Home Radio Segments Guest Segments How To Use Dividend Investing As A Key Strategy For Success

How To Use Dividend Investing As A Key Strategy For Success

Gary Smith, Dividend Investing

With Dr. Gary Smith, Fletcher Jones Professor of Economics at Pomona College, Author of Money Machine:  The Surprisingly Simple Power of Value Investing

Introducing The “Money Machine” Concept: It’s All About The Cash Flows

Our illustrious guest Dr. Gary Smith, Fletcher Jones Professor of Economics at Pomona College in California, has just published a new book in May 2017 titled Money Machine:  The Surprisingly Simple Power of Value Investing. The title is certainly catchy, but beyond that, it encompasses a core concept at the heart of Dr. Smith’s book: that all investments can be viewed as a “machine” for generating cash flows over time and thereby valued and priced.  The methods for analyzing an asset’s present and future cash flow do involve a certain amount of math (which we mercifully skip over here) but the ideas which justify and support the methods are grounded in common sense and easy to understand at a high level.

The Cure For Wishful, Emotion-Driven Investing: Value Investing

Steve starts out by remarking that Smith’s Money Machine immediately stood out to him as an exceptionally interesting book in the sea of incoming books and authors that he’s constantly surveying.  Steve then makes a wisecrack about not holding Dr. Smith’s Ph.D. in economics (from Yale, no less) against him, despite economists’ reputation as lousy investors, which he takes in stride.  Dr. Smith offers some background on what he attempted to do in his book by explaining that most investors are driven by the dream that they can invest, say, $100 in a stock and sit back and watch it increase in price to $110, $120,  $150 or $1000, until one day they wake up and see that they’ve made “serious money.”  The problem with this kind of wishful thinking is that there’s simply no way to predict where stock prices will go in the near, much less long-term future.  Part of the reason prices are unpredictable is that markets are susceptible to what economist John Keynes described as “animal spirits”—human emotions of fear, greed, lust, and panic which alternately batter and elevate stock (and other asset) prices.

What Kind Of Investments Are Money Machines?  Anything That Generates Money

The antidote to the “on a wing and a prayer” school of trying to buy low and sell high without discipline or analysis is the value investing philosophy.  To be a value investor, Dr. Smith argues, the key thing is to look at an investment in any asset—stocks, bonds, real estate, or an entire business—as a “money machine.”  What this means for bonds is that you look at them as a money machine that generates coupons; for stocks, a money machine that generates dividends; for real estate, a money machine that generates rents; and for a business, a money machine that generates cash.  The crucial question then becomes “how much am I willing to pay for this or that money machine for X number of years?”  The length of time you might own these money machines will vary and is an important part of the number crunching.  This method takes the volatility and uncertainty out of predicting the price of an asset over X number of years and instead asks the question, “what are coupons, dividends, rent, and profits going to be and is the price you’d have to pay a fair one for the returns you’ll get.”

Dividends, Wealth Building, And Earnings

Steve tells a story about a client he had many years ago when he was selling bonds who owned some Chevron stock which was generating a 4.5% dividend.  He tried to pitch the client on buying some Chevron bonds which were selling at a 7% yield, but she declined saying that her Chevron stock had been a very good investment over the course of 20 years.  Steve calculated that her original $6000 investment in Chevron was paying out a return of 17%, an almost unheard of rate.  With a little more investigation, he saw that the original $6,000 principle was now worth near $34,000.  The lesson learned, according to Steve, was the “power of increasing wealth” via reinvesting dividends and letting compound interest do its magic.  He notes that while many investors these days look closely at earnings, most of them ignore dividends when running the numbers on how much their stocks might appreciate.  Steve asks Dr. Smith why he focuses on dividends.  The short answer is that dividends are evidence that earnings are good; you can’t have dividends without earnings.  Dr. Smith admits that there are publicly traded companies like Google, Amazon, and Berkshire Hathaway that don’t pay out dividends but are extremely healthy nevertheless.  He remarks that reading about a company’s earnings is no substitute for receiving dividends every month or quarter.   He adds that while earnings can be faked (e.g., Enron), dividends cannot.  Furthermore, with good companies dividends grow, both in percentage terms and in raw terms as a stock price appreciates.  Dr. Smith observes that good stocks, like good bonds, real estate, and businesses “take care of themselves” over the long haul.

