PREFACE
CHAPTER 1.  LIVE AND LEARN
CHAPTER 2.  THE NATURE OF THE GAME
CHAPTER 3:  INFLATION AND THE MARKETS
CHAPTER 4:  GREED AND FEAR
CHAPTER 5:  WHAT CAN BE DONE?
CHAPTER 6:  WHEN TO SELL
CHAPTER 7:  INVESTMENT ALLOCATION CALCULATION
WRAP UP

INVESTMENT PRIMER

PREFACE

IN 1987 I LOST MY LIFE SAVINGS IN THE STOCK MARKET. IT MAY NOT SEEM LIKE MUCH BY TODAY’S STANDARDS BUT THE $25,000.00 I HAD ACCUMULATED AFTER WORKING FOR GENERAL MOTORS SINCE 1969 WAS ALL I HAD TO SHOW FOR 18 YEARS OF LABOR.

I HAD INVESTED IN 100 SHARES EACH OF 100 SMALL COMPANIES, THINKING THERE WAS SAFETY IN DIVERSITY. THEY WERE MOSTLY NEW HI TECH COMPUTER AND BIO TECHNOLOGY COMPANIES, MANY OF THEM RECENT IPO’S AND START UPS. ALMOST OVERNIGHT AFTER THE OCTOBER 19TH 1987 CRASH MANY OF THEIR VALUES FELL TO ALMOST NOTHING. THE ONLY WINNER I HAD LEFT WAS TELEPHONOS MEX AND SOME GOLD STOCKS. MY PORTFOLIO VALUE DROPPED FROM $25,000.00 TO $3,000.00 AND THEN I HAD TO SELL THAT TO PAY BILLS AFTER GETTING LAID OFF FROM MY JOB.

DOES THIS SOUND FAMILIAR TO YOU? DID YOU GET CAUGHT IN 2000 / 2001 THE SAME TRAP THAT I DID IN 1987? DID YOU THINK THERE WAS DIVERSITY AND SAFETY IN BUYING MANY DIFFERENT DOT COM AND NEW TECHNOLOGY COMPANIES? DID YOU HOLD AGGRESSIVE GROWTH FUNDS FROM THREE DIFFERENT COMPANIES AND CALL THAT DIVERSITY?

IF YOU DID, DON’T DESPAIR, IT MAY TURN OUT TO BE THE BEST THING THAT HAS EVER HAPPENED TO YOU. IF YOU NOW HAVE THE INCENTIVE TO LEARN HOW TO BECOME A REAL INVESTOR YOU CAN PROFIT FROM IT EVERY DAY FOR THE REST OF YOUR LIFE.

R. J. ADAMS
 

INVESTMENT PRIMER

CHAPTER 1:  LIVE AND LEARN

THERE’S ONE THING ABOUT LIFE IN THE INVESTING WORLD, IT’S NEVER BORING. MAKING MONEY AND LOSING MONEY IS ALWAYS EXCITING. THAT’S WHY NO MATTER HOW HARD THEY TRY THE GOVERNMENT CAN NEVER SEEM TO STAMP OUT GAMBLING. CASINO GAMBLING, LOTTERIES, FOOTBALL AND BASKETBALL POOLS AND CARD GAMES AT HOME WITH FRIENDS FOR MONEY NEVER GO OUT OF STYLE. WE LOVE THE THRILL.

THERE’S JUST SOMETHING ABOUT PUTTING YOUR MONEY WHERE YOUR MOUTH IS THAT EXCITES THE HUMAN SPIRIT. WINNING $20.00 AT A COMPANY PICNIC POKER GAME OR $100.00 ON THE OFFICE SUPER BOWL BOARD IS SOMETHING THAT CAN BE BRAGGED ABOUT FOR YEARS AND PROVIDE MUCH ENJOYMENT. 

WINNING IN THE STOCK MARKET PROVIDES THE SAME THRILL. BEATING THE MILLIONS OF INVESTORS WHO ARE BUYING AND SELLING STOCKS EVERY DAY MAKES US FEEL SMARTER AND BETTER ABOUT OURSELVES. IT GIVE US SELF CONFIDENCE. WE WALK WITH A SWAGGER WHEN OUR STOCKS ARE SOARING LIKE A SPACE MISSION LAUNCH. NOT ONLY CAN WINNING IN THE STOCK MARKET IMPROVE OUR STANDARD OF LIVING, IT GIVES US GREAT THINGS TO TALK ABOUT AT THE WATER COOLER. 

YES, THERE IS NO THRILL LIKE THE THRILL OF MAKING MONEY, AND LOTS OF IT. 

IT ONLY COUNTS WHEN YOU CASH OUT

MAKING IT ON PAPER HOWEVER IS ONE THING, KEEPING IT IS ANOTHER. FOR THOSE WHO HAVE EXPERIENCED CASINO GAMBLING YOU KNOW THE THRILL OF BEING AHEAD AT THE SLOTS, BLACKJACK TABLE, OR THE DICE GAME. BEING AHEAD IS ONE THING, GETTING AWAY FROM THE TABLE WITH PROFITS INTACT IS QUITE ANOTHER. MOST PEOPLE WHO CASINO GAMBLE REGULARLY ARE AHEAD AT SOME TIME IN THEIR GAMBLING SESSION, BUT VERY FEW WALK OUT THE DOOR WITH PROFITS INTACT.

THE STOCK MARKET IS JUST A BIG CASINO. IT JUST OPERATES ON A SLOWER BASIS THAN LAS VEGAS. IN LAS VEGAS EVERYTHING HAPPENS FAST, AND THERE ARE NO CLOCKS. A 3 DAY STAY IS A WHIRLWIND OF ACTIVITY. GAMBLING, DRINKS, SHOWS, GREAT FOOD, LIGHTS, ACTION, AND PROFIT AND LOSS. THE NEXT THING YOU KNOW YOUR ON THE WAY HOME WITH YOUR WALLET MUCH LIGHTER, BUT HEY, AT LEAST YOU HAD A GOOD TIME. WHEN THEY ASK YOU BACK AT THE OFFICE HOW YOU DID YOU CAN REPLY, I LEFT SOME THERE TO GROW INTEREST, I’LL GO BACK AND GET IT NEXT YEAR.

IN LAS VEGAS EVERYONE KNOWS THAT THE ODDS FAVOR THE HOUSE AND ACCEPT IT. THEY KNOW THAT THOSE PALACES IN THE DESERT CALLED CASINOS DIDN’T JUST APPEAR THERE BY MAGIC. THEY KNOW THAT THE PROFITS FROM THE GAMBLERS MONEY BUILT THEM, AND ACCEPT IT. IF IT WASN’T FOR GAMBLING LOSSES THAT BUILT THE CASINOS HOW COULD WE GO THERE AND HAVE FUN?, THEY WOULDN’T EXIST. WE ALL KNOW THAT THE ODDS FAVOR THE HOUSE AND ACCEPT THE RISK IF WE CHOOSE TO VISIT THERE AND GAMBLE. 

WELL NOW, SINCE WE KNOW THAT EVERY GREAT BUILDING AND EDIFICE MUST BE FUNDED SOMEHOW, WHERE DO ALL THE STOCK BROKERAGES AND INVESTMENT BANKING CENTERS COME FROM? DOES JP MORGAN / CHASE PRINT THEIR OWN MONEY IN THE BASEMENT? DOES MERRILL LYNCH HAVE A GOLD MINE UNDER THEIR OFFICE? DOES RAYMOND JAMES HAVE AN OIL WELL HIDDEN UNDER THE TAMPA BAY BUCCANEERS “RAYMOND JAMES STADIUM?” (THE ONE THAT HOSTED THE SUPER BOWL IN 2000?) OF COURSE NOT. THE MONEY COMES FROM THE POCKETS OF THE INVESTORS, FROM COMMISSIONS AND FEES FOR THE TRADING OF STOCKS AND BONDS.

THERE IS AN OLD JOKE FROM THE 1920’S THAT IS STILL TRUE TODAY. 

A GUIDE WAS GIVING A GROUP A HORSE DRAWN TOUR OF A NEW JERSEY HARBOR MARINA AND TOLD THE GROUP, LOOK OVER THERE AND YOU WILL SEE ALL OF THE FAMOUS WALL STREET BROKERS YACHTS. A NAIVE TOURIST ASKED THE GUIDE THE QUESTION, “YES, I SEE, BUT WHERE ARE ALL OF THE INVESTORS YACHTS?”

YES INDEED, WHERE ARE ALL THE INVESTORS YACHTS?

ANOTHER OLD WALL STREET JOKE IS THIS, “THAT RECESSIONS ARE WHEN STOCKS RETURN TO THEIR RIGHTFUL OWNERS.”

MY GRANDFATHER USED TO TELL ME WHEN I FIRST STARTED WORKING, “IT’S NOT HOW MUCH YOU MAKE THAT COUNTS, IT’S HOW MUCH YOU SAVE.” IN THE STOCK MARKET ITS NOT HOW MUCH YOU MAKE ON PAPER THAT COUNTS, ITS HOW MUCH YOU TURN INTO CASH AND KEEP.

THE STOCK BROKERAGES MUST PROMOTE BUYING AND HOLDING STOCKS AS MUCH AS POSSIBLE, THAT IS THEIR LIVELIHOOD. THE SAME IS TRUE FOR TELEVISION PROGRAMS WITH FINANCIAL THEMES. IF THERE WERE NO STOCK ACTIVITY WHO WOULD WATCH THEM? YOU MAY ASK WHY THEN DO THEY USUALLY SUGGEST BUYING AND HOLDING WHEN THEY DON’T MAKE MONEY ON THAT. THE ANSWER IS THAT THE MORE MONEY AND STOCK THAT A BROKERAGE OR FINANCIAL INSTITUTION CONTROLS THE MORE POWERFUL THEY ARE IN THE FINANCIAL WORLD. ON THE TELEVISION THE MORE PEOPLE WHO OWN STOCKS THE MORE INTEREST THERE IS IN WATCHING THEIR CHANNEL, WHICH IN TURN GENERATES ADVERTISING WHICH IS HOW THEY PROFIT AND KEEP THEIR JOBS.

SO, DON’T GET TOO ANGRY OR UPSET WHEN THE ABBY’S OR THE HENRY’S OR THE MARIA’S PROMOTE STOCKS. THEY ARE PROBABLY ALL VERY NICE PEOPLE WHEN YOU KNOW THEM IN PERSON. THEY ARE JUST DOING THEIR JOBS, NO MORE SO THAN A PERSON WORKING FOR AN ICE CREAM FACTORY WOULD TELL ALL THEIR FRIENDS TO BUY THE PRODUCT THEY MAKE OR A CHEVROLET DEALER WOULD PROMOTE CHEVYS. EVERYONE HAS TO MAKE A LIVING AND THEY MAKE THEIRS OFF OF THE STOCK MARKET AND THEY DO THEIR BEST TO PROMOTE IT. 

SO, DON’T GET MAD AT THEM, BUT DON’T PAY ANY MORE ATTENTION TO WHAT THEY SAY THAN YOU WOULD THE AVERAGE PAID TELEVISION INFOMERCIAL, BECAUSE THAT IS WHAT THEY ARE, JUST PEOPLE PAID TO PROMOTE BUYING AND SELLING OF STOCKS, THEY ARE JUST SHILLS FOR THE BROKERAGE HOUSES. 

IT DOESN’T MATTER TO THESE FOLKS IF YOU BUY YOUR STOCKS THROUGH THE COMPANY PLAN, FROM A BROKER (UNLESS IT’S THE BROKER ADVERTISING, HE WANTS YOUR BUSINESS) OR THROUGH MUTUAL FUNDS. ALL STOCK PURCHASING FROM ANY MEANS CREATES MORE STOCK TRADING VOLUME, RAISES STOCK PRICES AND CREATES MORE INTEREST IN THE STOCK MARKET. MORE INTEREST MEANS MORE VIEWERS FOR TELEVISION, MORE FINANCIAL THEME MAGAZINES SOLD, MORE NEW INVESTORS OPENING BROKERAGE ACCOUNTS WITH ONE FIRM OR ANOTHER. ALL THE FIRMS WILL GET SOME OF THE NEW CUSTOMERS SO ANY POSITIVE PUBLICITY ABOUT THE STOCK MARKET IS GOOD FOR ALL OF THEM.

CHAPTER 2:  THE NATURE OF THE GAME  or  Back to the  Top

BEFORE YOU CAN BE A SUCCESSFUL INVESTOR YOU MUST UNDERSTAND THE NATURE OF THE GAME. BEFORE I EVER PLAYED BLACKJACK IN LAS VEGAS AT A TABLE I PRACTICED ON THE 25 CENT VIDEO CARD GAME MACHINES AND WATCHED THE TABLE GAMES PROMO ON THE TV IN THE HOTEL ROOM. I DID THE SAME BEFORE GOING TO THE CRAPS TABLE. I AT LEAST WANTED TO KNOW THE RULES OF THE GAME BEFORE PLUNKING DOWN MY HARD EARNED MONEY. I STILL LOST, BUT NOT AS FAST, AND ONCE IN A WHILE I EVEN TOOK A LITTLE AWAY FROM THE TABLE, EVEN IF ONLY TEMPORARILY.

YOU MUST UNDERSTAND THE NATURE OF THE GAME IN WALL STREET BEFORE YOU WILL BE ABLE TO KEEP YOUR WINNINGS. THE ODDS IN A CASINO ALWAYS FAVOR THE HOUSE. THE ODDS IN WALL STREET LIKEWISE. THE HOUSE ON WALL STREET THOUGH IS NOT JUST STOCK BROKERAGES AND INVESTMENT BANKERS WHO CHARGE FEES FOR TRADING. IT CONSISTS OF EVERYONE WHO MAKES MONEY IN THE MARKET AND KEEPS IT. THAT IS WHO YOU ARE PLAYING AGAINST. FOR THE MOST PART THOUGH THE HOUSE CONSISTS OF VERY LARGE INSTITUTIONS, CORPORATIONS AND EXTREMELY WEALTHY INDIVIDUAL INVESTORS. THESE ARE THE ONES TO WHOM STOCKS RETURN DURING A RECESSION. NOT VERY MANY INDIVIDUAL INVESTORS ARE SUCCESSFUL IN THE LONG RUN AT KEEPING THEIR GAINS THROUGH A MARKET DOWNTURN.

THAT IS TRUE, NOT BECAUSE THE WINNERS ARE CHEATING, BUT ONLY BECAUSE MOST PEOPLE PLAY WITHOUT KNOWING THE RULES OF THE GAME AND LOSE BY DEFAULT. 

