There are several advantages to investing in a mutual fund instead of directly investing in stocks. First of all, stocks like Amazon.com sell for more than $1,700 a share and shares of Warren Buffett’s Berkshire Hathaway Class A stock sell for more than $300,000 a share! These are good investments and anyone who is routinely investing $100 a month cannot buy a single share. But, a mutual fund can and they do. A well-managed mutual fund invests in a range of stocks, bonds, and other investments to provide a good return on investment for the investors in the fund.

The “downsides” to investing in a mutual fund are two. The investor pays a fee to have his or her money “managed” by the fund. And, all too often, a mutual fund does not outperform an index fund that tracks the S&P 500! But, if you do not have the time and energy to do your own investing in stocks, consider a well-managed mutual fund with low fees or simply put your money into an index fund that tracks the S&P 500.

Investing in Stocks Online

For many investors, the old days of going through a traditional stockbroker for investing in stocks are gone. Today many if not most investors use an online stock broker. A good online broker offers research capabilities and often does not require an account minimum and does not charge annual fees like a mutual fund would. Popular online brokers include Vanguard, E-Trade, Fidelity, Charles Schwab, Ameritrade, and Merrill Edge. The same principles apply to investing in stocks online as to investing through a broker. On one hand, you will not be sold a “bill of goods” on a stock by a broker who is “pushing” it this week, which is a good thing. And, on the other hand, you will not have a wise old investment pro to guide you towards good investment choices and away from bad ones either.

Is Investing in Stocks Worth It?

Some folks will read this article and think that investing in stocks sounds like a lot of work. They will rightfully wonder if it is worth it to invest in stocks rather than simply putting their money in U.S. Treasuries or CDs in their bank. The truth of the matter is that if you are building an investment portfolio for retirement, to start your own business, to pay for college, and to live the life of your dreams, you need a balanced investment portfolio.

This means putting some money in the bank, building a ladder of CDs, purchasing US treasuries and AA corporate bonds, and investing in stocks. Always remember that you need to balance safety with the power to grow your investments. However, the “rule of 7” works best for well-chosen stocks. If you are not up to the challenge of picking your own individual stocks due to time constraints, go with index funds or swallow hard and pick a mutual fund.