Stocks And Bonds: Money Machines With Common Features

Many investors approach bonds by focusing on rate of return and on the coupons they receive, Dr. Smith says, but then look at stocks through the narrow filter of price alone.  This is a mistake, he asserts.  He notes that Warren Buffett has said that stocks can be viewed as a kind of “disguised bond,” treating dividends the same way you would bond coupons, with the difference being that dividends can increase while coupons do not.  Steve says he sees people obsessing over stock prices, believing that price appreciation is the number one route towards making money.  Countless investors chase those stories about getting in on a hot-ticket stock right after its IPO, riding the tail of a meteoric market, or some variation on this theme.  This type of gambling, driven by peer pressure, greed, and “fear of missing out”, has been the downfall of many an unseasoned investor.  Steve segues from here to a question for his guest: How can we look past an asset’s price and its distorting effects to determine what it’s really worth?

Mr. Market’s “Noise” Vs. Value Investing Methodology

Dr. Smith responds by referring to legendary value investor Benjamin Graham’s use of a metaphor to describe what moves stock prices: Mr. Market, who shows up every day to announce the price of any given stock at that moment, which is presumed to a cipher for what the company is worth.  Sometimes Mr. Market is reasonable and other times he’s “crazy” and totally off balance.   The remedy for such an unreliable market mover, according to Graham and other famous value investors, is to ignore Mr. Market and instead ask yourself, in Dr. Smith’s words:

“What would I pay to get the cash that comes from this money machine?”

That price, unlike noisy Mr. Market’s price, is what that asset is really worth.  That’s not to say that Mr. Market is totally useless; ironically, when he is at his craziest during a market crash, he brings a lot of opportunity to invest in companies offering strong cash dividends at a suddenly discounted price.  Value investing often functions as contrarian strategy, in both bear and bull markets.  When the dot-com bubble was raging, value investing analysis proposed sitting that market out, with great results in terms of protecting wealth.  By contrast, in 2009, a value strategy recommended “backing up the truck” and loading it up with underpriced stocks.

Steve comments that taking a contrarian stance often translates into going against the grain, not only in terms of market trends but also your own emotions.  You’re supposed to be skeptical and gloomy when your stocks are up and you’re richer, and optimistic when the market is swirling the drain and everyone around you is pessimistic and your portfolio is bruised.  He asks Dr. Smith for practical advice on how investors can achieve this kind of detachment from their basic instincts.  Aside from the cash flow framework, he answers, you simply have to learn to control your emotions, not follow the herd, and think independently.

The Nuts And Bolts Of Money Machine Models

Returning to the money machine cash flow model, Steve wonders about the nuts and bolts aspect of analyzing how much money a given asset throws off and then what that’s worth as far as a price you would be wise to pay to get a certain rate of return.  Dr. Smith explains that Money Machine delves into a number of metrics that can help make these kinds of determinations.  One is borrowed from John Burr Williams’ work on dividends, which looks at both the current dividend of a given stock and its rate of growth in order to approximate its long-term value.  It’s not unheard of for a stock’s dividend to grow from 2% to 7% over a period of a couple of decades.  Compared to Treasury bonds, which have been hovering around 2% for years, these kinds of dividend paying stocks look very attractive.

While many investors and financial pundits fret over the high P/E ratios in the stock market today, when those prices are compared to current interest rates of around 2%, stocks don’t look so expensive.  When comparing a 10-year Treasury bill yielding 2% until maturity to a stock paying a 2% dividend which is growing (the dividend) by 5% / year, it’s clear that the stock is a better investment, notwithstanding its price.

Real Investments Generate Cash

On the question of buying collectible assets like gold or baseball cards which generate no cash flow and thus can’t be analyzed as a money machine, Steve and Dr. Smith agree that these are not investments so much as they are exercises in wishful thinking.  Trying to buy some commodity or collectible and later sell it for a profit is a classic example of what Dr. Smith calls the “greater fool theory,” which exposes the logic of this activity as one where you pay a foolish price on the assumption that a greater fool will come along later willing to pay an even higher price.  He notes that if you had to choose between owning all the gold in the world, valued at somewhere around $11 trillion dollars, or owning some large corporations like Google, Exxon, and Amazon and all of the farmland in the US, the latter would throw off such huge cash flows over the ensuing decades that it would easily destroy the investment in gold.

Stock Market Bubbles: How Do We Know If We’re In One?

