Lessons Coal Taught Me

First, let me clarify: I keep most of my life savings in low-cost indexed funds. It's mostly the no-brainer way to invest. At the same time, I struggle with the unavoidable structure of indexes where more is invested in an overpriced security and less in an underpriced security. My brain says to do the opposite. I've never fully accepted this situation as "good enough." Further, I fundamentally believe that with reasonable research, intelligence and emotional control, an individual can outperform the indexes. Blasphemy - I know. I'm still trying to prove myself right.

Therefore, I allow myself to allocate a portion of my securities to individual stocks. For example, for over 15 years ago, I have periodically traded Ford, once selling it at 6 times its purchased price. Ford remains the best purchase I've ever made.

For years, I have also followed the world's largest private-sector coal company, Peabody. A few years ago I bought Peabody while it was on one of its periodic downward swings. When it dropped still further, I again researched the company. I noted that even the International Energy Agency predicted that coal would continue to be a huge and expanding source of energy worldwide - which it still is. I was confident that all was well, and I doubled down on my losses. Then for two long years I watched while it continued a steady decline into bankruptcy. Peabody is my worst purchase ever, wiping out all my Ford gains.

Contrary to popular thought, renewable energy didn't sink Peabody. It was undone by the low cost of shale natural gas and by a leveraged coal mine acquisition. Coal prices dropped with demand and the company couldn't service the debt.

Where did I go wrong? First, I didn't let the stock settle at a bottom before buying. Twice I bought into a steadily sinking stock. Second, I didn't look carefully at Peabody's heavy debt. Financial analysis is not just about profits and cash flow. It's also about the ability to handle rainy days. Last, it could be argued to sell after a certain point. But it can also be argued to buy at the same point.

For you, I offer some lessons. To repeat, indexing is a very good way to invest. With some basic understandings of investing and an occasional review of your holdings, you should do very well with little work. In contrast, it is risky to buy individual stocks. If Peabody can go under, so can anything else - including Amazon, Microsoft and, yes, Tesla. Second, you should understand anything that you buy, but regardless, you (and the expects) can still be widely off the mark and you can lose a lot of money. Finally, this is an extreme example. Most established stocks continue on year after year for decades, paying and increasing dividends, and gaining in value.

I still have my mostly worthless Peabody shares. Peabody continues to produce huge amounts of coal over six continents. And a couple of months ago I again bought Ford.

Hangout With My Son

Yesterday, I used Google Hangout to help my son set up his 401k. He's living the dream in Silicon Valley and wants to make good financial decisions. He already knows to never carry a credit card balance, to spend less than he earns and to invest in low cost indexed equities.

First, how much to save. Although he probably can save even more, we agreed that if you save 10% a year, keep it invested aggressively and don't ever withdraw a dime until you retire, you will do well.

Next, Vanguard defaulted him to a "Target Retirement" plan. Not a bad choice but at age 22, why waste away any of your 401k in bonds. In long term investing, cash is the scariest place to be, followed close behind by bonds. After inflation, cash loses money - sometimes a lot of money. In the 70s, cash lost half its value in less than ten years. I know, because his grandparents' retirement was decimated in that decade. Historically, bonds gain about 1% after inflation. That is, they double in value about once a generation.

Meanwhile, equities will return multiples more. I did some quick math for him and figured that in forty years, his bonds might go up about 50% but his equities will not just double or triple (after inflation), but will probably do this more than once. That's the earning power of investing in businesses that work hard every day to get the maximum return on your investment.

So instead of a target fund, he bought into three indexed ETFs: US equities, developed international equities and emerging markets. He put 60% into the overbought US market and 20% into each of the foreign markets. I suggested that he rebalance every year or two. Then when he's 40, he can look at buying some bonds as insurance for an equities catastrophe. That's it!

He sent me a screen shot of his completed form and then hit the enroll button. He's on his way to a safe and strong retirement, just a month into his first job.

Markets High, Markets Low - What to Do?

We're seven years into a thinning recovery, bonds are returning negatives, stocks are overpriced by most valuations and the global economy is shaky. And did I mention George Soros is back trading?

So what to do? I'm at my normal 60/40 equities and fixed income, with 40% of my equities outside the U.S. (and half of those in emerging markets). About a third of my equities are individual stocks, including the 1% remaining of Peabody Coal, my biggest single loss ever.

I agonize over a move to 50/50, an allocation I've never done. I spent my first twenty years investing in at least 80% equities.

So I roam through my holdings, ignoring the market noise. I trust the U.S. to continue to make money and return it to its stockholders. That includes my Wells Fargo, IBM, Charles Schwab, Ford, Cummins and even Seagate holdings. I trust the rest of the world won't implode - sans maybe China - mostly trusting my stocks in Mexico, Japan, France, Israel, Spain, Indonesia and around the world.

I'm fine with my REITs and my handful of Krugerrands. Bonds make me nervous, but they're spread around the world, in both governments and corporations. And I'm getting used to the 3-4% returns, unfortunately.

So I'm staying the course. I might clean out a few stocks that are getting a little pricey. And I'll probably let any sales sit in cash while I ride another bumpy stretch.

And if the market jumps another 20-30%, I'll be doing some selling. And if it drops 20-30%, some buying.

Which is about what I've done forever.