Every Wednesday, we publish our “Investor Toolkit” series. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific investing advice. Each Investor Toolkit update gives you a fundamental piece of our investment strategy, and shows you how you can put it into practice right away.

Tip of the week: “Like many theories, this one may explain how stock prices have behaved in the past, but no one can predict how they’ll behave in the future.”

The “pendulum theory” grew out of Sir Isaac Newton’s 17th-century studies of gravity and physics, particularly his second law of motion. Yet the theory turns up in discussions of all sorts of non-mechanical topics. It’s even become part of investing advice.

You could sum up the investment version of the theory like this: stock prices alternate between periods of overvaluation and undervaluation; the degree and duration of each period of overvaluation is related to the degree and duration of the subsequent period of undervaluation, and vice versa.

In other words, the theory says that when stocks head downward after a period of overvaluation, they won’t stop at fair value. Instead, they’ll keep dropping until they hit lows that are in some sense as out-of-whack as previous highs, or close to it.

Imagine having me build you a portfolio that’s tailored to your specific investment goals, temperament and financial situation. That's just one of the many ways you benefit when you become a client of our portfolio management services. Backed by my in-house team of investment experts, I’ll work to protect your money during times of market turbulence — and maximize your profits when the market rises. Click here to learn more about how you can profit from our Successful Investor portfolio management services.

Pendulum theory explains the past, not the future

Pendulum theory is a handy way to label the past, and it gives you a sense of how stock prices behave. But it’s useless for predicting the future or timing the market. That’s why it generally plays a small part in successful investing.

If you qualify as a “successful investor,” you probably recognize that the market never gets so high that it can’t go higher, nor so low that it can’t drop some more. This is a key part of understanding the stock market.

Today’s top pessimists lean on the pendulum theory, plus a narrow selection of downbeat statistics, to support their views.

When listening to pessimists, however, it pays to recall the words of Bernard Baruch (1870-1965). Baruch, one of history’s most successful investors, pointed out that the bearish or pessimistic market view always seems reasonable, even scientific, compared to the bullish or optimistic view.

The universe is constructed in such a way that nothing is certain. You can always come up with perfectly rational reasons why something won’t work. But people find ways to overcome obstacles, and some businesses succeed despite risks.

Sometimes it pays to be bearish, or pessimistic. Other times it pays to be bullish, or optimistic. But, over long periods, bulls make much more money than bears.

Sir Isaac Newton’s big investment mistake

Instead of trying to time the market, we take a value/quality investing approach that seeks to identify well-financed companies that are well-established in their businesses and have a history of earnings and dividends. These companies are likely to survive any economic setback that comes along, and thrive anew when prosperity returns, as it inevitably does.

Sir Isaac Newton, genius though he may have been, made a terrible mistake in the market. After taking profits early in the notorious South Sea Bubble of the 1720s, he decided to get back in and invested on borrowed money. He did so just as the bubble was at its peak; when it burst, he suffered enormous losses. The pendulum was not in his favour.

But in addition, he made the costliest investor mistake of them all: buying low-quality speculations when the market had already experienced a huge rise.

COMMENTS PLEASE

Do you try and time the market so that you are buying stocks at a low point before they rise? Has this been a successful strategy for you? Let us know what you think in the comments section below. Click here.

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you our advice on the fundamentals of successful investing, including specific stock market advice. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “If you let share price fluctuations dictate your buying and selling, you’re almost certain to lose money.”

It’s a fact of life on the stock market. Stocks go up and down every day. There may be an obvious cause in good or bad news. But there’s a large random element to stock price changes, particularly over short periods.

Here are the common errors that occur when investors follow share price fluctuations too closely.

1. Becoming more “bullish” or optimistic because stock prices have gone up. Some investors only feel safe buying stocks after prices have risen. Yet this is the opposite of the way you make most purchases (cars, clothing, etc.) Ordinarily, it’s better to buy when prices go down, not up.
2. Becoming more “bearish” or pessimistic because stock prices have gone down. When other investors sell and drive prices down, you may wonder if they know something you don’t. But that doesn’t mean you should act hastily. Random influences may be at work.