Dr. Smith is convinced that the stock market is not in bubble territory at the moment, even if certain stocks are.  He believes we’re a long way away from the dot-com era when new metrics were being made up and future cash flows were based entirely on hyperbole.   Steve asks how you can decide whether we’re in a bubble or not.  Dr. Smith argues that looking at earnings and dividends and comparing them to interest rates is the most important step.  He mentions that he lays out various other approaches to this question in his book and applies them to historic bubbles. Unlike the dot-com era or the “nifty 50” market of the late 60s (both periods where people thought they could get rich through price appreciation alone and which ended in massive financial bloodshed) today’s stocks are reasonably priced in terms of dividends and compared to interest rates, he avers.   Steve notes that if interest rates go up, stock prices should follow along with bonds.

Wrapping up their conversation, Steve asks Dr. Smith what he thinks of index funds for investors without the time or expertise to be more selective with their stock picks.  He replies that index funds are a good fit for a lot of investors, but the downside is that your money is spread out over such a wide number of stocks that it’s impossible to beat market returns.  Investors like Buffett have 75% of their funds invested in a half dozen stocks and, as a result of this and his acumen as an investor, he’s able to exceed market returns.  Compared to countless other fund managers, we might add, the near market returns of index funds look pretty impressive.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

Read The Entire Transcript Here

Steve Pomeranz: What’s in a name?  The idea we’re going to talk about today is based on the book Money Machine: The Surprisingly Simple Power of Value Investing.  Now, Money Machine is not just a cute title; it’s the basis for a common sense and grounded way of thinking about investing your money for future returns.  The author of Money Machine is with me today.  His name is Gary Smith.  Gary Smith is a Fletcher Jones Professor of Economics at Pomona College in Claremont, California.  He holds a BA in Mathematics and a Ph.D. in Economics from Yale University.  One final thought here; you know, we get a lot of authors and their books coming to us wanting our attention, but this one stopped me in my tracks. It’s a delightful exception and stand out.  Welcome, Gary Smith.

Gary Smith: Glad to be here. Thanks for having me, Steve.

Steve Pomeranz: First of all, Gary, I’m not going to hold it against you that you had a Ph.D. in economics because, generally, economists as investors, you know, not so great.

Gary Smith: Yeah, for sure.

Steve Pomeranz: But I think you stood out from the rest.

Gary Smith: Thank you.

Steve Pomeranz: Let’s get started. The full title is, Money Machine: The Surprisingly Simple Power of Value Investing.  Now, when you say Money Machine are you talking like the ATM type of money machine?

Gary Smith: No, not at all.  The inspiration is, most investors, when they go to buy a stock, they start dreaming, you know, “If I buy this stock for 40, maybe the price will go up to 50 or 60 or 80 or 100 or 1000.”

Steve Pomeranz: Right.

Gary Smith: “And I’ll make some serious money.” And the problem with that is that you’ve got to predict what’s going to happen to the stock prices, which are virtually impossible to predict.  Part of the reason is what Keynes called “animal spirits”, that stock prices are buffeted here and there by human emotions—by fear, by greed, by lust, by panic—and it’s just really hard to predict whether the stock prices will be higher or lower two minutes from now, two days from now, two weeks from now.

Steve Pomeranz: Right.

Gary Smith: And so, the alternative is to be a value investor and if you’re a value investor…and it’s not just stocks—it could be bonds, it could be real estate, it could be a business—if you’re a value investor, what you do is you think about the investment as a money machine.  For bonds, you’ll say, “Here’s a money machine that generates coupons;” for stocks, “Here’s a money machine that generates dividends;” for real estate, “Here’s a money machine that generates rent;” for businesses, “A money machine that generates cash.” And then once you think that way, then you start thinking, “Well, what would I pay to own this money machine?  I’d like to have it for a long time.” You could have dividends for 20 years to get coupons for 20 years, to get rent for 20 years, you get profits from business for 20 years.  What would I pay for that?

Steve Pomeranz: Mm-hmm (affirmative)

Gary Smith: The nice thing about that is if you think that way, you don’t have to predict what prices are going to be.  All you’ve got to do is predict what the coupons and the dividends and the rent and the profits are going to be and is it a fair price for what I’m going to get?  If you think that was then you’re a value investor.