IMAGINE TRYING TO PLAY IN A FOOTBALL GAME WITH ONLY ONE TEAM HAVING A COACH WHO KNOWS WHAT’S IN THE RULE BOOK. (TEAM A) THE OTHER TEAM HAS TO DISCOVER THE RULES ONE BY ONE AS THEY MAKE A MISTAKE AND ARE PENALIZED FOR IT. (TEAM B) IMAGINE ALSO THAT WHEN THE TEAM NOT KNOWING THE RULES IS PENALIZED AND YARDAGE IS MARKED OFF BACKWARDS THEY ARE NOT EVEN TOLD WHAT THEY DID WRONG. THEY HAVE TO TRY TO FIGURE OUT WHAT THEY DID WRONG AND CORRECT IT WITHOUT BEING TOLD WHAT IT WAS. PERHAPS THEY CAN WATCH THE GAME FILMS AFTERWARDS AND FIGURE OUT WHY THEY WERE PENALIZED AND AVOID THAT MISTAKE NEXT WEEK. BUT, THEY HAVE NO ASSURANCE THE GUESS THEY MADE OF WHAT THEY DID WRONG IS EVEN CORRECT. HOW MANY GAMES DO YOU THINK TEAM B WILL WIN IN A SEASON?. PROBABLY NONE, BUT THEY MIGHT GET LUCKY ONCE IN A WHILE AND BREAK FREE FOR A LONG TOUCHDOWN RUN.

THE STOCK MARKET IS ALMOST THE SAME AS THAT ANALOGY. ONE OF THE RULES OF THE STOCK MARKET IS THAT THE NORMAL BUSINESS CYCLE WILL DRIVE STOCK PRICES UP AND THEN LATER IT WILL DRIVE THEM DOWN. WHY IS THIS? WHY CAN’T WE JUST HAVE SLOW, FORWARD, STEADY, LONG TERM GROWTH? WHY CAN’T YOU JUST BUY SOME STOCK IN A COMPANY AND HOLD IT FOR YEARS AND COLLECT DIVIDENDS AND WATCH IT GROW? WHY CAN’T YOU JUST BUY MORE OF THAT PARTICULAR STOCK WHENEVER YOU HAVE EXTRA MONEY AND THEREBY INCREASE YOUR CONTINUED WEALTH GROWTH? 

WHY INDEED? WHY DO WE NEED A BUSINESS CYCLE? A BUSINESS CYCLE IS A NECESSARY PART OF A FREE MARKET SOCIETY. THE BUSINESS CYCLE IS THE RESULT OF THE NATURAL FORCES OF SUPPLY AND DEMAND. THOSE WHO KNOW THIS PROFIT FROM IT. THOSE WHO DON’T LOSE THEIR SHIRTS, AND SOMETIMES THEIR SHORTS.

LETS SAY FOR EXAMPLE; A NEW PRODUCT IS INVENTED, WE WILL CALL IT ELECTRIC POWERED SKATEBOARDS OR AN EPS FOR SHORT. PUBLIC DEMAND IS HIGH. COMPANIES POP UP LEFT AND RIGHT MAKING EPS’S. THEY ARE ALL GOING PUBLIC WITH STOCK OFFERINGS AND THE PUBLIC IS BUYING IN AS FAST AS THEY CAN. THE CEO’S AND HIGH OFFICIALS OF THOSE COMPANIES ARE GETTING RICH AND ARE FEATURED ON THE COVERS OF FINANCIAL MAGAZINES EVERY MONTH. THE SHARE PRICES ARE SKYROCKETING. THE BOOM CONTINUES FOR 5 YEARS UNTIL ALMOST EVERY HOUSEHOLD IN AMERICA HAS AN EPS. THE PUBLIC CAN’T GET ENOUGH OF THESE COMPANIES STOCKS. IPO’S THAT STARTED AT $15.00 ARE NOW VALUED AT $150.00. SUDDENLY THE BUBBLE BURSTS. STOCKS ARE PLUMMETING. THE CEO’S SOLD OUT LONG AGO. INDIVIDUAL INVESTORS ARE LEFT WITH THE LOSSES. WHY? OVER CAPACITY IS THE ANSWER. NOW THAT ALMOST EVERY ONE WHO WANTS AN EPS HAS ONE THE ONLY ONES THAT WILL BE SOLD ARE TO PEOPLE WHO HAVE ONE THAT WEARS OUT AND IT NEEDS TO BE REPLACED. THAT MAY ONLY BE 10% OF THE PREVIOUS MARKET SO 90% OF THAT EPS PRODUCING CAPACITY MUST DISAPPEAR.

THAT MY FRIEND IS SUPPLY AND DEMAND. WHEN DEMAND IS SATURATED, WHEN EVERY HOUSEHOLD IN AMERICA FINALLY HAD AND EPS AND THERE WAS NO ONE LEFT TO SELL TO. THE SHARES IN COMPANIES PRODUCING THEM HAD TO PLUMMET. MANY OF THE COMPANIES PRODUCING THEM WILL GO BANKRUPT, ESPECIALLY THOSE WHO USED BORROWED MONEY TO START THEIR BUSINESS AND NOW CANNOT MEET THEIR PAYMENTS TO THE BANK. SOME WILL MERGE WITH LARGER MORE PROFITABLE COMPANIES THAT HAVE DEEP POCKETS AND OTHER PRODUCT LINES. IN A FEW YEARS ONLY A HANDFUL WILL STILL EXIST, AND THEY WILL HAVE BECOME NORMAL COMPANIES WHOSE STOCK HAS FOUND IT’S TRUE VALUE AND BEHAVES IN THE SAME MANNER AS ANY OTHER SMALL COMPANY STOCK.

THAT VERY SIMPLY IS WHAT HAPPENED TO THE COMPUTER INDUSTRY IN 2000/2001. FROM 1990 TO 2000 COMPUTERS AND CHIPS WERE SELLING LIKE HOTCAKES UNTIL JUST ABOUT EVERY ONE WHO WANTED ONE HAD ONE. NOW WE ARE FACED WITH OVER CAPACITY. EVERYBODY HAS A COMPUTER. THERE ARE MORE MANUFACTURERS AND SELLERS OF COMPUTER EQUIPMENT AND SOFTWARE THAN THERE ARE BUYERS. MANY WILL NOT SURVIVE. THEIR STOCK PRICE WILL GO SO LOW THAT THE BANKS WILL CALL THEIR LOANS AND WHEN THEY CANNOT PAY THE BANKS WILL SELL OFF THEIR ASSETS AND THEY WILL CEASE TO EXIST. THE LUCKY ONES WILL BE BOUGHT UP BY A LARGER COMPANY AND SOME OF THE EMPLOYEES WILL BE ABLE TO KEEP THEIR JOBS. THE INVESTORS WILL GO AWAY EMPTY HANDED AND ANGRY HAVING LOST THEIR MONEY.

AFTER THE MARKET IS SATURATED THE COMPUTER MANUFACTURERS MUST COME OUT WITH NEW AND BETTER AND SUPERIOR PRODUCTS AND THEN CONVINCE US THAT WE NEED TO BUY THEM. THEY NEED TO CONVINCE US THAT THEIR NEW IMPROVED MODEL WILL MAKE OUR LIFE BETTER. IF THEY DO NOT DO SO WE WILL SPEND OUR MONEY ELSEWHERE, ON THE LATEST NEW HOT PRODUCT OR A FAMILY VACATION, OR A NEW CAR, A NEW TELEVISION, OR WHATEVER WE DESIRE. 

THIS IS TRUE NOT JUST FOR COMPUTER MANUFACTURERS, IT IS TRUE WITH ALL DURABLE GOODS AND EVEN WITH INFORMATION AGE PRODUCTS SUCH AS INTERNET SERVICE PROVIDERS. AOL BECAME DOMINANT BECAUSE IT PROVIDED THE SIMPLEST FORMAT FOR NEW USERS TO LEARN. AOL SWALLOWED UP COMPUSERVE WHICH WAS GREAT FOR SCIENTISTS BUT NOT FOR HOUSEWIVES AND PRODIGY SHRUNK TO BIT ROLE PLAYER STATUS. THE FREE ISP’S ARE HANGING ON FOR DEAR LIFE, TRYING TO SURVIVE. ONLY THE GIANTS WITH DEEP POCKETS LIKE MICROSOFT AND AT&T CAN CONTINUE TO SUPPORT THEIR INTERNET SERVICES. 

THIS SCENARIO IS NOT ABNORMAL, IT IS NORMAL AND IT WILL BE REPEATED OVER AND OVER WITH EVERY NEW INDUSTRY FOR AS LONG AS FREE ENTERPRISE AND THE STOCK MARKET EXISTS. 

THE NASDAQ STOCK RUNUP BUBBLE WAS MOSTLY DUE TO TECHNOLOGY RELATED STOCKS. WHEN THE BUBBLE BURST THE NASDAQ FELL LIKE A ROCK. 

THE RECENT NASDAQ EXPERIENCE IS AN EXTREME EXAMPLE OF WHAT ACTUALLY HAPPENS ALL OF THE TIME IN THE STOCK MARKET. THE AUTO INDUSTRY IS A PRIME EXAMPLE. OVER AND OVER SINCE THE 1920’S THE AUTO INDUSTRY HAS HAD BOOMS AND BUSTS. WHEN THE AUTO INDUSTRY HAS A BOOM ALMOST EVERYTHING PROSPERS. AUTOMOBILES CONTAIN STEEL, ALUMINUM, PLASTICS, ELECTRONIC COMPONENTS, GLASS, AND MANY MORE ITEMS. THEY ARE ALL FINANCED BY THE BANKING INDUSTRY AND BY THEIR OWN STOCK VALUES. 

THE WORKERS IN ALL OF THE AFFECTED INDUSTRIES MAKE MORE MONEY IN A BOOM AND MORE WORKERS ARE HIRED. OVERTIME ABOUNDS. THE MONEY FLOWS INTO THE ECONOMY IN ALL SECTORS. WORKERS MAKING GOOD MONEY BUY OR BUILD NEW HOMES AND THE BUILDING INDUSTRY FLOURISHES. EVERYTHING BOOMS, LIFE IS GOOD ON MAIN STREET. THIS IS WHY THE OLD SAYING WAS INVENTED “WHAT’S GOOD FOR GM IS GOOD FOR AMERICA.” FOR MANY YEARS, ESPECIALLY FROM THE 1950’S TO THE 1990’S THIS WAS FOR THE MOST PART TRUE, ALTHOUGH THE WORD “GM MIGHT BETTER BE REPLACED BY “U.S. INDUSTRY.”

SO WHAT HAPPENS NEXT? ALL OF THE AUTOMAKERS WANT TO GET MAXIMUM PROFIT FROM THE LATEST BOOM, SO THEY BUILD MORE CAPACITY AND HIRE MORE WORKERS. CARS AND TRUCKS ROLL OFF OF THE ASSEMBLY LINES AT A RECORD BREAKING PACE AT EVERY AUTOMAKER. THEY ARE ALL FIGHTING FOR THE CONSUMERS DOLLAR, AND THIS IS GOOD. COMPETITION SPURS BETTER QUALITY AND PRICING. THE CONSUMER GETS A GOOD PRODUCT AT A FAIR PRICE. EVENTUALLY THOUGH SUPPLY OUTSTRIPS DEMAND. SOON THE AUTO COMPANIES ARE LAYING PEOPLE OFF. NEXT ALL OF THEIR SUPPLIERS ARE DOING SO, THEN THE BANKS AND FINANCIALS ARE FEELING THE PINCH AND TIGHTEN THEIR LENDING POLICIES BECAUSE SOME AUTO SUPPLIER BUSINESSES AND ALSO PEOPLE WHO ARE LAID OFF ARE DEFAULTING ON THEIR LOANS. THEN THE BUILDING TRADES SUFFER. THE NEXT THING YOU KNOW NIGHTLY NEWS ON TV SAYS WE ARE IN A RECESSION.

RULE NUMBER ONE FOR INVESTORS IS THAT BUSINESS CYCLES ARE BOTH INEVITABLE AND NORMAL. THIS IS WHAT SEPARATES THOSE WHO KNOW THE RULES OF THE GAME AND THOSE WHO DON’T. MARKETS GO UP AND MARKETS GO DOWN. EXPECT IT, ANTICIPATE IT, AND LEARN TO PROFIT FROM IT. 

WHY ARE BUSINESS CYCLES IMPORTANT TO THE INVESTOR?

THE STOCK TOUT’S AND THOSE WHO PROFIT FROM INVESTORS WHO DON’T KNOW THE RULES CONSTANTLY HARP FROM THE HIGHEST PLACES. “BUY, BUY, BUY, AND NEVER SELL, THIS IS TRUE INVESTING. SHOW YOUR COURAGE, HOLD YOUR STOCKS AND MUTUAL FUNDS THROUGH THE DOWNTURNS, THEY WILL ALWAYS COME BACK, HOLD YOUR STOCKS FOR A LIFETIME.” THEY ALSO CONSTANTLY ESPOUSE THE THEME “YOU CAN’T TIME THE MARKET, NO ONE CAN, YOU’RE NOT SMART ENOUGH, DON’T EVEN TRY, JUST BUY AND HOLD, NEVER SELL.” IF YOUR STOCK DOES GO UNDER THEY WILL TELL YOU IT WAS JUST A FLUKE, YOU WERE UNLUCKY. IT WON’T HAPPEN FOR ANOTHER MILLION YEARS, BUY IN AGAIN. 

WHILE THEY ADVISE OTHERS TO DO THIS, THE BIG PLAYERS NEVER FOLLOW THIS RULE THEMSELVES. IF THEY DID THEY WOULD CEASE TO BE BIG PLAYERS IN A SHORT TIME. 

NOW, THIS BOOK IS NOT FOR DAY TRADERS. THE TV COMMENTATORS ARE CORRECT IN SAYING THAT FOR MOST PEOPLE IT IS IMPOSSIBLE TO FORESEE DAY TO DAY FLUCTUATIONS IN THE MARKET WITHOUT INSIDE INFORMATION OR MANY HOURS A DAY STUDYING THE MARKETS. EVEN THEN IT IS IFFY.

WHAT THEY DON’T TELL YOU IS THAT IT IS A LITTLE BIT EASIER TO SEE WHICH DIRECTION THE MARKET IS GOING AT 6 MONTH INTERVALS AND THAT THE WORST THAT WILL HAPPEN BY BEING OUT OF THE MARKET FOR A TIME IS THAT YOU WILL GET 5 OR 6 PERCENT ON YOUR MONEY IN A MONEY MARKET FUND OR 9% OR SO IN A BOND FUND. YOU WILL STILL MAKE A PROFIT, JUST NOT AS LARGE OF A PROFIT. WHILE THIS IS NOT AS GOOD AS A 20 PERCENT RETURN IT IS FOR CERTAIN MUCH BETTER THAN A 20 PERCENT LOSS. 

WHAT AN INVESTOR HAS TO DO IS MERELY TO JUDGE WHICH WAY THE MARKET IS GOING, UP OR DOWN SEMI ANNUALLY. IF ONE CAN LEARN TO DO ONLY THAT HE OR SHE CAN BE A SUCCESSFUL INVESTOR. THE WAY TO JUDGE WHICH WAY THE MARKET IS GOING IS BY LOOKING AT THE TAPE. BY TAPE I MEAN THE RECORD OF THE STOCK INDEX THAT MOST CLOSELY CORRESPONDS TO THE SECTORS OF THE MARKET A PERSON IS INVESTED IN.

