Sowing Seeds is a 4-part series about investing. It’s based on having studied several successful value investors with a strong bias toward treating equities as partial business ownership and not as lottery tickets.
First: Part 1, Market value is imaginary
Then: Part 2, The economy is irrelevant
Finally: Part 3, The second best buzz
Bonus: Part 4, Water your own tree, slowly

“Yeah, but Semple, how do you do it? What are the specifics?”

Investing is a lot like growing fruit trees in Israel. It takes a lot of water. And if you dump all your water on the seedlings at once, or expect to have fruitful trees in six weeks, you will waste a lot of water as it sinks into the sand. You will fail. Often miserably.

Trickle irrigation and patience are key, and, if absent, I think that either enterprise should be abandoned.

Cash flow is the goal

I think it’s best to look at every financial enterprise as a cash flow generator for investments. Whether it’s working for someone else or running your own business, the approach should be the same:

1. Maximize your income;
2. Minimize your expenses; and
3. “Plant some trees” with the difference.

Once the trees are bearing enough fruit, they can become the cash flow generator for — the lowest priority — your lifestyle.

Most people shoot themselves in the foot by putting lifestyle second to maximizing income, ignore minimizing expenses altogether, and then hope that a lottery ticket will save them from their laziness and lack of forethought.

Trickle Irrigation & Weed-Pruning

Whether investing $1 or $1,000, I ask myself the same questions:

1. What is the time horizon for the investment?;
2. What portion of my portfolio does it represent?; and
3. What do I think is acceptable risk in light of a) and b)?

My own business is my primary investment. Before getting into anything else, I first safeguard our operating capital in fixed income investments like GICs and low-risk money market funds. After that, I focus on investments that I want to hold for ten years or more. That leads to equities and exchange-traded index funds (ETFs) — never any other kind of fund. (More on that in a bit.)

I suppose it’s possible to think in shorter terms — one year, five years, etc — but I don’t have the expertise to make short-term predictions, and even then, after watching the stock market for the couple years, I don’t think anyone does. It seems like better luck could be had at a casino.

Preserving capital

As mentioned, I only keep fixed income investments (cash and GICs) for the dollars we need to run the company. A portion is Canadian and a portion is US. Usually we exchange some USD for CAD, and anything left is in US. The surplus USD is then ear-marked for long-term investments and goes into equities and exchange-traded, whole-market index funds.

Be your own broker…

I use an online brokerage and do all the trades myself for $9.95 per transaction. This is important because it cuts out a lot of unnecessary fees and commissions that come from using a broker or from non-exchange-traded funds. Non-exchange-traded funds have rarely beaten the market and high management expense ratios (MERs) plus high transaction costs eat away at your investment. Especially important is that a private brokerage account gives broad access to ETFs, which most brokers are reluctant to trade in because they make less money on them.

…dont’ get had by one

It’s worth noting that I would never use a broker to make trades. As Buffett likes to say, “It’s like asking your barber if you need a haircut.” They have no intrinsic motivation to be objective, quite the opposite. The more you trade, the more brokers make. But frequent trading underperforms over the long-term. Also, they are paid more on certain funds, usually with high MERs, so they will naturally try to sell those first.

Why are low MERs important?

You can buy index funds from RBC, TD, etc, but in general their fee structures are high: MERs between 2-3%. (May not sound like much, but over the long-term the opportunity cost adds up.) Also, fund managers take their 3% whether the fund goes up or down, which, I think, is wrong. Worst of all, there usually isn’t a separate line item for their fees on your statements; it’s just included in gains and losses. Something fishy about that if you ask me.

So what kinds of funds?

The best indexes to buy are ETFs (exchange-traded funds), because they have the lowest management fees. For example, my lowest MER charges 0.07% per year; that’s 30-40x cheaper than typical funds. If you want to experiment with that, ask your broker what he or she thinks of funds like iShares or Vanguard ETFs. Chances are that your broker wouldn’t make much money if you moved in that direction, so the reception to the idea will likely be luke warm.

What if I don’t have time for this?

If I had no interest in reading financial reports or investigating the stock market, I would put everything into a few total-market ETF indexes and buy more at regular intervals (monthly, quarterly or annually). On average, the S&P has averaged 7% per year. Not bad for a hassle-free investment with the lowest expenses. For Canadian dollars, there are iShares which have MERs ranging from 0.23% to 0.55%. For US dollars, Vanguard ETFs are highly recommended and super cheap with MERs as low as 0.07% per year.

Follow the leader, not the laggard

One thing to consider is that the stock market tends to lead everything else. The most recent decline started in October 2007, but Joe Public just heard about it in October 2008 once the media caught on. The same will happen on the upswing. People will still be whining about this myth called the economy after the stock market is raging again.

It’s kind of a hoaky method, but I like to use magazine covers as a gauge. In 2007, walking through an airport, you couldn’t find a cover that said anything but, “Stock market all-time high! It’ll never go down!” The next time I see that I’m going to start moving to cash.

Today, if you walk through an airport book store, it’s, “The end is near! Doom and gloom!” Plus every ad you see in the paper is pushing low-yield cash investments. Is that a sign of a turn-around? A buy signal?

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