Imagine having me build you a portfolio that’s tailored to your specific investment goals, temperament and financial situation. That's just one of the many ways you benefit when you become a client of our portfolio management services. Backed by my in-house team of investment experts, I’ll work to protect your money during times of market turbulence — and maximize your profits when the market rises. Click here to learn more about how you can profit from our Successful Investor portfolio management services.

Here are the best ways to counteract these errors:

• Learn all you can about your investments. Visit the web sites of the companies you invest in regularly. Get on their mailing lists, and read their quarterly and annual reports. Ask your broker for research reports. Read the business news every day. You’ll be less liable to be caught off guard by price fluctuations.
• Beware of advisor failings. Some advisors are “permabears” — perpetual pessimists. Other advisors are blind to risk, so their stock market advice is just as suspect. They frequently recommend investing in speculative stocks at outrageously high levels.
• Take a broad view. Consider earnings, dividends and other factors in making decisions. They matter far more than short-term stock-price trends.
• Invest consistently. Don’t follow a strategy of trying to buy at the bottom or sell at the top. (As the legendary investor Bernard Baruch said, “This can’t be done, except by liars.”) Pick out a selection of well-established companies, and invest gradually over a period of years. Plan to hold indefinitely. You can always change your mind and sell if fundamentals deteriorate or your needs change.
• Practice “dollar cost averaging.” Invest the same dollar amount on a regular basis. That way you’ll buy more shares when prices are low, and fewer when they’re high. We discussed this in an article entitled “A retirement investing plan built for more profits with less risk.” (view the article here).

COMMENTS PLEASE

How sensitive are you to stock market fluctuations? Do you buy stocks when the market is rising? Or do you prefer to buy when the market is down and prices are lower? How has your approach worked out for you? Have you changed your approach over the years? Let us know what you think in the comments section below. Click here.

Every Wednesday, we publish our “Investor Toolkit” series. Whether you’re a new or experienced investor, these weekly updates are designed to give you advice on investing, including specific stock market advice. Each Investor Toolkit update gives you a fundamental piece of our investment strategy, and shows you how you can put it into practice right away.

Tip of the week: “While some investors may have too few stocks in their portfolios, the more common mistake is to have too many stocks.”

The right number of stocks for you to own depends in part on where you are in your investing career. It makes sense that you should have fewer stocks when you begin and add more as you advance. But there is an upper limit to the number of stocks you should own—beyond that limit, the stocks in your portfolio can begin to neutralize each other and your returns can suffer.

• The beginning investor: Most investors start out with modest amounts of money. Still, we believe that you should invest at least several thousand dollars at a time, even if this means you can only buy a handful of stocks. Otherwise, your broker’s minimum commission will work out to too high a percentage of your investment on each purchase.
• Pick at least one stock from each of the 5 sectors. You should plan to invest in a minimum of four or five stocks right from the beginning. Pick one from each of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities). If you can’t manage to own one from each of the five when you start out, try to cover as many of the sectors as you can.
  
  You can buy them one at a time, over a period of months or even years, rather than all at once. After that, you can gradually add new stocks to your portfolio as funds become available, taking care to spread your holdings out as we recommend.

Imagine having me build you a portfolio that’s tailored to your specific investment goals, temperament and financial situation. That's just one of the many ways you benefit when you become a client of our portfolio management services. Backed by my in-house team of investment experts, I’ll work to protect your money during times of market turbulence — and maximize your profits when the market rises. Click here to learn more about how you can profit from our Successful Investor portfolio management services.

• As the value of your portfolio rises, add new stocks. When your portfolio reaches the $100,000 to $200,000 range, you should aim for perhaps 15 to 20 stocks. If you’re married, it’s best to treat your family holdings as one big portfolio, even if you and your spouse keep your money separate. That way, you can be sure you aren’t operating at cross purposes, or investing too much of the family fortune in one area.
• Our 3-part investment advice is key. When you get above $200,000 or so, you can gradually increase the number of stocks you hold. When your portfolio reaches the $500,000 to $1 million range, 25 to 30 stocks is a good number to hold.
  
