There's been a lot of bad advice dished out by the financial industry over the past 100 years or so. Most recently, we have Cliff Mason, the 22-year-old Harvard grad-cum-"liberal arts guy" who chooses to ignore the power of compounding returns.
But bad financial advice didn't start with Cliff.
Back in my day ...
The term "widow-and-orphan stock" was coined in the 1930s to describe mature companies with fat dividends and entrenched market positions. Given the market volatility at the time, it was only natural that proven performers such as AT&T
Unfortunately, the term and the advice don't recognize one crucial fact: widows and orphans should be very different types of investors.
Mary is 71, retired with a nest egg, with 10 or so years left to live. She has two investment goals:
- Preserve her savings
- Generate income from her investments
She doesn't need growth; she needs to avoid volatility, and she doesn't have enough time to ride out a market downturn.
Please, sir, may I have another?
Now meet Jimmy, our orphan. He's 12, he's inherited some capital, and he won't retire for another 55 years. Jimmy's investment goal is simply this: Buy shares of great businesses that will compound his money at high rates for the next few decades.
Given those two sets of criteria, our widow and our orphan should have portfolios that look very different from one another.
Different strokes, different folks
That's why Vanguard Target Retirement 2005 (VTOVX) is a fund for Mary. It holds more than 50% of its assets in bonds and Treasuries and just 44% in (mostly large-cap) stocks. Jimmy would be better served by Vanguard Target Retirement 2050 (VFIFX), which holds nearly 90% of its assets in stocks.
Young investors, however, can do even better than Vanguard 2050. Because 72% of that fund's assets are stashed in Vanguard Total Stock Market
Stocks for orphans
Young investors, on the other hand, should be looking for stocks that look like Wal-Mart back in 1975. In other words, a stock that is:
- Led by a dedicated management team
- Earning high returns on equity with a debt-free balance sheet
- Overlooked by the big money on Wall Street
- Emerging as the dominant player in a niche market
Investors who spotted those traits early on in Wal-Mart have been treated to greater than 25% annualized returns over the past 30 years -- enough to turn a $10,000 inheritance into a nearly $10 million fortune. While Wal-Mart's early volatility and meager dividend wouldn't have been a great fit for Mary, it's exactly the kind of stock that would have put Jimmy on easy street.
Know your profile
Designing a portfolio that fits your timeline and financial goals is the first step toward investing successfully. The second -- and perhaps more important -- is picking great stocks.
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