Look Forward NOT Backward!

Smart investors use volatile markets to upgrade their portfolios.  A common mistake investors make during market downturns is that they look backward, not forward.  Investors fixate on lost profits, on what they should have done.  This takes their eyes off what they should be doing to make money going forward. 

You cannot undo the past.  Smart investors don’t miss the future by looking at the past.  They take their lumps, learn their lessons, and do what they can to position their portfolios for the market’s inevitable reversal.  That means smart investors use volatile markets to trim their exposure and adjust accordingly. 

That’s the beauty of the market: at every ups and downs, there’s the probability to profit. 

Bottom line:  Nobody can tell you with certainty the perfect time to invest.  Nobody knows with certainty when a market has bottomed.  What I do believe can be said with a high degree of certainty is that markets move through peaks and troughs.  I can’t guarantee prices will be higher five or ten years from now, but history shows that a consistent investment program produces success over the long term.

First-Hand Experience In Fundamental Economics

Yesterday as my family and I were going into Target (TGT) to browse the toy section for holiday gift ideas, we witnessed a middle-aged man with a cart full of baby products (diapers, wipes, baby lotion, baby shampoo, and a small baby toy) walk out of the store without paying.  There were many people around, some noticed as we did, some didn’t and it was a busy time of day, almost perfect to pull off such a heist.

The man had a determined look on his face, almost a desperate, “I don’t know what else to do” look.  He simply focused straight ahead to the exit and never looked back. 

This is a prime example of how inflation affects America today.  Forget the recent Quantitative Easing solution that is “supposed” to help the economy, in truth all that money that pumped into the system only went to the top-tier citizens of the United States anyway.  The same citizens that caused this demise in the first place!

But, I can relate with the shoplifter, after all I have two young kids of my own, and a baby on the way.  Diapers costs $45 per box of 216 pieces.  Babies go through 8 per day on average.  So, in a little under a month, you’re spending $45 dollars on diapers alone, wipes come to about $20 per box on top of all the other expenses required for a baby.  Crib and crib mattress, sheets for the crib, a changing pad, strollers, car seats, appropriate-sized clothing, formula (if not breastfed), bottles for the milk, bottle warmers, disinfecting bags for pacifiers, bibs, and the list goes on and on!

Desperate times calls for desperate measure, and with the economy the way it is, where jobs are gone, incomes are down or at a plateau, consumer prices are up, the dollar value at an all time low, and lending institutions tightening their standards.  It’s no wonder some can be driven to bunk the system and steal. 

Brace yourselves, my feeling is, more and more people will be driven to do extreme things.

Simplicity Leads to Calmness

A big part of succeeding during volatile markets is staying calm.

When you’re calm, you make much better decisions.  When you’re calm, you don’t overreact to circumstances.  When you’re calm, you think more clearly. 

Being calm prevents you from making mistakes, in trading and in life. 

Of course, knowing you should be calm during crazy markets is one thing; actually being calm is quite another.

One way to ensure that you maintain a measured, calculated approach to volatile markets is by having a clear handle on your financial position and a clear plan of attack.  You do this through simplifying your investment approach.  Instead of choosing four or five stocks out of 7,500 or four or 5 mutual funds out of 19,000 to put in your portfolio, reduce the burden by Indexing.  This way, your costs are low and the probability of success increases in your favor.

The best piece of advice I’ve read about when it comes to trading strategy is the “KISS” concept.  Keep It Simple, Stupid!

I can’t think of any time when simple doesn’t beat complex.  That’s especially the case during volatile markets.

Be A Partaker, Not An Outsmarter

There are two kinds of investors:  Outsmarters and Partakers. 

Outsmarters believe they’re so clever they can beat the system, through inside advice and superior brainpower.  Partakers understand that the best way to make money is to share in the profits of successful businesses, by buying stock in Apple, Cisco, Walmart or McDonalds, for example.

Many investors, especially baby boomers, who are convinced they were born more brilliant than everyone else, begin their investing careers as Outsmarters.  They invariably get outsmarted themselves.

According to Bill Clinton’s autobiography, that’s exactly what happened to them in 1978.  They went into a typical Outsmarter deal-borrowing money to buy land in the Ozarks through Whitewater Development, a company they set up with an insider named James McDougal, along with his wife Susan.  Real Estate is especially tempting to Outsmarters since it’s a game in which the other players often appear to be rubes.  In this case, however, the Clintons and McDougals bought land for $880 an acre from a group that had purchased the property just 19 days earlier for $440 an acre.

The intention of the Whitewater investors was to find people to buy the lots at more than $880 an acre and make a big profit.  But in the end, they found that such buyers did not exist ($440 an acre turned out to be the right number).  The Clintons lost $68,300, according to an accountant’s report they commissioned.

The Clintons are just an example of Outsmarters out there as there are a lot of them.  There are, for example day traders, who think they can profit from tiny ups and downs of stocks over minutes or hours.  I do not doubt that some people can make a profit this way-after all, some people are born with the ability to throw a baseball 100 miles per hour.  But, beyond a tiny fraction of super talented and super-dedicated, day traders eaten up by the transaction costs-the commissions, the spreads between bid and asked prices and the interest incurred in buying stocks on margin.

Other Outsmarters are bottom fishers.  They figure they can identify stocks that have plunged but will soon emerge from the depths.  Occasionally, a smart investor will win by betting on these kinds of stocks, but most of the time…no.  When a stock is exceptionally cheap, there is almost always a reason. 

Remember that a stock that’s fallen can keep falling.  Did Internet Capital Group look like a good buy after it had declined from $196 to $45 in the first four months of 2000?  I sure did, and got burned in the process.  Over the next year it dropped to 34 cents.

Partaking, on the other hand, is the ticket to success in the stock market.  Investing in an index fund with an option to go Inverse (to profit when prices fall) is a way to share in the long-term growth and trend of the U.S. economy. 

My own preference is partaking in the growth of great companies.  Occasionally, it strikes me how incredibly generous the stock market is.  At little cost, I can become a partner in a business like GE, Microsoft or Apple, tagging along on a very profitable ride. 

Avoid Buy And Hold, Sell Your Big Loser!

I’m not a big fan of losing 70% of my money by riding down a stock that I should have dumped.  That’s the problem with buy and hold, it prevents you from selling investments.  You always risk having the big loser.  And that big loser can wreak havoc on a portfolio.

I read a story of a successful investor who, when on straight-to-the-point novice asked what this man’s secret of investment success was, replied simply, “Don’t lose.”

Take a stock that plummets from $100 to $20 per share.  That’s a decline of 80 percent.  But, for that stock to return to $100 per share, that price would have to rise 400 percent!

Now, take a portfolio that declines 50% (and many portfolios have declined 50% or more over the last few years).  The math here is quite simple.  In order to recoup your loss, the portfolio must increase 100 percent.

If you think about that in terms of time, the number of years required to recoup the loss (based on the stock market’s historical annual return of approximately 11 percent) is nearly seven.  In other words, based on historical market returns, a 50% decline in your portfolio shaves roughly seven years off your investment program.

Now, while nobody wants to lose seven years off an investment program, you can afford to play catch-up if you have an investment time horizon of at least 20 to 30 years, especially if you are willing to invest more money when stocks are down.

However, if you are someone in his or her fifties or sixties, the cost of losing big is even steeper.  You just don’t have enough time to make up the lost years as a result of one big hit.

Bottom line:  To everything there is a reason, including selling.  Volatile markets put an even greater premium on selling, as violent market moves can reduce capital gains in a surprisingly short period of time.