  Of course, you may fall a few stocks below that range, or go a few above it, particularly when you’re making changes in your holdings. That won’t matter if you follow our three-part advice: invest mainly in well-established companies; spread your money out across the five main economic sectors, and downplay stocks that are in the broker/public-relations limelight.

Our upper limit for any portfolio is around 40 stocks. Any more than that and stocks can begin cancelling each other out. Even your best choices will have little impact on your personal wealth.

COMMENTS PLEASE

How old were you when you began investing in stocks? Did you have a plan in mind? Looking back, what would you have done differently? Let us know what you think in the comments section below. Click here.

In “What works in Canada is working in the U.S.”, Mr. Brimelow demonstrates how Wall Street Stock Forecaster has performed according to the Hulbert Financial Digest (up 9.6% in the past 12 months vs. a 7.24% rise in the Wiltshire 5000 Total Stock Market Index).

Regarding Pat’s record of investment success in the U.S., Brimelow says, “…with 10 years of Hulbert Financial Digest monitoring now on the record, it seems clear that McKeough’s approach does indeed work south of the border.”

The article also includes Pat’s opinions on stocks such as Apple Inc. and Cintas Corp.

If you’re interested in reading more, click here to see the full article.

Below is the transcription of Pat’s comments.

Do You Trust Your Broker?

Q: Pat, here’s a question we hear a lot. How can I tell if my broker is really serving my interests?

Pat McKeough: That’s a good question. We just dealt with that in a recent Inner Circle report. I think the best way to do that is to use what some people call the encyclopedia buyer’s trick.

That is to figure out something that you know works for you—an investment that is bad for you, or that is particularly good for you. And ask your broker with an innocent look on your face, “Say, is such-and-such investment a good choice for me, Bob?”

And just see what he says. And if he’s not particularly interested, and it doesn’t yield a lot of income to the broker—if he’s not interested but it’s a good choice for you—then you have to wonder. Does he know something you don’t know? Or is he just not particularly interested in something that doesn’t carry some extra value for him to sell to you.

It’s unfortunate that many people have found at times over the years—I’m not going to say all of them, obviously not—there are brokers who are mainly thinking, how much can I make off of this transaction?

And that’s not a good way to build your portfolio.

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As a new subscriber, you will save a full $50.00 off the regular annual subscription rate when you accept this special offer, PLUS you can download all the details on Pat’s number one American stock pick in the complete Wall Street Stock Forecaster archive. Click here to take advantage of this offer.

While interest rates remain near historic lows, borrowing money to invest continues to look like an attractive investment strategy.

We believe that this strategy works best if you borrow to buy well-established, dividend-paying stocks. For instance, you could select from the 21 companies we recommend in the Income-Seeking Investors Portfolio of The Successful Investor newsletter.

Investing advice: Borrowing to invest can trigger significant tax advantages

Today, you can borrow for as little as 3.5% if you use your home as collateral. Over long periods, the total return on a well-diversified stock portfolio runs to as much as 10%, or around 7.5% after inflation. So you can expect to earn more than your borrowing cost.

Imagine having me build you a portfolio that’s tailored to your specific investment goals, temperament and financial situation. That's just one of the many ways you benefit when you become a client of our portfolio management services. Backed by my in-house team of investment experts, I’ll work to protect your money during times of market turbulence — and maximize your profits when the market rises. Click here to learn more about how you can profit from our Successful Investor portfolio management services.

Borrowing to invest can also be a highly effective tax shelter. You can deduct 100% of your interest expense against your current income. What’s more, the investment income you earn brings three key tax advantages: you get the dividend tax credit on qualified Canadian stocks and you only pay income tax on 50% of your capital gains.