THE NASDAQ MOST CLOSELY REPRESENTS THOSE WHO ARE INVESTED IN HIGH TECH STOCK AND SMALL CAP STOCKS. THE DJIA MOST CLOSELY REPRESENTS THE INDUSTRIAL SECTOR OF INVESTMENTS AND THE S&P 500 REPRESENTS A BROAD VIEW OF AMERICAN COMPANIES AND THE U.S. ECONOMY IN GENERAL.

WITH THESE INDEXES AND OTHERS THAT MONITOR INDIVIDUAL SECTORS WE DO NOT HAVE TO GUESS WHICH WAY THE MARKET IS GOING, IT IS PLAIN FOR ALL TO SEE BY CHECKING THE DAILY NEWSPAPER OR AN INTERNET FINANCIAL WEBSITE.

IN REALITY, IT IS EVEN EASIER THAN CHECKING THE INDEX PRICES. JUST CHECK YOUR PORTFOLIO VALUE, THE STOCK SECTION. THAT WILL TELL YOU IF STOCKS HAVE BEEN GOING UP OR GOING DOWN, ESPECIALLY IF YOU HAVE SOME MONEY IN AN INDEX FUND. 

WHEN THE MARKETS ARE GOING UP THEY GENERALLY CONTINUE TO DO SO FOR A TIME AND VICE VERSA. BULL MARKETS, WHEN STOCK PRICES ARE RISING, NORMALLY LAST 3 OR 4 YEARS. THE LAST ONE WAS UNUSUALLY LONG. BEAR MARKETS, OR WHEN PRICES ARE FALLING AND INDEXES HAVE LOST 20% OF THEIR VALUE USUALLY LAST FOR SOMEWHERE BETWEEN 6 AND 18 MONTHS. 

INFLATION IS THE REASON THAT BEAR MARKETS ARE SHORTER THAN BULL MARKETS. IF THERE WERE NO INFLATION THEN MARKETS WOULD GO UP 1/3 OF THE TIME, GO DOWN 1/3 OF THE TIME AND SIDEWAYS 1/3 OF THE TIME.

CHAPTER 3:  INFLATION AND THE MARKETS  or  Back to the  Top

THE STOCK TOUT’S WILL TELL YOU THAT IN THE LONG RUN STOCK PRICES WILL ALWAYS GO UP AND FOR THE MOST PART THIS IS TRUE WITH THE EXCEPTION OF COMPANIES THAT ARE TOTALLY MISMANAGED AND GO OUT OF BUSINESS OR FOR BUSINESSES THAT EXPIRE DUE TO THE FACT THAT THERE IS NO LONGER A NEED FOR THEM, LIKE HORSESHOE FACTORIES AFTER THE AUTOMOBILE BECAME POPULAR.

WHAT THEY DO NOT EXPLAIN TO YOU IS WHY THE MARKET ALWAYS GOES UP IN THE LONG RUN. THEY WOULD LIKE YOU TO BELIEVE THAT IT IS BECAUSE THE COMPANIES ARE GROWING AND WELL MANAGED AND ARE MAKING MORE MONEY EVERY YEAR. IF THIS WERE TRUE OF EVEN ONE COMPANY IT WOULD HAVE LONG AGO ACQUIRED EVERY LAST DOLLAR THAT EXISTS IN THE WORLD. MICROSOFT TRIED, BUT IT DIDN’T WORK. THE GOVERNMENT GOT SCARED OF BILL GATES AND SHUT HIM DOWN.

NOT MANY COMPANIES ARE REALLY GROWING EVEN THOUGH THEIR STOCK PRICES INCREASE GRADUALLY OVER THE YEARS. THE REAL REASON FOR MUCH OF THE APPRECIATION IN STOCK PRICES IS INFLATION. 

CENTURIES AGO GOVERNMENTS DISCOVERED THAT IF THEY CONTROLLED THE COINAGE OF THE MONEY SUPPLY OF THEIR EMPIRE THEY COULD FUND THEMSELVES SIMPLY BY COINING MONEY. IN MODERN TIMES IT BECAME EVEN EASIER, THEY JUST HAD TO PRINT IT ON SOME PAPER. IN TODAY’S WORLD THEY DON’T EVEN HAVE TO PRINT IT, THEY JUST CREDIT TO A BANKS ACCOUNT ELECTRONICALLY. 

ALMOST ALL GOVERNMENTS OF THE WORLD TODAY CREATE MONEY FROM NOTHING. A CONSERVATIVE RESPONSIBLE GOVERNMENT LIKE THE ONE IN THE UNITED STATES WILL HOLD DOWN THIS GOVERNMENT COUNTERFEITING TO SOMEWHERE BETWEEN 3 AND 5 PERCENT, EXCEPT WHEN THEY REALLY NEED IT SUCH AS IN TIMES OF WAR. UNSTABLE GOVERNMENTS WILL CREATE MONEY UNTIL THEIR CURRENCY COLLAPSES, THE PEOPLE ARE STARVING, AND CIVIL WAR RESULTS.

CREATING MONEY FROM NOTHING IS ACTUALLY A FORM OF TAXATION. BY DEVALUING THE CURRENCY THE GOVERNMENT COLLECTS A PORTION OF EACH DOLLAR THAT ANYONE HOLDS, FROM RICH AND POOR ALIKE. FOR THIS REASON STOCK PRICES SHOULD ALWAYS RISE IN THE LONG RUN EVEN IF A COMPANY DOES NOTHING BUT CONTINUE TO DO EXACTLY THE SAME AMOUNT OF BUSINESS AS THEY HAVE DONE IN THE PAST. INFLATION WILL PUSH UP THE PRICE OF THEIR STOCKS AND ALSO MAKE IT LOOK LIKE THEY EARNED MORE MONEY THAN IN THE PREVIOUS YEAR WHEN ACTUALLY THEIR PERCENTAGES WERE THE SAME. 

EXAMPLE: A COMPANY THAT DID ONE MILLION DOLLARS WORTH OF BUSINESS IN 1999 WOULD HAVE TO DO ONE HUNDRED AND FIVE MILLION DOLLARS WORTH OF BUSINESS IN 2000 IF THE INFLATION LEVEL WERE 5%. THE SAME IS TRUE OF THEIR STOCK PRICE. IF THE STOCK PRICE WAS ONE HUNDRED DOLLARS IN 1999 IT WOULD HAVE TO BE ONE HUNDRED AND FIVE DOLLARS IN 2000 TO STAY EVEN WITH INFLATION.

INDEXES

THIS IS THE REASON THAT THE STOCK MARKET ALWAYS GOES UP IN THE LONG RUN, OR AT LEAST THE INDEXES. BY THE WAY, IF A COMPANY IN THE INDEXES GOES OUT OF BUSINESS OR SHRINKS TOO FAR IN VALUE IT IS REMOVED FROM THE INDEX AND REPLACED BY ANOTHER ONE. SO, BY BUYING AND HOLDING ALL OF THE STOCKS IN THE DJIA IN 1920 YOU MIGHT THINK YOU WOULD BE RICH BUT YOU WOULDN’T BE. ONLY A HANDFUL OF COMPANIES IN THE DJIA IN 1920 ARE STILL IN IT TODAY. THE REST HAVE EITHER WENT OUT OF BUSINESS, MERGED WITH ANOTHER COMPANY OR WERE REMOVED FROM THE INDEX FOR OTHER REASONS. THE STOCK TOUTS DON’T TELL YOU THIS WHEN THEY ESPOUSE THEIR BUY AND HOLD STRATEGY AND SHOW YOU THEIR CHARTS. 

THIS IS ONE GOOD REASON FOR BUYING INTO AN INDEX BASED MUTUAL FUND. AT LEAST THERE WHEN THE COMPANIES IN THE INDEX CHANGE THE MUTUAL FUND COMPANIES ADJUST THE PORTFOLIO ACCORDINGLY FOR YOU. THE FEES ARE ALSO SMALLER FOR INDEX BASED FUNDS BECAUSE ACTIVE MANAGEMENT IS NOT NECESSARY. A COMPUTER CAN DO MOST OF THE WORK, TELLING THEM EXACTLY WHAT TO BUY AND SELL TO KEEP THE FUND IN PROPORTION TO THE INDEX IT IS MATCHING.

TODAY THE DJIA CONSISTS OF SUCH COMPANIES AS MICROSFOFT, HOME DEPOT, INTEL, MCDONALDS, SBC COMMUNICATIONS, WAL MART AND MORE THAT DIDN’T EXIST UNTIL MANY DECADES AFTER THE DOW JONES INDUSTRIAL AVERAGE WAS CREATED BY CHARLES DOW IN 1896. 

LIKEWISE SOME OF THE ORIGINAL COMPANIES IN THE LISTING WERE AMERICAN COTTON OIL, DISTILLING & CATTLE FEEDING, NATIONAL LEAD, TENNESSEE COAL & IRON, AND U.S. LEATHER. ONLY GENERAL ELECTRIC IS STILL ON THE LIST MAINTAINING THE SAME NAME.

MANY A STOCK TOUT WILL SHOW A PROSPECTIVE INVESTOR AN INDEX CHART SHOWING THE STEADY RISE IN SOME AVERAGE, USUALLY THE DJIA. FEW WILL TELL THE PROSPECTIVE CLIENT THAT THE CHART MEANS NOTHING FOR ANYTHING OTHER THAN PERHAPS THE PAST TEN OR TWENTY YEARS BECAUSE IT’S COMPONENTS HAVE CHANGED DRAMATICALLY. 

WERE THE TRUTH KNOWN A PERSON BUYING ALL OF THE STOCKS IN THE DJIA INDEX IN 1896, WOULD TODAY HAVE VALUE EQUAL TO THE WORTH OF ONE SHARE OF GE STOCK ADJUSTED FOR SPLITS.

INFLATION CAN PROFIT

BY KNOWING THAT IN THE LONG RUN THE MARKET INDEXES ALWAYS GO UP WITH INFLATION AND DOWN WITH BUSINESS CYCLES, EVEN IF IT IS NOT THE SAME COMPANIES IN THE INDEX, ONE CAN BEGIN TO SEE A WAY TO PROFIT FROM THIS KNOWLEDGE. IT IS A LOT SAFER TO PLAY THE STOCK MARKET WITH AN INDEX FUND THAN WITH AN AGGRESSIVE GROWTH FUND. THE NASDAQ TOOK A WHALE OF A BEATING IN 1999 BUT SOME AGGRESSIVE GROWTH FUNDS FARED EVEN WORSE. AS WE WILL SEE LATER, IF ONE TAKES PROFITS ON A REGULAR BASIS THEY HAVE NOTHING TO FEAR FROM STOCKS OR STOCK FUNDS.

NOW GOVERNMENT OFFICIALS AND BIG MONEY STOCK PLAYERS ARE WELL AWARE OF HOW THE INFLATION FACTOR AFFECTS THE STOCK MARKETS AND THEY USE IT TO THEIR ADVANTAGE. MOST PEOPLE ONLY RELATE INFLATION TO THE PRICE OF BREAD OR GASOLINE, NOT THE PRICE OF STOCKS. 

THE POLITICIANS AND THE BIG PLAYERS WOULD CERTAINLY NOT LET THEIR OWN INVESTMENTS BE REDUCED IN VALUE BY CONDITIONS THEY CREATE AND SUPPORT. IF THERE WERE NO WAY AROUND ESCAPING THE DEVALUATION OF HEIR OWN HOLDINGS THE HOUSE AND THE SENATE OF THE UNITED STATES WOULD SOON CHANGE THE LAWS. THEY DO NOT CHANGE THE LAWS BECAUSE THEY KNOW HOW TO WORK AROUND THEM. WHO EVER HEARD OF A SENATOR COMING OUT OF THE SENATE POOR. MANY GO IN WITH SMALL FORTUNES BUT MOST COME OUT WITH LARGE ONES. 

IF A POLITICIAN DOESN’T KNOW HOW TO PLAY THE MONEY GAME WHEN HE GOES IN HE WILL SURELY KNOW HOW SOON AFTER ARRIVING. THERE IS NO CLAMOR IN THE SENATE OR THE HOUSE FOR REVISING THE STOCK MARKET RULES TO PROTECT PEOPLE FROM LOSING THEIR MONEY. THE POLITICIANS ARE VERY SILENT WHEN IT COMES TO FINANCIAL MATTERS, EXCEPT FOR SPENDING TAXPAYERS MONEY. NO POLITICIAN WANTS TO CHANGE THE GAME THAT ENRICHES THEM SO WELL, AND IF ONE WERE TO TRY HE WOULD UTTERLY FAIL. NO ONE COULD WIN THEIR NEXT ELECTION WITH ALL THE FORCES BOTH POLITICAL AND FINANCIAL AGAINST THEM. 

WHAT IF A POLITICIAN WERE TO SUGGEST HAVING REAL MONEY, GOING BACK ON A GOLD STANDARD. HOW FAR WOULD THEY GET? WHAT IF THEY WERE MERELY TO SUGGEST THAT GOVERNMENT CREATION OF MONEY OUT OF THIN AIR SHOULD BE LIMITED TO 1% PER YEAR? EVEN FOR THAT THEY WOULD SOON BE DRUMMED OUT OF CONGRESS BY THEIR COLLEAGUES. SO, THEY GET THERE, FIND OUT WHAT’S GOING ON, IF THEY DIDN’T ALREADY KNOW, REALIZE THAT THEY CAN’T DO A THING ABOUT IT, SO THEY GO ALONG WITH THE PROGRAM. EVEN IF THEY DO NOT AGREE PERSONALLY THE ONLY ALTERNATIVE WOULD BE TO QUIT, AND THEN HOW COULD THEY SERVE THE PEOPLE THEY REPRESENT? TO QUIT WOULD JUST FORCE SOMEONE ELSE TO TAKE THE JOB WHO MAY NOT BE AS QUALIFIED AT IT AS THEY ARE. 

WHEN IN ROME DO AS THE ROMANS DO IT IS SAID, AND THEY DO. YOU AND I WOULD PROBABLY DO THE SAME THING, SO DON’T BE TOO HARD ON THEM EITHER, NO MORE SO THAN ON THE TELEVISION FINANCIAL COMMENTATORS. 

OUR PROBLEM IS AS SMALL INVESTORS, IS NOT THAT THE SYSTEM IS NO GOOD, IT’S JUST THAT WE DON’T KNOW HOW TO PLAY THE GAME. WE NEED TO LEARN.

