Watch CBSN Live

Should you invest in solid firms with ample cash?

(MoneyWatch) A regular reader of my blog recently sent me an email in which he pointed out that virtually every analyst on radio or TV is recommending that investors should only buy the stocks of high-quality firms with big cash positions -- "fortress" balance sheets that create wide "defensive moats" -- and pay large dividends. The defensive moat is created by both the large cash position and a very strong product brand. A classic example is Coca-Cola (COKE). These investments are being touted as substitutes for safe fixed-income investments, which are now offering yields we haven't seen since the Great Depression.

The reader then went on to state that nobody acknowledges that the information that leads to this conclusion is already priced in. What he could have added is that the research shows that whenever investor sentiment is high in an asset class, sector, or country, investment returns tend to be poor because the herd has pushed prices to levels that lead to low future returns. He concluded his comments with the following: If you're going to let the noise of the financial media influence your decisions, you would be better served to be a contrarian investor! In other words, most investors would be better off doing the opposite of what their instincts told them -- as George Costanza decided to do in the famous Seinfeld episode after realizing that his instincts always led him to the wrong decision.

That email made my day as it showed that my efforts to educate individuals about the prudent way to invest haven't been in vain. In fact, they are paying off. We have discussed many times the evidence demonstrating that high-yielding stocks should never be considered substitutes for safe fixed-income investments. The reason is simple -- their risks tend to show up at the same time as does the risk to stocks in general.

What's amazing is that it was only four years ago, in the financial crisis of 2008, that investors were reminded of this lesson. Are investors' memories really that short? It appears so. That's another reason why the winning strategy is to have a well-developed investment plan that includes a policy statement and asset allocation table. That's only a start, of course -- investors also must have the discipline to stick to that plan, ignoring media noise.

Photo courtesy of Flickr user 401K