Winning with the Market: Beat the Traders and Brokers in Good Times and Bad

If you answered up, you're one of two things: retired and living on the proceeds of your investments, or a short-term trader looking to unload a position. If you're an investor -- the person for whom this book is intended -- you want the market to drop big and stay down for as long as you can invest new money. You know that's the only way to find lots of bargains and make lots of money over the long haul. Only when you're ready to be withdrawing money to support yourself in retirement do you want the market to rally.

But I'll be the first to admit that actually wishing for a big market drop is psychologically tough. I think back to the fall of 1998, when, after a period of astounding gains, the financial markets weren't doing so well. Russia had effectively defaulted on its government debt and thrown enough gasoline on the smoldering ruins of emerging markets to start a worldwide financial firestorm. The Dow Jones Industrial Average dropped nearly 20 percent from its peak, an event that had not occurred in several years. Small stocks were in a virtual depression, the market for initial public offerings was barren, and even the vast bond market had stalled, with the exception, of course, of the supersafe market for U.S. Treasury debt. The fallout from this market malaise spread rapidly. Big banks took heavy losses, hedge funds that had made huge and risky market bets were foundering, and the Federal Reserve was sufficiently frightened of the economic consequences that might follow that it quickly cut short-term interest rates to head off a recession. Fear was rampant.

What a great time that was to be buying stocks!

Yet what did I hear? Groans and moans from people who had seen their 401(k) plan balances drop 15 percent or so (and these were people who wouldn't be retiring for twenty or more years). Older investors who had been thinking about taking retirement started talking about staying around a few more years "until things get better." The only people who seemed to be enjoying life during that upsetting period were those who had most of their money invested in bonds and other safe investments. They took full advantage of the rare opportunity to gloat about how smart they were to avoid risky stocks.

There will always be an element of emotion involved in investing. After all, the nature of investing is to take risks seeking reward. As long as the rewards seem to far outweigh the risks, life is a bed of roses and account balances can rise to the sky. The only intelligent thing to do is put everything in stocks and bask in the riches that result. But when the risks seize the upper hand, as they inevitably will from time to time, panic sets in. Prices of everything are falling and can only fall further. There is no end in sight to the bad news. The same stocks that had you anticipating early retirement now seem like lead weights that must be cut loose if you're to survive financially. The all-too-frequent result of such emotional turmoil is this simple but disastrous formula: Buy high, sell low.

One key, then, to a successful investment program is to minimize the emotional component of investing. The better able you are to set aside emotions and act logically, the better your investment portfolio is going to perform over the years to come. This book is aimed at helping you temper the emotional roller coaster of investing.

Another key to a successful investment program is knowledge. But not the kind of knowledge you're thinking about. You probably want to be able to analyze a balance sheet and income statement of a company, figure out if some stock's price-earnings ratio is in line with those of other companies in the same industry, and project where interest rates are going. All that stuff is great if you're working on Wall Street and need to impress your clients. But that isn't the kind of knowledge I'm talking about. I'm much more interested that you know what can't be known. And that's easy: you can't know where stocks or interest rates are going. No matter how deeply you delve into business texts, no matter how many finance courses you take, and no matter how much some Wall Street brokerage firm is willing to pay you, the simple fact is that neither you nor anyone else knows what is going to happen to any single stock, to the overall stock market, or to interest rates. And if anyone tells you he can do these things, he's either lying or deluding himself. That's why I'm going to emphasize throughout this book that you do everything you can to avoid contact with the investment industry. I want you to enter a brokerless world where you make your own decisions free from the pressures and solicitations of people who will make money on your investments regardless of whether or not you do.

I'm not offering to make you a great investor. My very firm view is that it is exceedingly difficult to be a great investor. Peter Lynches and Warren Buffetts are few and far between. I don't know what makes them tick, and apparently nobody else does, either. People who try to emulate them come up short for some reason. And don't think that both Peter and Warren haven't made some bad calls. But it is my equally firm view that it isn't difficult at all to be a very good investor. There is no reason you cannot earn a healthy return on your investments, one that is consistent with your appetite for risk, if you simply understand that there are limits to what you can expect. And, perhaps as important, you won't waste hours of your time and thousands of your dollars in a futile effort to beat the market.

Presumably most of your investments will be made in U.S. financial markets. The U.S. stock market is the most efficient in the world. It is huge, highly liquid, well regulated, and thoroughly studied. What that means in practical terms is that it is well-nigh impossible for the average individual investor to know something about the value of a particular stock that somebody else hasn't already discovered and acted upon. The price you're quoted by a broker for a stock already reflects all that knowledge. Stocks that seem bargains usually deserve the price at which they're trading. Equally true, stocks that seem ludicrously overpriced also probably deserve the price at which they're trading.

I certainly don't mean to discourage you from investing. There are times when overall stock prices, responding to the overwhelming emotions that can grip millions of investors simultaneously, do fall to levels that are attractive. Certainly the crash of 1987 is one example. Those who steeled themselves to buy heavily in the aftermath of that plunge can look back on the crash as a seminal event in their portfolio's growth. And individual stocks can also be subject to emotional tumult, affording quick-witted investors a chance to buy at a reasonable price (or, better yet, to sell at an unreasonable price). But those occasions occur infrequently, and to wait until they occur is not a sound investment strategy.

I'd rather you go into investing with your eyes wide open, recognizing that it is unlikely that your stock and bond picks will outperform the overall market by any wide margin for any significant length of time. They certainly won't if you don't take careful account of the costs of investing -- brokerage fees, research publications, and software, for example -- or the tax consequences (Uncle Sam will gladly take up to 40 percent of any profits you make if you let him). More important, I want you to be able to minimize the amount of time you spend investing. You can't put a dollar figure on the hours wasted chasing hot stocks or the consequences of the stress on you and your family as markets and brokers whipsaw you around, only to leave you with subpar results. When you have finished this book, I hope you'll set your sights realistically and make every effort to become a good investor, not a great investor.

My wife, Jane, and I spend a lot of our free time on our sailboat Galaxie, ranging from the sandy shoals of the Bahamas to the rockbound coast of Maine. As a consequence we understand and appreciate the role of careful design and construction in building a seaworthy boat. Boats that endure the stresses of the ocean for years aren't thrown together willy-nilly. Rather, they reflect much forethought and an understanding of how they will be used, where they will go, and how much they will cost. One can't have all the latest electronic gadgets, the water toys, and the spaciousness of a floating palace without paying a high price. But one can have a fine boat that provides comfort, safety, and the ability to go anywhere in the world at a reasonable cost. My intention is to help you build a fine investment portfolio that will stand you in good stead for the rest of your life, no matter your age now. It will take time to build. Indeed, you'll be working on it for the rest of your life. But that isn't any less true of boats. Own one long enough and the engine needs to be replaced, the sails mended, ropes replaced, and the hull painted.

Like a boat, an investment portfolio can be as simple or as complex as you want. I have helped deliver big sailboats and even bigger powerboats up and down the East Coast. Some of the big motor yachts have been true marvels of engineering, design, power, and decor. The people who designed and built those boats were obviously very talented craftsmen. But the owners paid a huge price, not only to have the boats built, but to maintain and use them. Most of us have a hard enough time keeping up with simple suburban tract houses or two-bedroom co-ops and condos. We don't need such hugely complex and expensive objects, and that's true of our investments, too. A simple, low-cost portfolio can provide everything most of us need. There may be times and circumstances when you'll want to add some frills to your portfolio, and that's fine. Just know that they will invariably come at a cost and with a risk. <...