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| By Nilus Mattive |
I hope your holidays were as enjoyable as mine!
A holiday tradition in our house is a huge game of Monopoly. It’s the perfect game to gobble up hours with my family.
But it is also a really informative game … especially for investors.
Let me back up …
Contrary to what many people believe, Monopoly is just as much about odds as luck.
For example, here are five facts that might help your next game:
- Seven is the most commonly rolled number when two dice are being used.
- Statistically speaking, Illinois is landed on most often.
- Owning the three orange properties is one of the most powerful moves in the game because people regularly end up in jail and then come out landing on those three spaces.
- Aiming to hold three or four of the railroads is equally smart since you regularly collect a solid amount of money and also have the opportunity to earn cash from every side of the board.
- And you typically receive the best return on investment by quickly putting three houses on whatever color sets you happen to own.
I could go on and on — heck, whole books have been devoted to the subject. However, the point is that understanding some of the math behind Monopoly automatically gives you a big advantage over other people you're playing against.
Likewise, understanding how numbers play into investing can give you a similar advantage when it comes to your portfolio.
So, now here are five mathematical misunderstandings that trip up lots of investors …
No. 1: “Cheap” Stocks vs. “Expensive” Stocks
Everybody loves "cheap" stocks. Unfortunately, this label means different things to different people.
To a lot of investors, a cheap stock is merely one that costs a small amount of money per share — maybe a penny stock or one under $10.
They view this as a positive because they can buy lots of shares.
But the reality is that there is no inherent advantage to owning 1,000 shares of a $1 stock or 10 shares of a $100 stock.
While you might see more relative volatility from lower-priced stocks, it doesn't necessarily make them better investments.
You're far better off looking for stocks that are "cheap" based on business fundamentals — earnings, cash flows, book value, etc. — no matter what their nominal price.
Speaking of which ...
No. 2: Dollars vs. Percentages
I frequently have people tell me how many dollars a particular stock gained or dropped without realizing that it doesn't really say very much by itself.
After all, a 10-point drop on a $20 stock is the same thing as a 50-point drop on a $100 stock.
So, I would much rather focus only on PERCENTAGE profits and losses. They have all the important things — like the starting price or total investment — baked right in.
Likewise, always look at different positions you might own as percentages of your total stock portfolio … and your total stock holdings as a percentage of your overall investable net worth.
Thinking in percentage terms helps put everything you're doing into the right context.
Of course, even people who already use percentages frequently make the following mistake …
No. 3: Percentage Gains vs. Losses
Pop quiz: If your stock rises 50% and then quickly falls 50%, is it back to the price you paid?
On the surface, the answer seems to be "yes."
But let's look at an example:
- Jane buys one share of XYZ at $100.
- It rises 50% to $150 (0.5 X $100 = $50).
- Then it drops 50% (0.5 X $150 = $75).
So, Jane actually has just $75 to show for her original $100 investment after that percentage roundtrip!
No. 4: Dividend Yields
Since I specialize in safe, often-income-related investments, I field a lot of questions about calculating yields.
When it comes to stocks, the simple answer is that you take the annual indicated dividend amount and divide it by the stock price.
So, a $10 stock that will pay out $1 in dividends over the next year has a 10% annual indicated yield ($1/$10 = 0.1 or 10%).
However, remember that once you own a particular investment, it's far more important to track YOUR yield on cost rather than the number you might find on a website.
This is because, once you buy a stock (or other income investment), your cost doesn't change.
At the same time, the dividends CAN change — either up or down.
So, if a company keeps raising its payments, your annual yields keep going up, too!
That brings me to one last thing to keep in mind …
No. 5: Stock Splits
A lot of investors misunderstand stock splits — in my opinion, they are neither inherently good nor bad. Companies simply do them to make their share prices seem more "affordable."
In other words, they are staying mindful of the very first point I made above — which is the fact that most investors feel better buying more shares of a lower-priced stock than fewer shares of a higher-priced stock.
Again, the reality is that a given investment amount is still buying you the exact same stake in the company whether it splits or not!
The reason is simple: All the stock's attributes simply get divided by the split factor — whether you're talking about per-share earnings, dividends or some other number.
So, whether you find yourself looking at a Monopoly board or a brokerage statement, keep some of these distinctions in mind … and always have a little cash put away for the unexpected twists of the game.
Best wishes,
Nilus Mattive
P.S. Knowing how to think about your investments is only half the battle. You also need to know what events are looming on the horizon to send them up or down. Fortunately, my colleague Juan Villaverde is set to share three massive converging events — starting this month — with you. All you have to do is sign up for this free event by clicking here.