Steve Pomeranz: I learned this a long time ago when I entered the business.  About five years in, this woman walked into my office and she had 364 shares of Chevron, and I was a bond salesman at the time, and I was like, “You know, you’re only getting a four and a half percent dividend yield on this. Why don’t you buy a bond at seven percent?” She goes, “No, you know, Chevrons really kind of been good to me over the years.” So I started to look it up, and I noticed that she had said that 20-something years before, she had paid $6,000 for these shares, and I looked at the dividend and I noticed she’s getting $1,700 a year in dividends today for a $6,000 investment that she had made years ago.  That was like a 17% rate of return. It was like what going is on here?  And then I realized, well, because the dividend had increased all these years, the stock price must be up. And sure enough, that 6,000 was worth about $34,000.

Gary Smith: Yeah.

Steve Pomeranz: And then I realized, oh, this is this power of increasing wealth and, in this case, it was the dividend that made me understand that.  It’s so funny that you talk so much about dividends because today people look at earnings and they don’t really care much about the dividends in terms of her calculations. Why do you?

Gary Smith: The earnings are good; you can’t say dividends unless you’ve got earnings.

Steve Pomeranz: That’s true.

Gary Smith: Yeah and there are some companies which don’t pay dividends like Berkshire Hathaway and Amazon and Google.

Steve Pomeranz: Right.

Gary Smith: Which are great companies, nonetheless, but reading about a company’s earnings is not quite as good as getting dividends every month or every three months.  The thing about earnings is that you’ve got companies like Enron that can fake the earnings.  You can’t fake dividends.  If you’re going to pay money out to shareholders, you’ve really got to have the money there to pay it to them.

Steve Pomeranz: Truth.

Gary Smith: It’s like a bird in the hand and two in the bush; the dividends are here, now.  Just like you said, you’ve got a good company and it’s paying a good dividend and the dividends are growing over time. The value of the stock or the bond or the real estate or the business, it’s going to take care of itself.

Steve Pomeranz: Yeah, there’s lots of talk about this idea of dividends, of growing, just like owning a bond that has an increasing coupon or interest rate year after year.

Gary Smith: That’s right.  So, when we think about bonds, most people buy bonds, they think about the rate of return and they think about the coupons they’re getting and stuff like that, but then when they go to think about stocks, they think about, “Is the price going to go up or down.” And so Buffett, one of the ultimate value investors says, “You can think about stocks like a disguised bond,” think about the dividends just being coupons. The only difference is the dividends grow over time and the coupons don’t.

Steve Pomeranz: My guest is Gary Smith. He is the author of the Machine Machine: the Surprisingly Simple Power of Value Investing, and we’re talking about what makes an investment worth more in the future.  We are forever, every single day and minute of the day, looking at stock prices.  We can see how much corporations are valued in the market and all of us, with few exceptions, are saying, “Well, you know, I mean, this is where the wealth is generated.  The stock price will go up if I could just buy it at this price like you said and I can earn 10 times my money,” you always also hear those stories about if you had bought Amazon during the IPO, the Initial Public Offering, you would have made a zillion dollars.

There are some examples in the book about when in the 60’s, when the Nifty Fifty was doing that, and you looked at Xerox, the same things held true. You could have bought Xerox at the Initial Public offering and then 10,000 would have turned into 11 million.  But, of course, where is Xerox today?  We won’t get into that, but here’s my question since we’re looking at prices: Why aren’t we looking at what things are worth, and how do we determine what a company is really worth despite what the price is really saying about it?

Gary Smith: Well, the great investors like Ben Graham, he talked about Mr.  Market, which is this person that shows up every day and says, “Here’s the price, here’s what something is worth.” IBM, Apple, Amazon, Google, whatever it is.  Sometimes Mr.  Market makes sense and sometimes Mr.  Market is crazy, and what investors should do—and this goes back to John Burr Williams, Benjamin Graham, Warren Buffett, all the great value investors—you’ve got to think about, not what Mr.  Market is saying, you’ve got to think about, “What would you pay to get the cash that comes from this money machine?” And that’s what a stock or a bond or a real estate, that’s what it’s really worth; it’s what you’d be willing to pay for it.  What Mr.  Market says is just noise.

Now, sometimes you can take advantage of Mr. Market’s craziness, like in 2009 when the stock market crashed and everybody was pessimistic, there were a lot of great buying opportunities out there because Mr. Market was crazy, but the buying opportunities were there because the cash flow from stocks was really, really cheap at that time.

Steve Pomeranz: Also, everybody was really terrified.

Gary Smith: Exactly.  Value investing often turns out to be a contrarian strategy.

Steve Pomeranz: Yeah.