RATE CUTS

AFTER A DOWNTURN IN THE ECONOMY OR THE STOCK MARKET MANY INVESTORS CLAMOR FOR INTEREST RATE CUTS FROM THE FEDERAL RESERVE. SO DO THE TOUTS AND SHILLS ON TELEVISION. THEY WANT STOCK PRICES TO MOVE UP QUICKLY TO PRESERVE THEIR JOBS SO THEY ALSO DEMAND INTEREST RATE CUTS. ONE CAN UNDERSTAND THAT, BUT WHAT DOES A RATE CUT REALLY DO? ACTUALLY, ALL A RATE CUT DOES IS TO GUARANTEE THAT AS MUCH MONEY AS CAN BE LOANED OUT WILL BE CREATED OUT OF THIN AIR. AN INTEREST RATE CUT IS MERELY ATTEMPTING TO CREATE MORE DEMAND FOR GOODS AND SERVICES BY INTRODUCING MORE MONEY INTO CIRCULATION. THIS DEVALUES ALL OF THE CURRENCY PRESENTLY IN CIRCULATION AND WILL EVENTUALLY CAUSE PRICE INCREASES FOR ALL GOODS AND THAT ALSO INCLUDES STOCKS. IN THE SHORT RUN IT PRODUCES A QUICK BOOST FOR THE ECONOMY, IN THE LONG RUN IT PRODUCES INFLATION. 

PEOPLE WHOSE LIVELIHOODS DEPEND ON THE STOCK MARKET, SUCH AS BROKERAGE HOUSES, INVESTMENT BANKERS, PEOPLE WORKING FOR FINANCIAL PUBLICATIONS AND TELEVISION COMMENTATORS ALL PUSH FOR RATE CUTS WHEN THE STOCK MARKET GOES DOWN. A 10% LOSS IN THEIR PURCHASING POWER DUE TO INFLATION WILL NOT AFFECT THEM AS BADLY AS LOSING THEIR JOB. IT’S HARD TO BLAME THEM, BUT THEY REALLY COULDN’T CARE LESS THAT IF THEY GET WHAT THEY ASK FOR FROM THE FED THEY WILL DESTROY SOME OF THE PURCHASING POWER OF EVERY PERSON IN AMERICA WHO WORKS FOR WAGES, ESPECIALLY THOSE WHO WORK FOR LOW WAGES. WAGE SLAVES SUFFER MOST DURING TIMES OF INFLATION, WHILE WALL STREET PROSPERS.

MR. GREENSPAN HAS BEEN TRYING TO GET THE ECONOMY MOVING AGAIN WITH A MINIMUM OF COUNTERFEITING. BY DOING THIS HE HAS INCURRED THE WRATH OF WALL STREET ANALYSTS WHO SEE PINK LAYOFF SLIPS COMING THEIR WAY IF THE AMERICAN PUBLIC LOSES ITS LOVE FOR STOCKS. THEY WANT AN IMMEDIATE UPSWING IN STOCK MARKET PRICES EVEN IF WOULD TAKE DESTROYING THE DOLLAR TO DO SO. JUST SAVE MY JOB, TO HELL WITH THE REST OF THE COUNTRY, IS THEIR MOTTO.

P/E RATIOS

ALAN GREENSPAN TRIED TO WARN THE AMERICAN PUBLIC THAT THE STOCK MARKET WAS OVER VALUED. NO ONE WOULD LISTEN. HE SAID THAT HIGH STOCK MARKET VALUATIONS WERE DUE TO IRRATIONAL EXUBERANCE. 

THE HYPE THAT WALL STREET HAS BEEN DRUMMING UP FOR YEARS AND YEARS IS INGRAINED SO DEEPLY IN THE AMERICAN PSYCHE THAT EVEN WHEN THE WORLDS PREMIER BANKER TELLS THE COMMON CITIZENS THAT IT IS NOT TRUE, THEY WON’T BELIEVE HIM. HE COULDN’T SAY MUCH MORE THAN THAT WITHOUT LOSING HIS JOB SO HE HAD TO BE CONTENT WITH SAYING WHAT HE DID. A FEW WISE PEOPLE MAY HAVE GRASPED WHAT HE WAS SAYING AND ACTED UPON IT. THOSE WHO KNEW AND UNDERSTOOD WHAT HE MEANT AND DID SO ARE SURELY APPRECIATIVE NOW.

WHAT HE WAS TRYING TO SAY WITHOUT SAYING IT IS THAT WHENEVER P/E RATIOS (PRICE TO EARNINGS) ARE FAR ABOVE THE NORMAL AVERAGE THERE IS DANGER OF A STOCK MARKET DOWNTURN. A GOOD P/E RATIO FOR A WELL MANAGED COMPANY IS ABOUT 12 TO 1. A PRICE TO EARNINGS RATIO OF 23 TO 1 IS ABOUT AVERAGE BUT NOT EXCEPTIONAL FOR INVESTING. ANYTHING OVER 30 TO 1 IS A DANGER SIGNAL. SOME STOCKS DURING THE NASDAQ APPROACHED AND EVEN EXCEEDED 100 TO 1 P/E’S. 

VALUE INVESTING

VALUE INVESTING IS SOMETHING THAT WAS EXPLAINED IN DETAIL BY BENJAMIN GRAHAM IN HIS BOOKS “THE INTELLIGENT INVESTOR” PUBLISHED IN 1949 AND IN “SECURITY ANALYSIS” PUBLISHED IN 1934. VALUE INVESTING IS IN A NUTSHELL BUYING STOCKS IN WELL MANAGED COMPANIES THAT SELL GOODS OR SERVICES THAT THERE IS AN EXPANDING MARKET FOR AND BUYING THOSE STOCKS AT THE LOWEST P/E RATIOS POSSIBLE, BUYING THEM WHEN STOCK PRICES ARE DOWN. 

WARREN BUFFET WAS A STUDENT OF BENJAMIN GRAHAM’S AND USED THIS PHILOSOPHY TO MAKE HIS FORTUNE. HE ALSO EXPANDED UPON IT. WHEN HE BECAME RICH HE NOT ONLY BOUGHT STOCK THIS WAY BUT BOUGHT ENTIRE COMPANIES THAT MET THIS CRITERIA. WARREN BUFFET RESISTED THE PUBLIC INFATUATION WITH OVERVALUED TECH STOCKS AND WENT ON WITH HIS TRIED AND TRUE METHODS THAT HAVE SERVED HIM FOR A LIFETIME. HE WAS PROVED RIGHT AND VINDICATED BOTH HIMSELF AND HIS MENTOR, BENJAMIN GRAHAM, PROVING THAT VALUE REALLY DOES MEAN SOMETHING EVEN IN TODAY’S HIGH TECH WORLD. 

NOW THAT IS NOT TO SAY THAT THERE ARE NO GOOD INVESTMENTS THAT CAN BE MADE IN THE TECHNOLOGY SECTOR. MICROSOFT WAS A GREAT BUY AT ONE TIME AND PROBABLY WILL BE AGAIN. THE SAME WITH INTEL AND OTHER TECH GIANTS ALONG WITH SOME NEW ONES. THE PROBLEM IS THAT AS LONG AS THEIR P/E RATIOS ARE TOO HIGH THEY ARE OVERVALUED AND WILL MOST LIKELY LOSE MONEY FOR THE INVESTOR FOR MANY YEARS BEFORE THEY MAKE A PROFIT. ANY COMPANY THAT MAKES MONEY AND IS WELL MANAGED CAN BE A GOOD BUY IF THE PRICE IS RIGHT. 

VALUE FUNDS ALONG WITH INDEX FUNDS ARE A GOOD WAY TO INVEST IN STOCKS. RESEARCH YOUR VALUE FUND CHOICES. SEE WHAT ASSETS THEY HOLD AND CHECK THE P/E RATIOS ON THEM. LOOK AT THE LONG TERM RECORD OF THE FUND AND AT THE LENGTH OF SERVICE OF THE MANAGER. VALUE FUNDS CAN SIMPLIFY INVESTING IN THE TRIED AND TRUE METHOD PROPOSED BY BENJAMIN GRAHAM. THE RUSSELL 1000 INDEX IS THE BENCHMARK FOR VALUE FUNDS.

CHAPTER 4:  GREED AND FEAR  or  Back to the  Top

WHAT DO THE POLITICIANS, THE MEGA BANKERS, AND THE FINANCIAL WORLD KNOW THAT WE DON’T? WHY CAN THEY MAKE MONEY YEAR IN AND YEAR OUT AND WE CAN’T? WHY ARE THEY OUT OF THE MARKET AND INVESTED SAFELY EVERY TIME A DOWNTURN COMES AND WE AREN’T? THEY UNDERSTAND THE GAME THAT’S WHY, AND WE DON’T. 

WHAT THEY UNDERSTAND IS THAT HUMAN BEINGS ARE RULED MOSTLY BY EMOTIONS, AND TWO OF THE MOST POWERFUL EMOTIONS ARE GREED AND FEAR. ONLY LOVE AND HATE ARE STRONGER THAN THESE TWO AND SOMETIMES WE LOVE AND HATE OUR STOCKS. 

BEING INVOLVED IN THE STOCK MARKET FOR THE FIRST TIME AND PROFITING FROM IT IS LIKE BEING IN LOVE. IT IS ENTHRALLING. WE CAN’T GET ENOUGH OF IT. WE LIVE, EAT, BREATHE AND SLEEP STOCKS. WE THINK ABOUT THEM ALL DAY LONG AT WORK. WE DON’T WANT TO BE WITHOUT THEM. WE WANT TO CALL OUR BROKER EVERY HOUR AND SEE WHAT’S GOING ON. ANY HOT TIPS TODAY?. WHAT SHOULD I BUY WHEN I GET MY NEXT PAYCHECK? WE READ THE WALL STREET JOURNAL AND DREAM OF LAYING IN A HAMMOCK IN A TROPICAL SETTING WITH A PINA COLODA IN ONE HAND AND A CELL PHONE IN THE OTHER TALKING TO OUR BROKERS ABOUT WHERE TO MOVE A MILLION OR TWO TODAY.

AHH, THE GOOD LIFE, LA DOLCE VITA, ALL BY VIRTUE OF THAT WONDERFUL THING CALLED THE STOCK MARKET, THAT PERPETUAL MONEY MACHINE. JUST BUY ANYTHING AND IT WILL GO UP. IF YOUR SMART YOURS WILL GO UP MORE THAN YOUR FRIENDS AND YOU CAN BRAG ABOUT IT. IF NOT, SO WHAT, IT STILL WENT UP 20% THIS MONTH AND THE NEW BMW CONVERTIBLE WILL BE DELIVERED NEXT WEEK. WE JUST MOVED INTO OUR NEW HOME THAT IS THREE TIMES WHAT WE COULD AFFORD ON OUR SALARY, BUT NO PROBLEM, OUR STOCKS WILL PAY FOR IT. LIFE IS BEAUTIFUL.

AND THEN, THE MARKET CRASHES, THE BULL MARKET ENDS, AS THEY ALL DO EVENTUALLY. NOW WE HATE OUR STOCKS. WE CAN’T STAND SEEING A BROKERAGE AD ON TV OR AN INVESTORS DAILY. CALL JUDGE JUDY AND PUT A RESTRAINING ORDER ON THEM, KEEP THEM AWAY FROM US. LIKE AN EX HUSBAND OR AN EX WIFE WE DON’T EVEN WANT THEM AROUND OUR HOME. DON’T REMIND ME OF THEM. 

WE WISH WE COULD SELL BUT THEY HAVE LOST SO MUCH, WHAT’S THE POINT. MANY ARE WORTHLESS AND WE COULDN’T SELL THEM IF WE WANTED TO. THE FEW GOOD ONES WE HAVE LEFT HAVE DROPPED IN VALUE BUT STILL EXIST. LOOKING AT THE BOTTOM LINE WE HAVE LOST MUCH OF OUR NET WORTH. BETTER CALL AND CANCEL THE BEAMER, CAN’T AFFORD IT NOW, DAMN STOCK MARKET. WE WISH WE HAD NEVER HEARD OF THE STOCK MARKET AND PUT OUR MONEY IN JUMBO CD’S AT 7%. AT LEAST WE WOULD STILL HAVE SOME LEFT. AND ON TOP OF THAT WE WOULDN’T HAVE OVERSPENT ON THIS BIG HOME THAT WE NOW WILL LOSE BECAUSE WE CAN’T MAKE THE PAYMENTS. DON’T EVEN SPEAK TO ME ABOUT THE MARKET, I DON’T WANT TO HEAR IT. I’M SELLING OUT AND PUTTING MY MONEY IN A PASSBOOK. NEVER AGAIN WILL I BUY STOCKS. I’LL BURY IT IN THE BACK YARD BEFORE I EVER BUY ANOTHER FREAKING STOCK. I’LL HIDE IT IN THE ATTIC IN A FIREPROOF BOX, BUT NEVER AGAIN WILL I PUT IT IN THAT DAMN MARKET.

THIS IS HOW IT GOES IN EVERY SEVERE MARKET DOWNTURN. MANY LOSE THEIR LIFE SAVINGS. THEY COULDN’T RESIST THE PROMISE OF EASY MONEY AND LITTLE BY LITTLE EVERY BIT OF SAVINGS WENT INTO THE MARKET. WHY LEAVE EVEN A PENNY IN A PASSBOOK. IT’S JUST LANGUISHING THERE. BETTER GET IT INTO THE MARKET WHERE IT WILL DO SOME GOOD. MONEY MARKETS?, BOND FUNDS? NO WAY JOSE. ARE YOU CRAZY, THAT’S FOR SUCKERS WHO DON’T KNOW HOW TO MAKE REAL MONEY. 100% STOCKS IS THE PLACE TO BE AND ANYONE WHO DOESN’T AGREE IS AN IDIOT. JUST ASK ABBY, SHE’LL TELL YOU.

AND AFTER THE CRASH AND A YEAR OF WAITING FOR IT TO BEGIN TO RECOVER WITH NO SUCCESS, THEY SELL OUT. THE LAST OF THE SMALL INVESTOR BULLS GIVES UP AND SWEARS OFF THE MARKET. NEVER AGAIN. LIKE A DRUNK WITH A HANGOVER. NEVER AGAIN, NEVER AGAIN, UNTIL THE NEXT TIME THAT IS.

SO THEY SWEAR OFF STOCKS AND DON’T THINK ABOUT THEM AGAIN UNTIL ABOUT FIVE YEARS LATER WHEN A NEW BULL MARKET IS RAGING. ALL THE YOUNGER PEOPLE AT THE OFFICE ARE BUYING IN, MAKING MONEY, HAND OVER FIST THEY ARE MAKING IT. MAYBE IT REALLY WAS JUST A FLUKE LAST TIME. IF I HAD JUST HELD THE RIGHT STOCKS, ONES THAT DIDN’T GO BANKRUPT. IT WASN’T MY FAULT, IT WASN’T THE MARKETS FAULT, IT WAS JUST BAD LUCK. THE PLANETS WEREN’T LINED UP RIGHT. THE CEO’S OF THE COMPANIES I OWNED WERE POOR MANAGERS. A BLACK CAT WALKED IN FRONT OF ME THAT DAY. I BROKE A MIRROR. MAYBE GOD WAS MAD AT ME BUT HE’S OVER IT NOW. WHATEVER. I’LL PICK BETTER THIS TIME. I CAN’T LET ALL THESE YOUNG GUYS GET AHEAD OF ME, I GOTTA GET BACK IN THE MARKET. MY BOSS IS IN THE MARKET, HE’S SMART, IT MUST BE OK NOW. THIS TIME I’LL BE SMARTER. I’LL WATCH IT CLOSER, I’LL READ MORE. IF THERE EVER IS ANOTHER DOWNTURN I’LL SEE IT COMING, BUT THERE WON’T BE. THIS IS A NEW ECONOMY IT CAN’T HAPPEN ANY MORE. A NEW GUY IS IN CHARGE OF THE FED. IT’S A NEW ERA. THEY SAY SO ON TV. I’M IN LOVE AGAIN. I LOVE MY STOCKS, I LOVE MY STOCKS, I LOVE MY STOCKS.