In addition, you are only liable for capital gains when you sell; if you buy high-quality investments, you’ll wind up holding some of them for as long as you live. It’s a great tax-deferral technique. And it’s perfectly legal.

Investing advice: 6 keys to make the most of borrowing to invest

As appealing as low rates and the undoubted tax advantages of this strategy are, borrowing to invest does entail risks. The amount you owe on your investment loan will stay the same, regardless of what the market does, so every dollar your portfolio loses will come out of your equity. In addition, if you take out a variable-rate loan, the interest rate you pay could eventually rise.

That’s why we invariably advise that you only consider borrowing to invest if all six of the following apply to you:

1. You are in the top income-tax bracket and expect to stay there for a number of years;
2. Your income is secure;
3. You have 10 or more years until retirement;
4. You follow our low-risk investing advice and stick with quality investments;
5. You have the kind of temperament to sit through the inevitable market setbacks without losing confidence at a market bottom and selling out to repay your loan;
6. You have already made your maximum RRSP and TFSA contributions.

You get our recommendations on the best stocks for Canadian investors when you try a risk-free introductory subscription to The Successful Investor. As a new subscriber, you can save $50.00 — and you will also get FREE “My #1 Canadian Stock Pick for 2012.” Click here to take advantage of this special subscription offer.

Below is the transcription of Pat’s comments.

Stocks and bonds: A Judgment on Bonds

Q: Pat, I know you’ve been advising people against investing in bonds. How much would rates have to go up before you’d change your mind and recommend buying bonds?

Pat McKeough: I have to tell you that’s not the kind of advice I’d give. Brokers are famous for giving price targets. The idea is that you’ve got this $25 stock and we’ve got a $29 target on it. That kind of means that when it gets to $29 to sell and go buy something else.

But the problem is: what else has changed? You shouldn’t just have a single statistic that you are going to react to when it’s reached, regardless of what other things have happened with the company. And that’s true of an individual stock, but it’s even more true of something like interest rates.

Interest rates change for a variety of reasons. If you don’t know what brought on the change—or the length of time it took—you’d be acting almost on a random basis, because you’re not really looking at what’s recently happened.

And any time we change our opinion on a stock, it’s not because it went up a certain number of dollars or a certain percentage, or some other event happened. It’s because we’re looking at it and we see this is no longer an attractive choice for investment. And I think that’s the way to look at it.

It’s like the old saying: “If you’re going to play the game, look at all your cards.”

Safe-money investments: “If you’re going to play the game, look at all your cards.”

Bonds may not be your best buy right now, says Pat McKeough, but there are safe-money investments that are just right for today’s market. And you don’t have to take big risks to make big gains with these investments. You’ll find the best of them in Pat’s newsletter for conservative investors, Canadian Wealth Advisor. He relies on three investments that can bring you profits year in and year out: Real estate investment trusts (REITs), exchange-traded funds (ETFs) and established stocks. As a new subscriber you can save $50.00 for a full year (12 issues) of this unique Canadian advisory. Click here to start your subscription now.

When you decide you want to invest on your own in the stock market, you face a decision every investor has encountered. You have to choose whether to use a discount broker, a full-service stock broker, or a portfolio manager. This decision is no formality; it will play an important role in the way you approach your investments.

Here is how the three choices stack up:

• Full-service investment advisor: This is the traditional stock broker (although brokers also sell bonds, mutual funds and other investments). Stock brokers are now more commonly referred to as “investment advisors.” But in fact, most brokers or investment advisors are commissioned sales people who make investment recommendations that you can accept or reject.
  
  There’s nothing inherently wrong with this arrangement, of course. But it can introduce conflicts of interest that can influence your brokers’ recommendations, and you should be aware that this might not always work in your favour.
  
  For instance, your broker’s income is proportional to the frequency of your trading, but increased trading is likely to cost you money. Commission rates vary among investments, which gives brokers an incentive to sell the investments that pay the highest commissions. But a general rule is that the riskier an investment, the more commission a broker earns for selling it.
  