Gary Smith: And so, with the dot-com bubble, when you had companies selling for ridiculous prices but no earnings, no dividends, hardly any business plan, that was a time to be out of the …  The value investor would say that contrarian strategy is to sit this one out.  In 2009 when everyone was terrified, the contrarian strategy, the value strategy is back up the truck and load it up with good stocks at cheap prices.

Steve Pomeranz: Yeah, but to be successful as a contrarian, you need to be really gloomy when your stocks are doing well.  I know stocks are up, I’m richer, I feel terrible, and when the stock market is terrible and your portfolio is down and everybody you’re listening to is negative and pessimistic, you’re supposed to feel great.

Gary Smith: Yeah.

Steve Pomeranz: How does a human being do that?

Gary Smith: Well, it’s just our human emotions and, as I argue in the book, part of the success or the secret of success to being a value investor is thinking about the cash flow, but part of it also is to control your emotions.  When you see dot com stocks going up and all your neighbors getting rich, try to resist the temptation to buy those things.  It’s hard and when everybody’s scared and terrified of the economy and the world and the stock market, it’s hard to be optimistic, it’s hard to go against the grain.  I’d say half the secret to being a successful value investor is to control your emotions and not follow the herd but to think independently.  All the good value investors do that.

Steve Pomeranz: Yeah, I know.

Gary Smith: The Michael Larsons and the Warren Buffetts and the Benjamin Grahams, the John Burr Williams, they formed their own opinions and it helps being out in Nebraska.

Steve Pomeranz: It does, I think.  Yeah, I agree.  We don’t have a lot of time, but you look at the amount of cash that this entity, whatever it may be, real estate, a business or whatever it is, throws off and then you try to figure out, “Well, how much would I pay for that to get a certain rate of return?” How do you actually make those determinations without getting too technical?

Gary Smith: There’s a lot of different metrics that I mention in the book.  One is just what I call “The John Burr Williams equation,” which is like you alluded to before, what’s the current dividend and how fast are dividends growing?  That’s a rough estimate of what your long-run return is going to be from stock.  If you’ve got a stock paying a two percent dividend, the dividend’s going up to five percent a year.  In the long run, you’ll make about seven percent a year, just in the dividends, just from the dividends, and then you say, “What’s my alternative?” Can you trade your bonds paying two percent?  If it’s a great company, one of the top companies in the country, it’s a General Electric, it’s an Apple, it’s a Southwest Airlines, it’s a great company paying a good dividend and a dividend that’s likely to grow over time and compare that to Treasury bonds, it looks pretty nice.

Steve Pomeranz: Where does that put us today then because, if you read or listen to a lot of the market mavens and the pundits, they’re saying the PE ratio or the Price Earnings ratio hasn’t been this high since 2007, 1999 and yet, I think from what I’m hearing, maybe the market isn’t so terribly overvalued if you’re comparing it to the yield on Treasurys—the ten-year Treasury’s a little over two percent.

Gary Smith: That’s the key.  What’s your alternative?  If you’re thinking about Treasury bonds, paying two percent, and think about stocks that pay two percent dividends, it’s pretty hard to think that Treasury bonds are a better investment.

Steve Pomeranz: Mm-hmm (affirmative) Plus, you’ve got the dividend growth.

Gary Smith: That’s what I’m saying, is that you’ve got your two-percent coupons, which aren’t growing or you’re got your two-percent dividends that are growing by five percent a year.

Steve Pomeranz: Yeah.

Gary Smith: We’re not a bubble, this is not at all like the dot com bubble where people were inventing new metrics to value a company. Web pages and stuff like that, which had nothing to do with cash flow.

Steve Pomeranz: Now, that’s not to say that there aren’t stocks in the stock market that are selling at bubble proportions because they are.

Gary Smith: Oh, yeah, definitely.

Steve Pomeranz: For sure.  Yeah.  Okay, so, this means if we’re looking at cash flow as the main determinant of future returns, then this takes us away from buying collectibles like baseball cards or gold even.  Let’s go to gold because everybody loves-

Gary Smith: Or beanie babies.

Steve Pomeranz: Beanie babies, yeah.  Everybody loves gold, I mean, we love to wear it, we love to look at it, we treasure it and yet it does not throw off any cash flow.  As a matter of fact, you wrote in your book that Warren Buffett said, “Of course, you’ve got to dig a hole to get it out, you’ve then got to get it out, you’ve got to refine it and then you’ve got to dig a hole to put it back in and then you’ve got to pay somebody to watch it.” So, where does that put us with this idea of buying gold as a long-term investment?