AND, HISTORY REPEATS ITSELF.

THAT DEAR READER IS WHAT THOSE IN THE KNOW, KNOW, AND THOSE WHO DON’T KNOW, DON’T KNOW. THAT GREED AND FEAR RULE THE MARKETS. WHY IS THIS SO IMPORTANT? THE IMPORTANCE IS THAT IN EVERY BULL MARKET THE GENERAL PUBLIC FALLS IN LOVE WITH THEIR STOCKS. THEY BID THEM UP FAR BEYOND THEIR TRUE VALUES. THEY CANNOT BE CONVINCED BY ANYONE THAT THE STOCKS ARE NOT WORTH IT. EVEN IF THE PRESIDENT WERE TO COME ON TV AND TELL THEM TO SELL THEY WOULD REFUSE AND CALL HIM A FOOL. THEY BID THE MARKET INDEXES UP AT LEAST DOUBLE WHAT THE STOCKS IN THE INDEXES ARE WORTH, SOMETIMES MORE. GREED RULES THE DAY. THE DESIRE FOR EASY MONEY ENAMORS THE PUBLIC WITH STOCKS AND THEY WILL NOT BE DENIED. 100 TO 1 P/E’S ARE NOT ENOUGH TO DISSUADE THEM. NO FORCE ON EARTH CAN STOP THEM FROM BUYING UNTIL THE MARKET BEGINS TO FALL. 

IMAGINE THAT STOCKS WITH A TRUE VALUE OF $100.00 ARE SELLING FOR $250.00. THAT IS WHAT IT IS LIKE AT THE TOP OF A BOOM. THAT IS WHY WE CANNOT HAVE A STABLE SLOW GROWING MARKET, BECAUSE WHEN PEOPLE FALL IN LOVE WITH STOCKS THEY WILL BUY NO MATTER WHAT THE PRICE. NO ONE CAN STOP THEM. THEY DEMAND THEIR RIGHT TO BUY STOCKS AT EXORBITANT PRICES. 

AND THEN, WHEN THE CRASH COMES FIRST COMES FEAR. FEAR DRIVES THE FIRST WAVE OF SELLING AND THEN THE MARGIN CALLS FROM THE BROKERAGES. AFTER THAT HATE SETS IN. HATE FOR THE STOCK MARKET, HATE FOR THE BROKERS, MAYBE EVEN A LITTLE HATE FOR THAT BEAUTIFUL STOCK ADVISOR ON TELEVISION. WELL, IT WASN’T HER FAULT, SHE PROBABLY LOST MONEY TOO. SHE LOOKS SO SWEET. SHE COULDN’T POSSIBLY HAVE KNOWN. SHE JUST TOLD ME TO BUY THAT TECH STOCK THREE DAYS BEFORE THE CRASH. SHE DIDN’T KNOW, SHE’S A VICTIM TOO. OTHER THAN HER I HATE THEM ALL.

AND AFTER HATE, WHAT EVERYONE IS NOW CALLING CAPITULATION. I GIVE UP. I JUST WANT TO SELL OUT AND FORGET ABOUT THE MARKET. AND THEY DO. LIKE A BROKEN LOVE AFFAIR, I JUST DON’T WANT TO THINK ABOUT THAT PERSON ANYMORE. REMEMBER WHAT I SAID, THE TRUE VALUE OF THE FICTITIOUS STOCK WAS $100.00. AS THE MARKET GOES DOWN AND MORE PEOPLE HATE THEIR STOCKS THEY WANT THEM OUT OF THEIR SIGHT AT ANY PRICE. THEY WILL SELL A STOCK WORTH $100.00 FOR $25.00 JUST TO GET RID OF IT AND CLOSE OUT THAT DAMN ACCOUNT. I DON’T EVEN WANT TO SEE A MONTHLY STATEMENT TO REMIND ME OF THE MARKET. I WANT TO FORGET THAT THERE IS SUCH A THING AS THE STOCK MARKET THEY WILL SAY.

THAT IS WHAT HAPPENS OVER AND OVER AGAIN, AND WILL CONTINUE TO HAPPEN AS LONG AS HUMANS AND THE STOCK MARKET CO-EXIST. 

CHAPTER 5:  WHAT CAN BE DONE?  or  Back to the  Top

THE BIG PLAYERS KNOW LONG BEFORE A BOOM IS OVER. NOT JUST MONTHS, YEARS. WHEN P/E RATIOS ARE OVER 35 TO 1 THE END IS NEAR. IT MAY BE A YEAR OR TWO AWAY, BUT IT’S COMING. IT’S TIME TO START TAKING PROFITS WHENEVER A RALLY OCCURS. NOT ALL AT ONCE. A LITTLE HERE, A LITTLE THERE. UNTIL THE STOCK PORTION OF THE PORTFOLIO. IS DOWN TO 10%. YOU CAN NEVER KNOW FOR SURE WHEN IT IS OVER SO HAVING A FEW STOCKS WILL KEEP YOU IN RIGHT TO THE END. IF IT DROPS 30% OVERNIGHT YOU WILL ONLY LOSE 3% OF YOUR PORTFOLIO. NO PROBLEM, IT WILL SOON BE MADE UP BY PROFITS FROM BONDS AND MONEY MARKET FUNDS. 

AND AFTER IT’S OVER, THE CRASH THAT IS, YOU HAVE PLENTY OF MONEY TO BUY BACK IN AT BARGAIN PRICES. WHEN THE LAST BULL ON TV THROWS IN THE TOWEL, AND SAYS SELL, YOU KNOW IT’S OVER. IT’S TIME TO BUY AGAIN. ACTUALLY ONE CAN BEGIN TO BUY ANYTIME WITH DOLLAR COST AVERAGING AFTER THE 20% DROP IS MADE AND A BEAR MARKET IS ANNOUNCED IN ALL OF THE INDEXES. ONCE ALL THREE (THE DJIA, THE S&P 500, AND THE NASDAQ) ARE IN BEAR TERRITORY YOU HAVE ALREADY SAVED ABOUT 20% OR MORE OF YOUR CAPITAL. IF YOU WANT TO WAIT, JUST WATCH THE INDEXES AND WHEN THEY ALL START TO CREEP UPWARDS BEGIN BUYING THEN. 

WHY IS MISSING THE BIG DROPS SO IMPORTANT?

THE TV COMMENTATORS WILL NOT OFTEN TELL YOU THIS AND EVEN WHEN THEY DO, MOST PEOPLE WILL NOT UNDERSTAND IT. IF YOU CAN JUST MISS THE BIG STOCK MARKET DROPS THAT OCCUR ONCE EVERY FEW YEARS YOU WILL BE IN FINE SHAPE. THAT’S ALL THE BIG PLAYERS HOPE TO DO. 

LET ME EXPLAIN. IF YOU HAVE A THOUSAND DOLLARS AND YOU LOSE HALF OF IT WHEN THE MARKET DROPS 50% YOU NOW HAVE $500.00. IF YOU HAVE HELD THROUGH A DOWNTURN WHERE THE MARKET LOST 50% YOU WILL HAVE TO GAIN 100% TO GET BACK TO EVEN. THIS COULD TAKE YEARS. WHY IS THIS SO? BECAUSE A 50% GAIN ON YOUR $500.00 ONLY BRINGS IT BACK TO $750.00. IT TAKES A GAIN OF 100% TO GET BACK TO EVEN AFTER A LOSS OF 50%. 

THAT IS THE REASON IT IS NOT ALL THAT CRITICAL TO HAVE MARKET TIMING PERFECTED TO THE POINT OF SELLING AT THE HIGH AND BUYING AT THE LOW. BEING A YEAR EARLY ON GETTING OUT OF THE MARKET AND BEING 6 MONTHS LATE GETTING BACK IN WILL STILL BE BETTER THAN WAITING 5 YEARS AT 10% TO 20% A YEAR TO GET BACK TO EVEN. IF ONE WERE TO GET OUT AFTER A 10% DROP AND MISS THE REST OF A DOWNTURN IT WOULD STILL BE FAR BETTER THAN HOLDING ON THROUGH A CRASH. HAVING $900.00 TO BUY BACK IN WITH LATER IS FAR BETTER THAN WAITING FOR YOUR $500.00 TO GROW TO $900.00 ONCE AGAIN. 

THAT BRINGS US TO POINT NUMBER TWO. EVEN IF YOU WAIT UNTIL THE MARKET IS BEGINNING TO CLIMB AGAIN, WHICH MAY TAKE SIX MONTHS TO A YEAR, YOU WILL GET A LOT MORE SHARES OF STOCK FOR YOUR $900.00 THAN YOU WOULD OWN IF YOU HAD HELD YOUR OLD ONES. 

FOR EXAMPLE; IF YOU HAD TEN SHARES OF STOCK WORTH $100.00 EACH FOR A TOTAL OF $1000.00 WHEN THE MARKET BEGAN TO CRUMBLE AND YOU SOLD THEM AFTER THEY DROPPED 10% YOU WOULD HAVE $900.00 CASH. NOW YOU SIT ON THE CASH FOR A YEAR AND MAKE AN AVERAGE OF 7% BETWEEN THE MONEY MARKET AND THE BOND FUNDS. NOW YOU HAVE $963.00 TO BUY BACK IN WITH. 

SINCE THE MARKET HAS DROPPED 50% BUT CAME BACK UP 10% BEFORE YOU DECIDED TO BUY BACK IN, THE STOCK YOU SOLD AT $90.00 IS NOW SELLING FOR $55.00. WITH $963.00 YOU CAN BUY BACK 17 1/2 SHARES. THAT IS 7 1/2 MORE THAN YOU WOULD HAVE IF YOU HAD HELD YOUR 10 SHARES ALL OF THE WAY THROUGH THE DOWNTURN. BASICALLY YOU GOT THE 7 1/2 SHARES FREE. 

THAT’S NOT ALL. JUST THINK HOW MUCH FASTER 17 1/2 SHARES WILL GROW WHEN THE MARKET IS RISING THAN 10 WILL. IT’S NOT QUITE DOUBLE, BUT ALMOST. 

THIS IS WHY THE MARKET INSIDERS HAVE LONG SINCE SOLD OUT THEIR STOCK POSITIONS BEFORE A CRASH COMES. THEY ARE NOT WORRIED ABOUT BEING A YEAR EARLY, THEY KNOW THAT THEY WILL MAKE IT UP MANY TIMES OVER WHEN THEY BUY STOCKS BACK AT HALF PRICE OR LESS. NOR ARE THEY WORRIED ABOUT BEING A LITTLE BIT LATE GETTING BACK IN. THE MONEY ON THE SIDELINES IS COLLECTING INTEREST AND GROWING EVERY DAY. IT’S JUST THAT MUCH MORE TO BUY BACK IN WITH WHEN THE TIME IS RIGHT. 

IT IS FAR BETTER TO SELL A LITTLE EARLY AND BUY BACK IN A LITTLE LATE THAN TO GET CAUGHT IN THE CRASH.

SOME WOULD SAY THAT THEIR IS A CONSPIRACY TO CONTROL THE MARKET. THAT WAS TRUE AT TIMES YEARS AGO WHEN THE MARKET WAS SMALL, BACK IN THE EARLY 1900’S TO ABOUT 1934. EVEN THEN IT WAS DIFFICULT AND SOME BIG PLAYERS SOMETIMES LOST THEIR SHIRTS WHEN UNFORESEEN EVENTS OCCURRED OR ANOTHER BIG PLAYER WAS ON THE OPPOSITE SIDE. 

NO, THE MARKET FORCES NEED NO CONSPIRACY TO MAKE THEM RISE AND FALL. HUMAN NATURE, GREED AND FEAR, LOVE AND HATE TAKE CARE OF THAT JUST FINE. GREED KEEPS THEM IN TOO LONG UNTIL FEAR DRIVES THEM OUT.

SO, DON’T FALL IN LOVE WITH YOUR STOCKS, AND DON’T HATE YOUR STOCKS, THEY HAVE NO FEELINGS FOR YOU. THEY ARE NOT EVEN PIECES OF PAPER ANYMORE LOCKED IN YOUR SAFE. THEY ARE JUST ELECTRONIC BITS OF DATA ON A COMPUTER SOMEWHERE SHOWING THAT YOU OWN SHARES IN A PUBLICLY TRADED COMPANY. DEAL WITH THEM WITHOUT EMOTION. BUY THEM WHEN THEY ARE GOING UP AND SELL THEM WHEN THEY ARE GOING DOWN, OR PRIOR TO THE MARKET MOVES IF YOU CAN. SAVE YOUR EMOTIONS FOR REAL LIFE, NOT FOR THE STOCK MARKET. 

CHAPTER 6: WHEN TO SELL  or  Back to the  Top

A GOOD RULE TO FOLLOW IS THE 10% RULE. WHEN YOUR STOCKS OR MUTUAL FUNDS OR MARKET INDEXES DROP 10%, SELL IT. DON’T HOLD A LOSER. GET OUT. REASSESS THE SITUATION. YOU CAN ALWAYS BUY BACK IN. MAYBE NO BEAR MARKET IS IN SIGHT YET, MAYBE ITS A BAD STOCK OR A BAD FUND. IF SO, WAIT A COUPLE OF WEEKS OR A MONTH OR TWO AND BUY A BETTER ONE, ONE THAT’S GOING UP, NOT DOWN. 

WHEN THE NASDAQ DROPPED 10% IN MARCH OF 2000 MANY COULD HAVE STILL GOT OUT WITH A GREAT PROFIT. IF THEY HAD ONLY IMPLEMENTED AN AUTOMATIC STOP ORDER WITH THEIR BROKER TO SELL ANYTHING THAT DROPPED 10% OR MORE, MUCH OF THEIR PROFITS FROM THE PREVIOUS YEARS WOULD HAVE BEEN SAVED. 10% IS NOT MUCH TO LOSE WHEN YOU HAVE ALREADY DOUBLED YOUR MONEY, OR MORE. THE NASDAQ HAS AT THIS TIME LOST OVER 60% (MARCH 2001) OF ITS VALUE. THOSE WHO ARE BUYING BACK IN NOW AFTER SELLING OUT WITH A 10% LOSS WILL POSSESS MANY MORE SHARES THAN THOSE WHO ARE STILL HOLDING ON AND HOPING FOR A RECOVERY THIS YEAR OR NEXT. IT MAY BE A FEW YEARS BEFORE WE SEE NASDAQ 5000 AGAIN.