  In addition, brokers have no “fiduciary relationship” with their clients. They are not legally required to do what’s best for the client. They are just supposed to try to make sure that the securities they sell are “suitable” for their clients. “Suitable,” of course, can cover a wide range of desirable and not-quite-so-desirable securities.
  
  A good stock broker is one who understands investing and who has the integrity to settle conflicts of interest in the client’s favour. Good stock brokers can provide an effective and economical way to manage your investments. It is well worth your while to take the time to find a broker you can trust.

Imagine having me build you a portfolio that’s tailored to your specific investment goals, temperament and financial situation. That's just one of the many ways you benefit when you become a client of our portfolio management services. Backed by my in-house team of investment experts, I’ll work to protect your money during times of market turbulence — and maximize your profits when the market rises. Click here to learn more about how you can profit from our Successful Investor portfolio management services.

• Discount stock broker: Unlike full-service stock brokers, discount brokers simply carry out buy and sell orders for their clients, and charge lower commission rates than full-service brokers. You pay even lower commissions if you trade stocks online, instead of placing orders over the phone.
  
  The main drawback of using a discount broker is that it gives you unlimited opportunity to make costly mistakes on your own. The clerk who takes your order won’t recognize, much less warn you, if they see you’re about to do something you’ll regret. In contrast, good full-service brokers will try to talk you out of bad ideas.
  
  Discount brokers are your best choice if you make your own investment decisions. Why pay extra for full service you don’t need or use? But if you use a discounter, you may want to secure outside sources of investment advice (such as our newsletters), if only to serve as a second opinion on your decisions.

• Portfolio Manager: Portfolio managers take a more active role than brokers. Instead of simply presenting you with investment advice that you can accept or reject, they generally make and carry out investment decisions for you, for a fee. Consequently, portfolio managers are more stringently regulated than full-service or discount brokers. In particular, portfolio managers must maintain a fiduciary relationship with their clients. Rather than simply choosing suitable investments, they must always try to do what’s best for the client.
  
  The best portfolio managers take pains to eliminate conflicts of interest between themselves and their clients. However, some portfolio managers rely on brokers to find clients. This can reintroduce conflicts of interest that you hoped to avoid by dealing with a portfolio manager instead of a broker.

If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

Pat McKeough responds to many personal questions on specific stocks and other investment topics from the members of his Inner Circle. Every week, his comments and recommendations on a selection of the most intriguing questions of the past week go out to all Inner Circle members. And each week, we offer you one of the highlights from these Q&A sessions.

This week, we heard from an Inner Circle member asking for investment advice on America’s largest drug store chain. Pat discussed the company’s prospects following a big acquisition last year, and this year’s decision to put an end to a key commercial relationship.

Q: Pat: What is your recommendation for Walgreen? Thanks.

A: Walgreen Co. (symbol WAG on New York; investor.walgreens.com), is the largest retail drug chain in the U.S., with over 8,270 outlets across the country. It also sells a wide variety of general merchandise.

In addition, the company sells its goods online through its own website and Beauty.com, SkinStore.com and VisionDirect.com.

In early 2011, Walgreen paid $409 million for Drugstore.com Inc., which sells over 60,000 health and personal care items. The purchase further strengthened Walgreen’s Internet presence and lets it compete with other online drug sellers.

Investment advice: Walgreen ends key relationship with benefits manager

In the three months ended November 30, 2011, Walgreen’s sales rose 4.7%, to $18.2 billion from $17.3 billion a year earlier. Earnings per share rose 1.6%, to $0.63 from $0.62, thanks to the higher sales and the company’s cost cutting efforts.

Walgreen ended its relationship with pharmacy benefits manager Express Scripts (symbol ESRX on Nasdaq) on January 1, 2012. (Pharmacy benefits managers negotiate discounts from drug makers so their clients—employers—can provide drug benefits to their workers with less cost.)