Gary Smith: Another analogy that Warren Buffett had, which you take all the gold in the world and you melt it down into a big cube and it would fit inside a baseball field easily and it would be worth, I don’t know, like 11 trillion dollars.  It’s an enormous amount at current prices.  You could have that and you could sit there and 100 years from now, it would still be there, still be the exact same thing and you could hug it, but it would not hug you back.  Or you could take your 11 trillion dollars and you could buy some Exxons and Googles and Apples and Amazons and you can buy all the farmland in the U.S.  And that is all going to throw off an enormous amount of cash flow over the next 20, 50, 100 years and gold does not compare.  We talk about people trying to guess what prices are going to be, and so you buy today hoping you can sell tomorrow for a higher price and that’s called the greater fool theory.

Steve Pomeranz: Why the greater fool theory?

Gary Smith: Because you buy something at a foolish price, hoping you can sell it to somebody who’s an even bigger fool than you.  That’s not investing, that’s not value investing, that’s just wishful thinking.

Steve Pomeranz: Well, you have a quote in your book from Bernard Baruch, it says, “There is no greater dangerous illusion than the belief that one can get something for nothing.”

Gary Smith: Exactly.

Steve Pomeranz: I did hear this once before that in Roman times an ounce of gold would buy you a really good toga; today it buys you a really good suit.  The value really hasn’t changed or adjusted all that much.

Gary Smith: Nope.

Steve Pomeranz: Yeah, it hasn’t made anybody rich.  Now, on the way to the office today, I heard a commercial telling me that the announcer had figured out a secret way of earning the stock market returns without losing money when the market was down.  What message is he selling us?  What is he telling us?  Can that be possible?

Gary Smith: Well, he’s probably buying the put options to protect himself if the market goes down, but put options aren’t free.  It’s like an insurance on your portfolio, but every couple of months you’ve got to pay for that insurance.

Steve Pomeranz: Yeah.  So, I’m trying to warn our listeners about looking at or hearing things that sound too good to be true.

Gary Smith: Exactly.

Steve Pomeranz: This is where the Bernie Madoff Syndrome comes in.  No, seriously, if you add that message to the fact that all your friends and neighbors are doing it and even if someone that you respect in your community or someone that you’ve read about that you respect is also involved, that can add to the illusion of something.  You’ve got to really look inside it and understand what you own.

Gary Smith: Yeah, and if you don’t understand it, you probably shouldn’t invest in it.  If it sounds too good to be true, it probably is too good to be true.

Steve Pomeranz: How do we know if we’re in a bubble?  How can you tell?

Gary Smith: Well, the main thing is just to look at prices relative to earnings and dividends and then compare that to interest rates.  I lay out several different alternative approaches in the book, and right now we are nowhere close to the bubble that we saw in 2000 or other bubbles we’ve had in the past like the Nifty Fifty that you refer to where these are 60, 70, 80, 90 and people thought you could get rich just by prices inevitably going up.  Today prices are reasonable compared to dividends or any of the interest rates.

Steve Pomeranz: Yeah, so if interest rates do start to rise, then we’re going to see some decline in the price in stocks, most likely.

Gary Smith: And also a decline in the price of bonds.

Steve Pomeranz: And, of course, as well.  The book is Money Machine: The Surprisingly Simple Power of Value Investing. It’s a great first book.  There’s some math in it, but it’s simple math, and it really will explain to you what you should look at if you’re going to decide to invest in the stock market.  One last question for those people who don’t really have the time or the skills: What do you think about index funds?

Gary Smith: I think index funds are good.  What they do is they prevent you from making silly mistakes, and so they sort of protect you from your emotions.

Steve Pomeranz: That’s a big part of it.

Gary Smith: The problem with them is, that index funds are so widely dispersed that it’s hard to make any real money.  Like you look at Warren Buffett’s portfolio, he’s got like 75% of his stock portfolio in six stocks.

Steve Pomeranz: Yeah.

Gary Smith: You spread yourself among 100 stocks or 1,000 stocks and you’ll do about as good as the market, but you’re not going to beat the market.

Steve Pomeranz: That’s for sure.  You’re not going to beat the market.  Again, my guest, Gary Smith, author of the Money Machine: The Surprisingly Simple Power of Value Investing. Thanks so much for joining me, Gary.

Gary Smith: Thank you, Steve.