TAKE SOMETHING OFF OF THE TABLE

WHEN I USED TO FREQUENT LAS VEGAS I OCCASIONALLY HAD WINNING SESSIONS. IN THOSE TIMES WHEN I WALKED AWAY A WINNER IT WAS BECAUSE AFTER GETTING AHEAD I TOOK SOMETHING OFF OF THE TABLE. MY PRACTICE WAS THAT IF I STARTED WITH $500.00 AND I DOUBLED IT I WOULD PUT $600.00 INTO MY INNER LEFT SPORT COAT POCKET AND NEVER RETRIEVE THAT MONEY DURING THAT SESSION. HAVING THAT THERE GUARANTEED ME THAT I WOULD WALK AWAY FROM THE TABLE A WINNER EVEN IF I LOST ALL OF THE $400.00 LEFT ON THE TABLE. THERE IS A GREAT PSYCHOLOGICAL DIFFERENCE BETWEEN WALKING AWAY FROM THE TABLE A $100.00 WINNER RATHER THAN A $100.00 LOSER. 

THIS PRINCIPLE CAN ALSO BE APPLIED TO THE STOCK MARKET. WHEN YOU HAVE HAD A GOOD RUN ON A STOCK OR A MUTUAL FUND, TAKE PROFITS ON OCCASION. YOU DON’T HAVE TO TAKE IT ALL, BUT MAKE SURE IF YOU HAVE HAD A PHENOMENAL RUN OF GOOD FORTUNE THAT YOU DON’T WAKE UP SOME MORNING TO SEE THAT IT HAS ALL VANISHED. TAKE SOME OFF THE TABLE AND PUT IT SOMEWHERE FOR SAFEKEEPING. THAT’S THE WHOLE POINT OF INVESTING, TO MAKE MONEY AND TO KEEP IT.

MARKET TIMING

SEPTEMBER IS FOR SELLING

THAT THE MARKET RUNS IN CYCLES IS WELL KNOWN TO THOSE WHO MANAGE LARGE AMOUNTS OF CAPITAL THAT IS INVESTED IN THE STOCK MARKET. THAT IS WHY MANY STOCKS ARE CALLED, CYCLICALS. THE CYCLICAL STOCKS PERFORM AS SUCH DURING THE VARIOUS SEASONS OF THE YEAR. THEY GO UP AND THEY GO DOWN ON A REGULAR BASIS. THERE IS A LARGER CYCLE THAT IS MOST IMPORTANT TO THE INVESTOR. CYCLICAL INDIVIDUAL STOCKS ARE THE TERRITORY OF SHORT TERM TRADERS AND THAT IS NOT THE SUBJECT HERE. THE SUBJECT HERE IS THE POTENTIAL TWICE A YEAR FLUCTUATIONS OF THE STOCK MARKET. 

BOTH OF THE MAJOR MARKET CRASHES FOR THE DJIA HAVE COME IN OCTOBER. THE 1929 CRASH ON OCTOBER 29TH, AND THE 1987 CRASH ON OCTOBER 19TH. FOR SOME REASON THE FALL SEASON SEEMS TO BE ONE OF THE PRIME TIMES FOR A MARKET DOWNTURN. IT HAS BEEN ATTRIBUTED BY SOME TO THE BUSINESS FISCAL YEAR WHICH VERY OFTEN ENDS ON THE LAST DAY OF SEPTEMBER. WHATEVER THE REASON OCTOBER IS A GOOD MONTH TO HAVE A MINIMUM OF STOCK MARKET EXPOSURE. 

SINCE PROFITS NEED TO BE TAKEN OCCASIONALLY TO INSURE STOCK MARKET SUCCESS, SEPTEMBER IS A GOOD MONTH TO TAKE SOMETHING OFF OF THE TABLE. CHECKING ONES PORTFOLIO IN SEPTEMBER AND PUTTING SOME PROFITS TO WORK IN BONDS OR MONEY MARKET FUNDS AND ALSO SELLING OFF SOME DOGS EARLY BEFORE THE REST OF THE PEOPLE DO IT IN DECEMBER IS A GOOD STRATEGY. 

IF YOU FOLLOW THE MARKETS STARTING ON SEPTEMBER 1ST YOU SHOULD BE ABLE TO DO YOUR SELLING ON AN UP DAY. GET ALL THE PROFIT YOU CAN, SELL ON AN UPSWING IN SEPTEMBER. YOU DON’T HAVE TO SELL IT ALL, AS YOU WILL SEE LATER. JUST INSURE YOURSELF THAT YOU DON’T GIVE BACK ALL OF YOUR WINNINGS. 

MARCH IS FOR MAKING MONEY

THE STOCK MARKET IS GENERALLY IN AN UPSWING FROM NOVEMBER THROUGH FEBRUARY. WE USUALLY HAVE WHAT IS CALLED THE “SANTA CLAUS RALLY” JUST BEFORE CHRISTMAS, AND THEN SOME TAX LOSS SELLING ON THE LAST TRADING DAY BEFORE THE NEW YEAR, FOLLOWED BY AN UPSWING IN JANUARY. IF JANUARY GOES WELL THE MARKET WILL PROBABLY END ON THE UPSIDE AT THE END OF THE YEAR. HOWEVER, ABOUT MARCH 15TH PEOPLE BEGIN TO GET SERIOUS ABOUT FINANCES DUE TO THE APRIL 15TH DEADLINE FOR FILING INCOME TAXES. 

MANY PEOPLE TODAY USE INVESTMENT ACCOUNTS IN A SIMILAR MANNER AS PEOPLE DID SAVINGS ACCOUNTS YEARS AGO. THEY KEEP A CERTAIN AMOUNT IN CASH AND WRITE CHECKS AGAINST IT AND EXTRA MONEY IN STOCKS AND OTHER INVESTMENTS. WHEN THE TAX MAN COMETH SOME INVESTMENTS MUST BE TURNED INTO CASH TO PAY THE GOVERNMENT. THIS GENERALLY HAPPENS FROM MID MARCH TO APRIL 15TH. THAT MAKES THE LAST TWO WEEKS IN FEBRUARY AND THE FIRST TWO WEEKS IN MARCH EXCELLENT TIMES FOR PORTFOLIO REVIEW AND RE-ADJUSTMENT. AS IN OCTOBER REVIEW YOUR PORTFOLIO AND TAKE SOME STOCK PROFITS OFF OF THE TABLE OR SELL SOME DOGS. TRY TO SELL ON AN UP DAY DURING THE FIRST TWO WEEKS OF MARCH.

DOGGY STOCKS

SOME PEOPLE HATE TO SELL DOGGY STOCKS. THEY WOULD RATHER HOLD THEM FOR TWO YEARS UNTIL THEY BREAK EVEN OR MAKE A SMALL PROFIT JUST TO AVOID TAKING A LOSS. DOES THAT MAKE SENSE? WHY NOT GET RID OF THE THING AND MAKE 5% OR 9% IN A BOND FUND OR MONEY MARKET FUND RATHER THAN HOLD IT WAITING TO BREAK EVEN. BETTER TO CASH IT IN AND THEN BUY A DIFFERENT STOCK WITH THE PROCEEDS THAN HOLD ON TO A LOSER. BY SELLING A LOSER YOU CAN ALSO GET SOME LOSSES TO TAKE OFF OF YOUR INCOME TAX. 

RISK AND REWARD

THE HIGHER THE RISK, THE GREATER THE POTENTIAL FOR REWARD, BUT ALSO FOR LOSS. EVERY INVESTOR MUST DETERMINE FOR HIMSELF OR HERSELF WHAT IS THE RIGHT MIX OF STOCKS, BONDS AND MM. WE ALL HAVE DIFFERENT PERSONALITIES AND DIFFERENT SITUATIONS. AS WE AGE MOST OF US BECOME MORE CAREFUL WITH OUR INVESTMENTS BECAUSE THE LENGTH OF OUR WORKING YEARS, OUR EARNING CAPACITY IS DIMINISHING. A PERSON 25 TO 35 YEARS OF AGE MAY BE ABLE TO TAKE A LOT MORE RISK THAN A PERSON RETIRING IN 5 YEARS. A PERSON RETIRING IN 5 YEARS CAN STILL TAKE MORE RISK THAN A PERSON DEPENDING ON INVESTMENT INCOME FOR LIVING EXPENSES. 

BECAUSE OF THIS WE ALL HAVE TO DETERMINE OUR OWN RISK TOLERANCE AND HOW MUCH PROFIT WE TAKE FROM OUR STOCK MARKET ENDEAVORS. A YOUNG PERSON MAY WANT 70% INVESTED IN STOCKS, 20% IN BONDS AND 10% IN A MONEY MARKET FUND. 

A MIDDLE AGED PERSON MAY WANT 50% IN STOCKS, 30% IN BONDS AND 20% IN THE MONEY MARKET. 

A PERSON 5 YEARS FROM RETIREMENT MAY WANT TO BE EVEN MORE CONSERVATIVE AND KEEP 30% IN STOCKS 35% IN BONDS AND 35% IN THE MM.

A RETIRED PERSON MAY WANT ONLY 10% IN STOCKS, 30% IN BONDS AND 50% IN THE MM, OR MAYBE NO STOCKS AT ALL. 

THESE ARE NOT RULES, JUST EXAMPLES. CIRCUMSTANCES VARY. SOME RETIRED PEOPLE MAY BE VERY WEALTHY AND WITH MILLIONS IN THE BANK KEEP MANY MORE MILLIONS IN THE STOCK MARKET. SOME YOUNG PEOPLE MAY HAVE CONSERVATIVE PERSONALITIES AND NEVER INVEST MORE THAN 20% IN THE STOCK MARKET DURING THEIR LIFETIMES. BUT, WHATEVER YOUR RISK TOLERANCE YOU WILL BE MUCH MORE SUCCESSFUL IN INVESTING IF YOU HAVE A PLAN AND STICK TO IT. HAPHAZARD INVESTING WILL USUALLY YIELD HAPHAZARD RESULTS. 

HOW CAN YOU FIND YOUR RISK TOLERANCE. THAT’S EASY, START SOMEWHERE AND ADJUST THE PERCENTAGES UNTIL YOU ARE HAPPY WITH THE AMOUNT OF RISK YOU ARE TAKING AND CAN STILL SLEEP AT NIGHT. IF YOU DON’T KNOW WHERE TO START TRY 1/3 IN EACH CATEGORY. 

IF THIS IS TOO BORING, YOU CAN RAISE THE STOCK PORTION AND DECREASE THE OTHERS. IF ITS TO NERVE RACKING YOU CAN DECREASE THE STOCKS AND RAISE THE OTHERS UNTIL YOU FIND JUST THE RIGHT MIXTURE WHERE YOU FEEL COMFORTABLE. 

FIND THE PLACE WHERE YOU FEEL COMFORTABLE WITH THE RISK, BUT NEVER BE 100% INVESTED IN ANYTHING UNLESS YOU ARE LIVING ON THE INCOME AND PUT IT IN INTEREST BEARING SECURITIES. A GOOD RULE IS NEVER TO PUT MORE THAN 80% IN ONE CATEGORY AND NEVER LESS THAN 10% EACH IN THE OTHER TWO. (THE ONLY EXCEPTION TO THIS MIGHT BE DURING A BEAR MARKET WHEN YOU MAY WANT TO BE COMPLETELY OUT OF STOCKS TEMPORARILY)

AFTER A NUMBER OF YEARS YOU MAY GRADUALLY CHANGE YOUR INVESTMENT MIX. IN SOME CASES PEOPLE MAY START OUT CONSERVATIVELY BECAUSE THEY HAVE LITTLE CAPITAL AND MAY NEED IT IN THE EVENT OF AN EMERGENCY, AND THEN INCREASE THE RISK LATER WHEN MORE CAPITAL IS BUILT UP WHILE STILL ALLOWING PLENTY OF CAPITAL FOR EMERGENCIES.

EXAMPLE: 
A YOUNG COUPLE WITH $10,000 TO INVEST MAY WANT TO KEEP $5000 IN CASH IN CASE OF A JOB LAYOFF, AND DIVIDE THE OTHER $5000 BETWEEN STOCKS AND BONDS. 5 YEARS LATER THAT COUPLE MAY HAVE $30,000 SAVED AND RATHER THAN KEEPING HALF IN CASH CUT THAT DOWN TO $7500 BECAUSE NOW THAT AMOUNT IS MORE THAN WHAT MAY BE NEEDED FOR EMERGENCIES BUT IS LESS OF THE PORTFOLIO PERCENTAGE WISE. 

IT IS A GOOD PRACTICE TO REVIEW YOUR PERCENTAGES EVERY TIME YOU TAKE PROFITS AND SEE IF YOU ARE STILL HAPPY WITH THE WAY YOUR MONEY IS ALLOCATED AND CHANGE IT IF DESIRED.

IN THE NEXT SECTION WE WILL DISCUSS THE ACTUAL DYNAMICS OF TWICE ANNUALLY BALANCING OF YOUR MONEY. KEEP IN MIND THAT THE EXAMPLE BELOW USING 1/3, 1/3, AND 1/3 IS ONLY AN EXAMPLE AND CAN BE USED WITH ANY PERCENTAGES THAT YOU CHOOSE FOR YOUR PERSONAL PORTFOLIO.

CHAPTER 7:  INVESTMENT ALLOCATION CALCULATION  or  Back to the  Top

1/3 STOCKS 1/3 BONDS 1/3 MONEY MARKET

WHAT IS THE WHOLE IDEA OF INVESTING? FOR MOST OF US IT IS TO PROVIDE FOR OUR FINANCIAL WELL BEING IN THE FUTURE. TO PROVIDE FOR OUR DREAM HOME, OUR CHILDREN’S EDUCATION, AND OUR RETIREMENT. 

IN ORDER TO DO THIS WE MUST SOMEDAY TURN OUR STOCK MARKET PROFITS INTO REAL MONEY. WHAT A TRAGEDY IT WOULD BE IF WE SAVED FOR 20 YEARS, FROM AGE 35 TO 55 AND HAD FINALLY ACCUMULATED $500,000.00 DOLLARS IN STOCKS. OUR PLAN WAS TO TURN IT ALL INTO CASH AT 56 YEARS OF AGE AND LIVE COMFORTABLY ON A $50,000 A YEAR INCOME FROM THE 10% INTEREST. NOW, SIX MONTHS BEFORE OUR RETIREMENT THE STOCK MARKET CRASHES AND OUR $500,000 IN AGGRESSIVE GROWTH FUNDS HAS NOW BECOME $125,000. AFTER ALL THOSE YEARS OF SCRIMPING AND SAVING WE NOW WILL HAVE TO WORK FOR 5 OR 10 MORE YEARS AND KEEP SAVING AND HOPE FOR AT LEAST SOME OF OUR INVESTMENT VALUE TO RETURN. IF WE ARE LUCKY PERHAPS WE CAN RETIRE AT 62. 