Walgreen and Express Scripts were in negotiations to renew their contract because Walgreen believed the reimbursement rates that Express Scripts was offering under the previous deal were too low. Express Scripts says it is still open to signing a new contract, but Walgreen refuses to make a better offer.

The company raised its quarterly dividend by 28.6% with the September 2011 payment. The shares now yield 2.6%. Walgreen also continues to aggressively buy back its shares: it repurchased $608 million of stock in the latest quarter, in addition to $2 billion worth in the preceding year.

Walgreen trades at 11.9 times this year’s forecast earnings of $2.86 a share.

In the latest Inner Circle Q&A, Pat looks at the potential loss of earnings for Walgreen without Express Scripts and examines its attempt to pre-empt those losses with a new savings club of its own. He concludes with his clear buy-hold-sell advice.

Inner Circle members see Pat’s analysis and recommendations on the stocks that other members have asked about in each week’s Inner Circle Q&A. You can view it immediately when you become a member of this unique investment group. You will get Pat McKeough’s answers to your personal investment questions, full access to our members-only Inner Circle website, and many other membership privileges. Click here to get started right away.

(Note: If you are a current member of the Inner Circle, please click here to view Pat’s recommendation. Be sure to log in first.)

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific investment advice on the widest possible variety of topics. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “The odds may be against starting your own business, but those who do it right can enjoy a huge payoff.”

You can still get rich as an employee of a company—ask any highly paid executive of a Canadian corporation. However, high-paying jobs are hard to find. Most corporate structures are pyramid-shaped, with a few high-paying positions at the top and many lower-paying jobs down below. Moreover, the slow economic recovery and relatively high unemployment means that many people continue to vie for jobs—especially those that pay well.

Your best chance of getting rich is by putting your money in your own business. But this can be risky investment advice. Many new businesses wind up failing. As many as 80% go bankrupt or simply shut down in their first five years, according to a number of surveys. Many owners of failed enterprises lose their life savings, and even their homes and marriages.

Today, we’ll look at the risks of going it on your own—and then at the path successful entrepreneurs follow when they start up a business.

Why new businesses fail:

• Owners underestimate the amount and variety of work. In a small business, everything is your job, until you hire somebody to do it. And even then, you still have all of the responsibility.
• Cash flow: owners run out of capital to pay their bills before the company’s profits begin to flow.
• Some “bright idea” businesses fail because there’s no real demand for their product or service.

Imagine having me build you a portfolio that’s tailored to your specific investment goals, temperament and financial situation. That's just one of the many ways you benefit when you become a client of our portfolio management services. Backed by my in-house team of investment experts, I’ll work to protect your money during times of market turbulence — and maximize your profits when the market rises. Click here to learn more about how you can profit from our Successful Investor portfolio management services.

How to improve your chances of success:

• Keep your job and run the business on the side until it starts making money.
• Make sure you have adequate capital. Apply for loans, lines of credit, merchant charge-card accounts and so on before you need them.
• Choose a “me-too” business over a pioneering one. Improve on existing products or services, or buy a franchise.
• Make it your life’s work. Learn all you can about the industry, and keep learning. Plan on working long hours for many years without supervision or immediate rewards. Above all, stick with it. Many entrepreneurs go broke two, three or more times before they launch the business that makes their fortunes.

Here’s an extra piece of investment advice: the odds against success in your own business apply just as much to shares in start-up businesses that trade on the stock exchange. If anything, the odds against publicly traded start-ups are worse; that’s because some publicly traded start-ups are created by stock promoters who merely go through the motions of building a business: their real business is selling stocks to the public.

That’s why it pays to downplay junior stocks in your portfolio. Instead, invest most of your money in well-established companies with a history of sales and earnings, if not dividends.

Canadian Wealth Advisor covers safe money investments for turbulent times, primarily ETFs, REITs and well-established dividend-paying stocks. You can get a special risk-free introductory subscription to Canadian Wealth Advisor at a savings of $50.00 off the regular rate. Click here to get started right away.