The Three Components of Long-Term Investing

Almost everything I try to accomplish when it comes to portfolio construction is a combination of three ideas that I learned from Columbia professor Benjamin Graham, Berkshire Hathaway Vice Chairman Charlie Munger, and Wal-Mart founder Sam Walton.

Benjamin Graham’s theory of diversification is one of the most basic suggestions that I find compelling to follow. In fact, Graham’s arguments in favor of diversification is so common-sensical that most investors take it for granted that diversification is a given, and the only question thereafter is how to diversify. Most people have moved beyond Andrew Carnegie’s recommendation to “put all of your eggs in one basket, and watch that basket” because they want to continue to make money in the event that something bad happens. If your McDonalds holding starts to falter, you still have Exxon and Chevron pumping out oil dividends for you. If Wal-Mart starts to run into trouble, you have Coca-Cola dividends coming in still. It is a great way to arrange your life so that you can run into trouble with some stocks and still make money due to the heavy lifting performed by the other companies in your portfolio.

The second strategy concept I find highly persuasive is Charlie Munger’s recommendation that investors spend most of their time focusing on companies that consistently increase their intrinsic value. He calls this “sit on your ass” investing. All you do is accumulate capital, find an excellent business at an attractive or reasonable price, buy shares, and count the dividends as they roll in.

Nothing is guaranteed in this life, but it is highly likely that Exxon will continue paying out its dividends like it has done since 1882. General Mills, Procter & Gamble, and Colgate-Palmolive have been paying out dividends since the 1880s and 1890s. If those four companies become meaningful parts of your wealth-building story, you can know that you are buying into a business model that was able to pay dividends during WWII when the Germans and Japanese were actively trying to kill Americans and take an ax to the leading powers of Western Civilization.

The third concept I find useful is the notion of liquidity. This comes from Sam Walton who once said that you cannot go bankrupt if you do not owe anybody anything.

When I study the great businessmen of the 20th century who have failed, one of the following three elements is almost always present:

(1) Excessive risk taking

(2) A drinking problem


(3) A liquidity crisis/cash flow problem.

In the past five years, we saw an excellent, and generally conservative bank, Wachovia, collapse because it did not have liquidity. A shortage of cash at the wrong time can be a great way to bring some long-term pain into your life that may perhaps have some serious ramifications down the road.

That is why I gravitate towards stocks that pay dividends. If you buy 300 shares of Royal Dutch Shell, you will have $1,080 deposited into your banking account each year. It adds to the cash flow you have coming in from your job. I love the long-term economics of a company like Berkshire Hathaway and Google, but I couldn’t build an entire portfolio stuffed with those companies because they do not improve your liquidity. But with dividend stocks, every dollar you set aside adds $0.03-$0.04 to your annual cash flow.

A great way to be a terrible  investor is to make concentrated bets in terrible companies that set you up for a liquidity crisis. The good news is that you can structure your assets in the exact opposite way to achieve a more desirable outcome for yourself. You can follow Graham’s advice and diversify across 20-50 companies so that you can handle unexpected business performance and still grow your health. You can deal with the highest quality companies so that the probability of business failure is miniscule on an individualized basis, and becomes even more remote when you view a portfolio of 30 companies with unassailable moats. And if almost all of your holdings pay out meaningful dividends, you can have money coming into your checking account all the time so that you can avoid a liquidity crisis.

Diversification. High-quality. Cash coming in. That’s it. That’s the secret. Combine those three elements, and wealth-building for the long haul is yours.

Originally posted 2013-07-21 08:05:01.

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5 thoughts on “The Three Components of Long-Term Investing

    1. Tim McAleenan says:

      Thanks! Yeah, I keep toying around with the spam filters so I don't have to spend ten minutes per day knocking the junk that shows up, but some of them end up blocking all comments. Go figure.

  1. Stephen J Melnykevic says:

    his is a really relevant article for me right now.

    I have been stuck with deciding between 1.) Using new capital (via Roth contribution of $550/month) to start new positions or add to positions that are not full and having dividends re-invested back into the companies that paid them 2. ) Pool the dividends to add to the contribution to start completely new companies.

    I currently have 7 companies, 6 of which pay dividends (AFL, KO, PM, BP, CVX, AAPL) and one that does not (LGF). I struggle and find it difficult to not reinvest dividends from KO, CVX and PM back into each company as they are such outstanding companies.

    What are everyone’s thoughts on this dilemma? I am 30 years old with a 31K portfolio so my dividends are small but still growing.

  2. Alexander DeCamp says:


    This dilemma has passionate proponents and logical arguments for either side. Your situation seems to make this dilemma easier though: Tim's argument is by investing via DRIP, one is losing the ability to make purchases at a reasonable price. If one owns HSY for example, they have been DRIPing into the 30 P/E HSY has been hovering around lately and not deploying that dividend payment in the most efficient manner. In your case, I would reckon your goal is a bigger portfolio, which means you are still seeking to add perhaps 20-30 positions to your portfolio. You might at this point be better off leaving the DRIP off for two main reasons. First, your broker at best is probably charging you 7-10 dollars per transaction. Obviously the larger purchase the smaller the percentage the broker takes away. Your dividends will allow you to save money for an individual position faster. Second, and related to the first point, you're generating about $1000 per year in dividends. If you are seeking new positions to diversify your portfolio, this extra 13% above your current yearly contributions will allow you to accumulate your portfolio positions quicker. With 7 positions, I would seek diversification as quickly as possible to around 20+ positions. Simply, your goal is to diversify into more positions as fast as possible. Turning your DRIP off will allow you to do this.

    As a caveat, if you are not able to devote the time to maintaining due diligence on your positions, perhaps DRIP is a viable option. Otherwise, I'm generally against DRIPing with nearly any size portfolio.



  3. says:

    Isn't DRIPs a good way to Dollar Cost your purchases since, you will be buying at fixed intervals?

    I had a neighbor who asked me if I had a plan to save for my retirement. I told him that I had one at work.

    He said 'No! I mean are you saving for retirement?'

    He told me that he bought Detroit Edison [Now called DTE] stock on a monthly basis.

    He said 'Laddy, I can tell you that I have a pension from Chrysler and it is only the frosting on my cake'

    I think the plan is to make money. Its up you, the individual, to decide which tool you are going to use [Stocks, Bonds, Commodities, Mutual Funds etc. and how much diversification you want and how much Asset Allocation will satisfy you] to achieve your goal.

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