THIS SCENARIO COULD NOT HAPPEN IF WE HAD ON OCCASION HAD TAKEN SOME PROFITS OFF OF THE TABLE. PERHAPS WE MAY NOT HAVE HAD $500,000 UNTIL AGE 57 IF WE HAD INVESTED MORE SAFELY, BUT AT LEAST WHEN WE GOT THERE WE WOULD STILL HAVE IT. 

A GOOD OLD FASHIONED WAY TO MANAGE ONES PORTFOLIO IS TO OCCASIONALLY TAKE SOME PROFITS OFF THE TABLE AND PLACE THEM IN SAFE INVESTMENTS FOR THE LONG TERM. ONE WAY TO DO THIS IS TO BALANCE THE PORTFOLIO TWICE A YEAR TO 1/3 STOCKS, 1/3 BONDS, AND 1/3 MONEY MARKET FUNDS. (OR ANY PERCENTAGES YOU MAY CHOOSE)

DOING SO WILL INSURE THAT SOME OF THE MONEY FROM THE INVESTMENT CATEGORY THAT IS THE MOST PROFITABLE WILL BE TAKEN OFF OF THE TABLE OR REINVESTED IN ANOTHER CATEGORY THAT IS UNDERVALUED. 

IF STOCKS ARE UP THEN THE MONEY MARKET AND BONDS FUNDS SHOULD BE EVENED OUT BY SELLING SOME STOCKS AND PLACING THE MONEY IN THE OTHER CATEGORIES. IF THE STOCK MARKET HAS DECLINED THEN IT MAY BE TIME TO BUY IN AT LOW PRICES. YOU MAY HAVE MADE 6% ON THE MONEY MARKET, 9% ON THE BONDS AND LOST 3% ON STOCKS. IF SO, IT IS TIME TO BUY SOME MORE STOCKS. 

BY USING THIS METHOD THERE IS NEVER ANY GUESSWORK AS TO “TIMING THE MARKET.” THIS TOTALLY ELIMINATES GUESSWORK. WHAT IS THERE TO TIME? ALL ONE HAS TO DO IS LOOK AT THE DOLLAR VALUE OF EACH INVESTMENT CATEGORY AND SEE WHICH ONE IS HIGHEST, WHICH IS LOWEST, AND WHICH IS IN BETWEEN. AFTER THAT, MAKE THEM ALL EVEN AGAIN AND REPEAT THE PROCESS IN SIX MONTHS. (OR IF NOT EVEN, THEN TO THE PERCENTAGES YOU DESIRE)

THE STOCK TOUT’S AND TV COMMENTATORS WILL NEVER ADVISE YOU TO DO THIS. THEY WILL SAY YOU ARE UNDERINVESTED IN STOCKS. THEY RARELY EVER RECOMMEND BEING LESS THAN 70% INVESTED IN STOCKS EVEN IN THE WORST OF TIMES OR EVEN IF YOU ARE ALREADY RETIRED AND CANNOT REALLY AFFORD ANY LOSS GREATER THAN 10% OR ANY LOSS AT ALL. 

OVER A CALENDAR YEARS TIME (JANUARY TO DECEMBER) THE STOCK MARKET RARELY LOSES MORE THAN 50% OF ITS VALUE, IN FACT THIS HAS HAPPENED ONLY ONCE TO THE DJIA, IN 1931 WHEN THE MARKET LOST 52% OF ITS VALUE. NORMALLY THE STOCK MARKET LOSES BETWEEN 20% AND 30% OF ITS VALUE DURING A BEAR MARKET PERIOD. A 20% LOSS OF VALUE IN A STOCK INDEX IS WHAT IS CONSIDERED TO BE A BEAR MARKET. ANY FLUCTUATIONS OF LESS THAN 20% ARE CONSIDERED TO BE NORMAL MARKET CONDITIONS. BY LIMITING YOUR STOCK MARKET EXPOSURE TO 1/3 YOU WILL BE REDUCING THE RISK TO YOUR TOTAL PORTFOLIO TO ABOUT 10% OR IN THE WORST CASE SCENARIO, 15%. 

NOTE: THE NASDAQ LOST 60% OF IT’S VALUE BETWEEN MARCH 2000 AND MARCH 2001. THE NASDAQ IT MUST BE NOTED IS A HIGH RISK PLACE TO INVEST AND PEOPLE NEED TO BE AWARE OF THAT BEFORE PLAYING THAT MARKET. DIVERSITY IS IMPORTANT IN ANY STOCK PORTFOLIO.

EXAMPLE:

IF YOU HAVE $1000.00 INVESTED IN EACH OF THREE INVESTMENTS FOR A TOTAL OF $3000.00, EVEN IN A DOWN YEAR FOR THE STOCK MARKET YOU WILL HAVE A NET GAIN.

THE 1000.00 IN THE MONEY MARKET AT 5% WILL BE 1050.00
THE 1000.00 IN THE BOND FUND AT 9% WILL BE 1090.00
THE 1000.00 IN THE STOCK MARKET AT A 7% LOSS WILL BE 930.00.

AT THE END OF THE YEAR YOU WOULD STILL HAVE $3070.00 A SMALL PROFIT, BUT A PROFIT NONETHELESS. 

NORMALLY STOCKS AND BONDS GO SOMEWHAT OPPOSITE OF EACH OTHER. THE BOND YIELD MAY BE DOWN IN A YEAR STOCKS ARE GOING UP. THE MONEY MARKET YIELD IS ALWAYS A HANDFUL POINTS BEHIND THE BOND YIELD, TYPICALLY ABOUT 4 OR 5 FOR HIGH QUALITY BONDS. 

AFTER A YEAR LIKE THE EXAMPLE ABOVE IT WOULD BE TIME TO BALANCE ALL OF THE FUNDS WITH ABOUT $1023.00 TO START OUT THE NEW YEAR. 

BY BALANCING YOUR INVESTMENTS YOU WILL BE ABLE TO SLEEP BETTER AT NIGHT, OR AT LEAST BETTER THAN YOUR NEIGHBOR WHO IS 100% INVESTED IN AGGRESSIVE GROWTH FUNDS. WHEN YOUR STOCKS ARE GOING DOWN YOUR BONDS ARE BECOMING MORE VALUABLE. WHEN STOCKS AND BONDS ARE GOING DOWN AT LEAST YOUR MONEY MARKET PORTION IS GAINING INTEREST. WHEN STOCKS ARE GOING UP AND THE OTHER TWO ARE MAKING MONEY ALSO, ITS TIME TO CELEBRATE. 

WHILE WE USED A YEAR IN THE EXAMPLE TO SIMPLIFY THE MATH THE INVESTMENT PORTFOLIO SHOULD BE ADJUSTED TWICE A YEAR, IN SEPTEMBER AND AGAIN IN MARCH. 

PORTFOLIO STOCK PERCENTAGE

ONE WAY TO CALCULATE YOUR ACCEPTABLE PERCENTAGE OF STOCK INVESTMENTS IS TO DETERMINE HOW MUCH YOU CAN AFFORD TO LOSE WITHOUT CRYING, WHINING, KICKING THE DOG, THE CAT, YOUR SPOUSE OR LOOKING FOR THE 1-800-LAWYER NUMBER TO CALL TO TRY TO SUE SOMEONE, ANYONE, TO GET SOME OF YOUR MONEY BACK.

AS PREVIOUSLY STATED, THE STOCK MARKET RARELY LOSES MORE THAN 50% OF ITS VALUE IN A YEARS TIME. MORE LIKELY IT WILL ONLY LOSE 30% IN A BEAR MARKET. IF YOU KNOW HOW MUCH YOU CAN AFFORD TO LOSE YOU CAN DOUBLE THAT AMOUNT TO FIND YOUR ACCEPTABLE STOCK RISK. 

EXAMPLE:
A COUPLE HAS A PORTFOLIO CONSISTING OF $100,000. THEY FEEL THAT THEY COULD AFFORD TO LOSE $25,000 AND STILL BE ABLE TO MEET ALL OF THEIR FUTURE PLANS FOR A VACATION HOME PURCHASE AND FOR FUNDING THEIR TWO CHILDREN’S COLLEGE EDUCATIONS. KNOWING THAT THEY CAN RISK LOSING $25,000 MAKES IT SIMPLE TO DETERMINE THAT THEIR ACCEPTABLE RISK LEVEL FOR THE STOCK MARKET IS $50,000 BECAUSE EVEN IF THEY LOSE HALF OF THAT INVESTMENT THEY WILL STILL HAVE $75,000.

THE RISK LEVEL OF STOCKS CAN BE FURTHER REDUCED BY MAINTAINING A BALANCED PORTFOLIO. A $50,000 STOCK PORTFOLIO MIGHT CONSIST OF THE FOLLOWING;

$10,000 BLUE CHIP STOCKS, FUNDS, OR EQUITY INCOME FUNDS
$10,000 LARGE CAP VALUE OR GROWTH / INCOME STOCKS OR FUNDS
$10,000 NASDAQ / S&P STOCKS OR INDEX FUNDS OR AGGRESSIVE GROWTH FUNDS
$  5,000 MID CAP GROWTH / INCOME OR VALUE STOCKS OR FUNDS
$  5,000 SMALL CAP GROWTH / INCOME OR VALUE STOCKS OR FUNDS
$10,000 YOUR PERSONAL FAVORITE STOCKS OR FUNDS FROM ANY CATEGORY

A PORTFOLIO DIVERSIFIED IN THIS MANNER IS UNLIKELY TO LOSE MORE THAN 15% OF ITS VALUE BEFORE YOU HAVE OPPORTUNITY TO SELL SOME OFF EVEN IN THE WORST OF MARKET CONDITIONS. AS WAS SEEN BY THE YEAR 2000 DIP IN THE NASDAQ THERE WAS PLENTY OF FOREWARNING BEFORE THE DJIA BEGAN TO DIP ALSO. THE DJIA ONLY LOST A LITTLE MORE THAN 6% IN 2000. 

IN 2000 THE NASDAQ INDEX DROP GAVE AN INDICATOR THAT THE S&P 500 COULD DROP AND THE S&P DROP GAVE WARNING THAT THE DJIA COULD BE NEXT. THE ORDER MAY VARY WHEN THE NEXT BEAR MARKET ARRIVES, BUT WEAKNESS IN ONE MARKET SECTOR MAY PRECEDE FUTURE WEAKNESS IN ANOTHER SECTOR GIVING THE INVESTOR WHO IS ALERT TIME TO RE-ADJUST HIS PORTFOLIO THEREBY REDUCING POTENTIAL LOSS. 

ONCE AGAIN, DIVERSITY DOESN’T JUST MEAN HAVING SEVERAL AGGRESSIVE GROWTH FUNDS FROM VARIOUS COMPANIES, IT MEANS VARYING THE TYPE OF STOCKS YOU OWN AND SPREADING THE RISK AROUND TO DIFFERENT MARKET SECTORS THAT RESPOND DIFFERENTLY TO THE VARIOUS MARKET INDEXES. 

IT IS NOT MEANT TO GIVE THE IMPRESSION THAT INVESTING IN STOCKS WILL ALWAYS RESULT IN LOSING MONEY. NOTHING COULD BE FURTHER FROM THE TRUTH. THE STOCK MARKET HAS HISTORICALLY RETURNED ON THE AVERAGE ABOUT 8% A YEAR WITHOUT REINVESTED DIVIDENDS AND 11% WITH THE DIVIDENDS REINVESTED. RECENTLY THERE ARE LESS DIVIDENDS AND MORE GROWTH BUT THE TOTALS ARE ABOUT THE SAME. IT’S JUST THAT THE STOCK MARKET DOESN’T INCREASE IN A SMOOTH AND ORGANIZED MANNER. IT MAY GO UP 20% FOR THREE YEARS AND THEN DOWN 30%. AVOIDING THE DOWN YEARS IS THE KEY TO SUCCESS. 

THE MARKET GOES UP AND SIDEWAYS MUCH MORE THAN IT GOES DOWN. THE KEY IS TO LIMIT THE LOSSES DURING A DOWNTURN AND LOCK AWAY SOME PROFITS DURING THE UPSWINGS.

WRAP UP  or  Back to the  Top

BY BALANCING YOUR PORTFOLIO TWICE A YEAR AND BY AVOIDING BEAR MARKETS YOU WILL BECOME A SUCCESSFUL INVESTOR. NO, YOU WILL NOT HAVE THE THRILL OF SEEING 100% OF YOUR SAVINGS SKYROCKET TO PREVIOUSLY UNSEEN HIGHS, BUT NEITHER WILL YOU SUFFER THE AGONY OF GUT WRENCHING STOCK MARKET LOSSES. YOU WILL ACCUMULATE WEALTH SLOWLY AT A NORMAL PERCENTAGE OF ABOUT 10 TO 15 PERCENT A YEAR. SOME YEARS, IN BULL MARKETS YOU WILL MAKE MORE, AND IN BEAR MARKETS LESS, BUT YOU WILL PRESERVE MOST OF YOUR CAPITAL. IF YOU NEED A THRILL, BETTER TO VISIT CEDAR POINT AND RIDE THE ROLLER COASTER THAN LOSE YOUR MONEY IN THE STOCK MARKET. 

HAPPY INVESTING, R. J. ADAMS

EMAIL: RADAMS8501@AOL.COM

NOTES

USE THE BEST TAX STRATEGIES POSSIBLE. CHECK YOUR EMPLOYERS PLAN AND SEE WHAT CHOICES ARE AVAILABLE. 401K’S OR ROTH IRA’S. SEE YOUR TAX ADVISOR FOR YOUR BEST ALLOCATION OF TAXABLE AND TAX DEFERRED OR NON TAXABLE INVESTMENTS.

ALWAYS MAKE SURE YOU AVOID AN OCTOBER SURPRISE.

FUND YOUR INVEXTMENT PORTFOLIO ALL THE TIME THROUGH PAYROLL DEDUCTIONS OR SOME OTHER DOLLAR COST AVERAGING PLAN.

TRY TO SET UP YOUR PORTFOLIO SO IT MAKES A PROFIT EVERY WEEK, OR AT LEAST EVERY MONTH. LOOK FOR WAYS TO BALANCE THE PORTFOLIO SO SOME INVESTMENT IS ALWAYS GOING UP MORE THAN ANOTHER ONE IS GOING DOWN. FIND THE PROPER MIX OF STOCKS, BONDS AND MONEY MARKET FUNDS TO PROFIT WEEKLY OR AT LEAST MONTHLY. FINDING THE PROPER MIX IS THE KEY TO GOING TO BED RICHER EVERY FRIDAY NIGHT THAN WHAT YOU WERE WHEN YOU GOT UP ON THE PREVIOUS MONDAY MORNING. 

