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Table of Contents
1. Feature Article: Think Small
2. Mutual Fund Profiles: Fidelity Low-Priced Stock (FLPSX) and Heartland Value (HRTVX)
3. Tip of the Month
4. Questions and Answers

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Feature Article: Think Small
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Judging from e-mails, the financial media and human nature, most investors are very frustrated. Is it possible to find an investment that provides the combination that everyone wants: a high rate of return with a reasonable amount of safety? If you are patient and willing to think small, the answer is yes. Using the investment logic of Benjamin Graham, Warren Buffet's financial teacher, here is why small stocks will likely be a great area for investment over the next 10 years.

As I discuss at length in my book Rogue Investor, Benjamin Graham believed three factors were critical to successful investing: Enough Knowledge, Margin of Safety and Passage of Time. In the following paragraphs, I will address each one of these factors.

Enough Knowledge: Over the past 75 years, small companies have returned approximately 13 percent per year. Over this time period, this average return is better than any other market sector. Small companies also tend to perform much better during bear markets than large companies. This is because bear markets are usually associated with difficult business conditions for large companies, since by definition bear markets are typically defined by a 20 percent or more decline in a major stock market index (Dow or S&P 500 Index), which is comprised of, guess what, large companies. In addition, small companies are more nimble than large companies and tend to perform the best at the beginning of a new economic cycle, much like today.

Several other factors also bode well for small companies over the next decade: (1) advances in technology in combination with much cheaper technology now make it possible for small companies to compete directly with large companies, (2) limited initial public offerings over the last few years (primarily due to poor market conditions) have reduced the number of small companies coming into the marketplace, (3) extremely difficult business conditions over the last few years have sent the weaker companies into bankruptcy, and many of the remaining small companies have proven that they can prosper in good or bad times, and (4) during the 1990s, small stocks did not go up in value nearly as much as large stocks, so they are due for a recovery.

Margin of Safety: If you compare the valuation of small stocks to large stocks, small stocks have never been cheaper than right now. On average, small stocks (companies with a total market value of less than one billion dollars) are selling at more than a 40 percent discount to large stocks. In the history of the U.S. stock market, this is the steepest discount ever.

Passage Of Time: Patience is the foundation of any great investor. Part of the problem with society today is that everyone wants instant results. Successful investing does not work that way. Do not measure your investing success or failure like just about everyone else does, by how well you do over six months or a year. Great investors measure their investing success over decades. If you are patient, small stocks have consistently been a great investment choice.

Small stocks also address one other major issue that was ignored by many investors over the last decade: diversification. As discussed above, small stocks tend to go up when large stocks are moving sideways or going down. Having small stocks as part of your overall investment portfolio will reduce your total investing risk.

In the next section, I discuss one of the best small stock mutual funds. For investors who do not want to buy individual stocks, investing in a small stock mutual fund is a good choice. For investors who do want to buy individual stocks, I will be starting a new investing program next month that will help you identify the best small companies to invest in.

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Mutual Fund Profiles: Fidelity Low-Priced Stock (FLPSX) and Heartland Value (HRTVX)
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Fidelity Low-Priced Stock Fund meets almost all of the characteristics of a great mutual fund. Low risk, high return, and a fund manager who has been at the helm for 13 years. The only drawbacks are that if you are not investing in a qualified 401k plan there is a three percent sales load and, from time to time, Fidelity closes this fund due to its popularity.

Heartland Value Fund is a great small company fund that focuses on a value investing approach. This fund also has a long history of success and its long-term fund manager, William Nasgovitz, has established himself as an expert in buying undervalued micro-cap companies (less than 100 million in total company value). No sales load and fairly low yearly expenses are also a bonus.

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Tip of the Month
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Think small if you are looking for a way to achieve a high investment return and diversify your portfolio.

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Questions and Answers
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Last month I asked: What home improvements yield the most value when you sell your home?

As a rule of thumb, home improvements usually cannot be completely recovered when you sell your home. For example, if you spend $3,000 building a deck, it is unlikely that you will be able to sell your house for $3,000 more just because you spent that much on your deck. Over time, the value of home improvements to any potential buyer decreases due to wear and tear, advances in building materials and changing tastes. So make sure the primary reason you are considering any home improvement is for the benefit of yourself and your family while you live in the home, and not because you think it is going to allow you to make a lot more money when you sell your home.

A second rule of thumb to remember is that the more you spend on any home improvement, the less likely you are going to get a high percentage of the money back when you sell your home. Fancy fixtures may look good, but a plain item that functions just as well is all most potential buyers want. 

Finally, indoor improvements tend to yield the most value, because they tend to last longer and most potential buyers tend to spend the majority of their time looking inside the home before they make a decision to buy.

Items that typically yield the most value when you sell your home are finished basements, remodeled kitchens and remodeled bathrooms, provided you do not spend extravagantly on extras. Finished basements are usually a good home improvement investment because they can affordably expand the usable square footage of the home without requiring a major construction effort. Remodeled kitchens and bathrooms are also typically a good investment, because many home  purchase decisions are driven by women and they want these areas of the house to be functional and look good.

Items that typically yield the least value when you sell your home are pools and sheds. Pools can actually reduce the number of people that are interested in buying your home because of the associated liability. Pools also require operation and maintenance that can be costly and time consuming. Sheds, although functional, typically do not increase a home's value very much.

Home additions are a mixed bag. Because it typically costs so much to expand a home, the potential risk of recovering your investment is higher. However, if construction costs are kept under control and the home addition significantly expands the square footage of your home and adds another bedroom, it can pay off.

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Disclaimer: There are no guarantees in investing. I make no assurances regarding the investment information presented in the Rogue Investing Report.

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