We're standing on the shoulders of giants in the Rule Maker Portfolio. That's how we can see the sun when it's raining, because we've got good seats.
Tom Gardner got us started in 1998 with a simple idea: Investors should look to purchase shares of familiar, high-quality companies, and plan to hold for the long term provided the business executes. This doesn't mean the company won't have problems. It will. But unless our ship hits an iceberg, we'll hold on.
What works about Tom's approach is its simplicity. Anyone can make investing complicated, but reducing it to circles, straight lines, and squares -- figures all of us can draw -- is hard work.
The obstacle this basic thinking gets us over -- and it's a train wreck for many beginning investors -- is that we can't expect junk to blossom. We have to buy shares of great companies to profit over the long run in the stock market. What this approach eliminates is penny stocks, turnaround plays, many emerging technologies, active trading, and other pitfalls that snare too many investors, young and old.
This doesn't mean you can't make money using one of the above strategies. Some folks can, and that's great. If that's the horse you want to ride, hop on. Our stock market is a robust, liquid, efficient organism because we've got abundance in the ecosystem. We don't talk a lot about options, futures, and swaps at The Motley Fool, but these techniques and practices add depth and efficiency to the market overall, and benefit many businesses.
Swaps, for example, enable banks to hedge against interest rate risk, and this practice is vital to financial fitness. Futures contracts allow airline companies to lock in fuel prices in a rising-rate environment. With jet fuel accounting for roughly 15% of the cost structure of a company like Southwest Airlines (NYSE: LUV), hedging is big medicine. It's all to the good.
But Tom's strategy steers us away from rocky shorelines on a maiden voyage, at least it did me, and derivatives, fast trading, and complex strategies don't work too well for the average investor.
In line behind Tom is Philip Fisher, author of Common Stocks and Uncommon Profits, who taught us about the importance of solid management. He also told us what to look for, such as a management team that's frank with investors when bad things happen. He taught us about the importance of sales, marketing, and R&D, and how managers in these divisions must work together in order for R&D to focus on products consumers want and sales people can actually sell.
Warren Buffett and Charlie Munger, chairman and vice chairman of Berkshire Hathaway (NYSE: BRK.A), combined to teach us about the importance of buying great companies at good prices. We were a little late to class for the good prices part of the lesson, but we hear it now. The Rule Maker managers will be mindful of the prices we pay for companies going forward, and will look to purchase shares of companies that could justifiably double in five years, as we did recently with Johnson & Johnson (NYSE: JNJ). We'll even consider selling some shares of a company we regard as painfully overpriced. Cisco (Nasdaq: CSCO) at $77 last year would have been a good candidate.
Perhaps the most telling lesson from Buffett is that he puts his lessons into words every year in Berkshire's annual report. This is the model of corporate stewardship all managers should emulate. Hit this mark and you're in the bulls-eye. Buffett said the annual report should read like an open chat with a curious relative. Managers, you've got the podium, tell us about your business. This is what makes Buffett more than a capitalist.
Vanguard Group founder John Bogle sparked the index fund flame, and there is no light that shines brighter in the investing wilderness. We know of no other vehicle accessible to all investors that can match the performance of a diversified index fund, provided it's given time to work.
It's important to remember we've got no guarantee future stock returns will look anything like the 11% average annual climb we've seen over the last 80 years. No sir. We've got a track record of historical returns that -- combined with a strong economy, healthy business practices, transparent accounting rules, and an active Securities and Exchange Commission -- gives us good legs to stand on even in uncertain times.
We regard diversified index funds as the staple of an investor's long-term portfolio. The Rule Maker strategy relates to this in that we see it as a starting point for investors interested in studying businesses and who want to try their hands at picking stocks. We view index funds as the basic sauce, with a Rule Maker company or two, or a few, sprinkled in for flavor.
There are others we could thank for our strategy, but I'll end with Benjamin Franklin, whose messages about hard work, common sense, and thrift influences the way I think about investing. His story about the farmer who gives land to his son echoes the approach to investing we take in the Rule Maker: We look to build wealth slowly.
"My son, I give thee now a valuable parcel of land; I assure you I have found a considerable quantity of gold by digging there. Thee mayest do the same: but thee must carefully observe this, never dig more than a plough deep."
Have a great day.
Richard McCaffery doesn't own shares of any of the companies mentioned in this article. You can see what he does own and criticize his background by viewing his profile. The Motley Fool is investors writing for investors.