THIS IS ESPECIALLY EASY TO DO IF YOU HAVE AN EMPLOYER 401K PLAN THAT PERMITS YOU TO RE-ALLOCATE YOUR INVESTMENT CHOICE PERCENTAGES ON A WEEKLY OR MONTHLY BASIS. JUST CHANGE THE ALLOCATION EACH MONTH TO 50% OF WHAT IS GOING UP THE MOST AND TO 25% IN THE OTHER TWO CHOICES. REMEMBER, THE MARKETS RUN IN TRENDS OFTEN LASTING FOR YEARS. YOU NORMALLY WILL ONLY HAVE TO ACTUALLY ADJUST YOUR PORTFOLIO BALANCE ABOUT TWICE A YEAR, BUT WATCH IT AND REVIEW IT EVERY MONTH TO MAKE SURE YOUR VALUES ARE GOING UP AND NOT DOWN. REMEMBER, SOMETHING IS ALWAYS GOING UP, SO THATS WHERE YOU WANT TO HAVE THE LIONS SHARE OF YOUR PORTFOLIO WHENEVER POSSIBLE. THERE IS NO REASON TO EVER LOSE MONEY FOR MORE THAN ONE MONTH.

CONDITIONS CONTINUOUSLY CHANGE, SO THE ASTUTE INVESTOR MUST ALWAYS BE ON THE ALERT TO SEE WHAT INVESTMENT IS AT THE PRESENT TIME COUNTERBALANCING U.S. STOCKS. SOMETIMES IT MAY BE GOLD OR PRECIOUS METALS FUNDS, OR INTERNATIONAL EQUITY FUNDS, OR INTERNATIONAL OR U.S. BOND FUNDS. REMEMBER, SOMETHING IS ALWAYS GOING UP WHEN THE U.S. STOCK MARKET IS GOING DOWN. FIGURING OUT IN ADVANCE WHAT IT IS FOR THIS MONTH IS THE DIFFICULT PART THAT REQUIRES HARD WORK.
 

NEWSPAPER / MAGAZINE ARTICLES

Top firms teeter, so bear can't be far behind 

By Adam Shell, USA TODAY     3/25/01

NEW YORK - Corporate America icons like General Electric, American Express, AT&T and Home Depot aren't supposed to melt down in stock market declines like fly-by-night Internet companies. They're well-known brands. They make money. And investors can count on them being in business 5 years down the road. Unfortunately, even the mightiest companies crumble when pessimistic bears wrest control of Wall Street from optimistic bulls. With the Dow Jones industrial average on the cusp of its first bear market since 1990, all four of these brand-name Dow stocks have seen their share prices plummet 38% or more from their 52-week highs.

The Dow is now down 19.9% from its January 2000 peak, a mere 11 points away from a grizzly bear market, or a decline of 20% or more. The Dow has dropped almost 1,500 points, or 13.5%, from its most recent peak of 10,858 on March 8. The USA's other two major stock indexes, the tech-heavy Nasdaq composite and the Standard & Poor's 500, are already deep in bear-market territory.

What's scary is that the spreading of the market decline from high-priced, speculative tech stocks to stalwarts like GE means even the most prudent, conservative investors are watching their account balances dwindle at an alarming rate.

"It's one thing to see Yahoo go down, but when you start to see the GEs of the world (roll over), it's a real confidence destroyer," says Chuck Carlson, portfolio manager at Horizon Investment Services.

"The Dow's (steep decline) signals that we've been gripped by the full teeth of the bear," says Jeffrey Hirsch, publisher of the Stock Trader's Almanac.

And history says the pain could last awhile. Since 1901, the Dow has suffered 19 bear markets, says InvesTech Research. The average bear lasts 19 months and drags down stock prices about 37%.

But averages only tell part of the story. On the bright side, the Dow hit its peak of 11,722.98 on Jan. 14, 2000. If this turns out to be an "average" bear, the Dow would hit bottom in July. While that means 4 more months of pain for investors, it's still a lot better than the 34-month bear during the Great Depression and the 23-month water torture of the 1973-74 bear.

The bad news? The Dow has a lot further to fall if it were to suffer an average 37% decline. In fact, it would need to tumble another 2,000 points, or 21%, before bottoming just below 7400. To match the 45% decline in 1973-74, the Dow would have to tumble almost 3,000 more points, or 31%, from its current level.

Many experts worry this downturn could have more room to run. "What's potentially scarier this time is that the declines are coming on the heels of a magnificent 5-year run for stocks," Carlson says. The Dow climbed almost 8,000 points from the end of 1994 through its peak on Jan. 14, 2000. "Bear markets basically shave off the excesses from previous bull markets," Carlson says, adding that it's not unusual for a correction to take back two-thirds of a major run-up.

More sobering news: Since 1928, it's taken investors who bought at the peak prior to bear markets an average 4.4 years to recoup their losses, InvesTech says.

Before investors get too despondent, it's important to remember that bull markets follow bear markets, says Hugh Johnson, strategist at First Albany. "Since World War II, stocks have risen 74% of the time, and since 1900, they've been up 64%" of the time, he says.

How today's bear market stacks up

Though the Dow Jones industrial average dropped to 9389.48 Thursday from its high of 11,722.98 on Jan. 14, 2000, a 19.9% decline, it would have to fall even more to match bear markets of the past:
 
 

EXCERPT FROM “THE DAILY RECKONING” NEWSLETTER  3/27/01
BY BILL BONNER

S.A.D. "Bears and cynics should enjoy it while they can," says a Forbes columnist, because it won't last long. The invitation is accepted. We will enjoy it with the same enthusiasm with which we would attend a tort lawyer's funeral. In today's letter I yield to temptation, and give myself over to the few pleasures a bear market affords: recrimination, gloating, I-told-you-so's and schadenfreude. 

There are two ways to look at the recent manic episode in the stock market. Depending on what mood you are in, you could see it as merely a case of "irrational exuberance" or it could be looked at more darkly - as almost criminally slick. "Someone is out of a lot of money," remarks the Washington Post. "And that someone is the retail investor. 

The insiders - entrepreneurs, venture capital firms, investment banks, and large institutional investors - pulled out their capital long before the fall, leaving mom and pop investors holding the bag. "Instead of the greatest legal creation of wealth," says the Post, "the high tech financial bubble represented the greatest ever legal transfer of wealth - from retail investors to insiders." Whether it was a just a Big Bubble, or a Big Con, the effect is the same - money is lost. But at least the latter interpretation leaves the victim with a grievance to fill the vacancy left by the departure of his fortune. Nursing it carefully, it could even grow into a promising lawsuit. 

Thus, for example, did shareholders in Dr.Koop.com take their case to the courts for redress. In the spirit of mischief, I offer the following details to aid the plaintiff's cause: The facts were reported by our own Ned Harper in "The Great Dr. Koop Swindle," of August 2000. "On February 15th, 2000," Ned wrote, "auditors came to [Dr.Koop's] Austin, Texas headquarters to have a look at the books. The accountants saw big trouble. They issued a 'going concern' warning on drkoop.com." You might think that news of this gravity might be the sort of thing the SEC would like to see passed along to investors. But the Dr. Koop crew apparently decided to keep it to themselves. "I went to the web site," Ned reports, and "had a look at the press release issued the day of the warning... "Titled 'Dr. Koop Grows Revenue 75%,'" CEO Donald Hackett made it sound like everything was coming up tulips. "The successful execution of our business strategy has firmly positioned the company for growth," he continued. Even in the information age, or so it seems, some information is not worth passing along. No mention is made of the "going concern" warning. Investors, alleging fraud, say that Dr. C. Everett Koop sold off $915,000 of his stock a week and a half after the warning. "In fact," Ned elaborates, "between February 15th and 18th, other panicky officers and directors sold off their shares for a profit of over $7 million...including Nancy Snyderman (the ABC News health reporter)..." The stock traded as high as $45. But, according to "Deathwatch" website, the company ran out of money on March 4, but today you can still buy a share for $.16. Attitudes change with the seasons of the market, dear reader. When the sun is shining, everything seems possible. Who would blame Dr. Koop when his shares were rising? But when the days grow short and the weather turns bad, investors get a form of Seasonal Affective Disorder (S.A.D.). They grow grumpy, sullen, surly - and litigious. 

Another target that might interest plaintiffs' attorneys is a company called Ariba Inc. "Consider the numbers," suggested Eric Fry on the Daily Reckoning website last October. "Since Ariba became a public company on June 23, 1999, insiders have filed to unload about 13.2 million shares of stock, to realize about $1.8 billion." The unloaders are living proof that some people made a lot of money from the Great Tech Bubble. "Not a bad haul for officers and associated muckety-mucks of a profitless company..." Eric continued. But "profitless" doesn't do justice to Ariba. If Dr.Koop was a case of irrational exuberance, Ariba was exuberance run stark, raving mad. The company was worth a colossal $36 billion at its peak, despite having only $200 million in total revenues from its inception in 1996 until Eric's piece appeared. And profits? Profits? Forget it. Ariba lost $463 billion in the 12 months leading up to Eric's report. Neverthless, "the reigning 'Queen of the Internet,' Mary Meeker and her Morgan Stanley Dean Witter colleague Charles E. Phillips lavished eloquent praise on Ariba in July 1999," Eric recalls, "just as the company began its public life - a life sired, incidentally, by the bankers on the other side of the Chinese Wall at [Morgan Stanley]." Apparently, just about everyone - except, of course, the ordinary retail investor - was in on the joke. "Although Credit Suisse First Boston analyst Brent Thill initiated coverage of Ariba on Sept. 24, 1999, with a buy rating, and followed up with 13 reiterations of his rating over the past 12 months, Credit Suisse Asset Management was not completely persuaded. It sold nearly 80,000 shares, or 43% of its original stake, in the quarter ended June 30. The names of the company's lead underwriter, its venture-capital backers and many of its initial investor-clients can be found on the list of selling insiders, as well." One of the biggest insiders was CEO Keith Krach. In a radio interview on April 12, Krach said he and his group "were building a great company in the 21st century and we are focused on the long run." Focusing on the long term did not prevent Krach from seeing his short-term interests clearly. Eric reports: "Krach has filed to sell 2.2 million shares (split adjusted) over the last 12 months, netting $179 million...even as the red ink mounted to almost a half-billion dollars last year, top management pocketed more than $1 billion from stock sales." "Little investors never stood a chance," concludes the Post. "Because they simply don't have the access - both to key information and to early deals, as big investors." But at least they have access to lawyers. A class action lawsuit against Ariba was filed last Thursday as the stock slumped to $9.12 after once trading at $173. Readers who would like to join the suit are invited to follow the sirens to the law firm's website at www.bernlieb.com. 

Your reporter, on his way back from the Trevi fountain, the Spanish steps, the coliseum...and other wonders. Bill Bonner * * * * * * 

VALUE FUNDS, BACK IN STYLE: FROM FORBES MAGAZINE

The Return of Value Funds:  James M. Clash & Neil Weinberg, 2/05/01

For the past decade value funds have been the wretches of the investing world. While tech funds took flight with double-digit returns, their value counterparts limped behind, burdened with stodgy companies like banks and food. For the ten years through 1999 the tech-laden, growth-worshipping Janus Fund turned in a scorching 21% annualized return. Value-conscious Vanguard Windsor II made only 14% a year. Windsor wanted cheap stocks, which usually means companies valued on Wall Street at low multiples of their earnings, dividends or book value. Janus owned fast-growing Cisco and Sun Microsystems, damn the P/E ratio. As long as Cisco's price/earnings ratio stayed high, its stock price climbed at the same rate as its earnings, which were bounding ahead. 

But there was no guarantee that Cisco's (P/E would stay put. The growth game came to an abrupt halt on Mar. 13, 2000. After an ungainly 330% climb in just over 18 months to 5049, the Nasdaq index, dominated by fast-growing technology stocks, turned back. It fell 51% by year-end. Mighty Janus lost 15% last year. And there is every reason to think the crash is not over. Trading at a still-enormous 102 times trailing earnings, Nasdaq must shed another 45% to get back to its historic market average.

Growth's misfortune has been value's opportunity. Spooked investors have dumped yesterday's glittering tech stocks and grabbed the pariahs of 1999 like health care, utilities and real estate-prime fare for value funds. By the end of last year the Russell 3000 Value Index trounced Russell's Growth Index counterpart, 8% to -22%. Mutual funds followed suit: The average value fund returned 10%, outpacing the average growth fund by 20 percentage points.

Remember that star investor of yesteryear, Warren Buffett? His Berkshire Hathaway stock a giant value mutual fund in drag, gained 27% last year. How about the lesser-known Jerome Heppelmann? His PBHG Small Cap Value Fund quietly gained 33% in 2000 And Windsor II, managed by James Barrow, rose 17% 

As 2000 wore on, fund investors began to realize that something was still winning in a dud market. The long-standing net outflow of money from value funds turned into a $100 million inflow in November, says research firm Strategic Insight. Meanwhile, growth funds' inflow flagged, from $16 billion in November 1999 to $4.4 billion a year later. It is highly likely that value will inch past growth in net flows very soon. Unless other investors-like pension fund managers and individuals buying stocks-go the other way, value should get the upper hand in its arm wrestle with growth.

Value has enjoyed brief moments in the sunshine in the recent past, only to be shoved back into the cellar. Jitters over Asia's economic meltdown tempered growth fund inflows and let value funds attract slightly more investment dollars in 1997 and early 1998. Then sexy growth funds roared back.

Nevertheless, a strong case can be made that value's run is just beginning. Part of this is psychological: Many techs, particularly those with small or nonexistent earnings, face a tough time wowing sobered-up Wall Street in an economically sluggish year. Most value fund managers are schooled in the disciplines of their grand vizier, the late Columbia Business School professor Benjamin Graham, so they have a penchant for solid companies with good earnings that bleeding investors should find comforting. Value stocks' still-affordable prices are another selling point. The cheapest 100 stocks on the S&P are going for a collective ten times earnings.

But the broader argument for value's ascendancy stems from the cyclical nature of investing. Growth had been up for a long time and now that it's catching its breath, value gets a turn at being kingpin. "I'm not even remotely concerned that value will die an early death," says Charles Royce, president and portfolio manager of the venerable Royce Funds, which have been listed on our Best Buys and Honor Roll rosters. His flagship fund, Pennsylvania Mutual, has posted percentage returns in the mid-teens through the 1990s.

Jeremy Grantham, chief strategist at Boston money manager Grantham, Mayo, Van Otterloo, has a little formula that explains why the value sector is on the upswing. He has some credibility: He was disparaging dot-com stocks back when all the smart money was talking about a new paradigm in investing Grantham looks at the average price/book ratio for the 125 S&P 500 stocks with the lowest such ratios, then compares that to the average for the whole 500. Historically, the bottom quartile averages a price/book of just over half the ratio for the whole market. By last March these bottom-dwellers were going for a price/book one-fourth that of the overall market. A recovery was long overdue.

Below are Forbes' Best Buys in small-, mid- and large-cap value funds. All are no-loads and combine good risk-adjusted returns with low annual costs of ownership. If you think value investing is the way to go, these are excellent choices. 

Five-year return 12/31/95 through 12/31/00; one-year return 12/31/99 through 12/31/00. Sources: Forbes; Lipper Inc.; Morningstar, Inc.
 Back to the  Top