"You will never be truly powerful until you take control of your own money: how you think about it and how you invest it. This book will show you how."-Suze Orman, bestselling author of The 9 Steps to Financial Freedom
The Bear-Proof Investor: Prospering Safely in Any Marketby John F. F. Wasik
Proven strategies for keeping your money safe and your investments growing no matter which direction the market is heading
After so many years of booming bull markets, the recent downturn has thrown a scare into millions of Americans. Novice investors are watching the news from Wall Street and wondering if they have any business being in the stock market anymore.
Proven strategies for keeping your money safe and your investments growing no matter which direction the market is heading
After so many years of booming bull markets, the recent downturn has thrown a scare into millions of Americans. Novice investors are watching the news from Wall Street and wondering if they have any business being in the stock market anymore. And if not, what then?
Veteran personal-finance author John F. Wasik has carved out a niche for himself dispensing time-tested, commonsense advice for the average middle-income investor and for working families-in other words, the overwhelming majority of Americans. Here, Wasik focuses on protecting, and even growing, your assets even if the market hunkers down for a long cold spell. His timely wisdom focuses on trend-proofing your portfolio, capitalizing on inescapable demographic shifts, identifying the long-term winners, value investing, dividend reinvestment, and dollar-cost averaging.
For the millions of Americans who want to stop worrying about their money, The Bear-Proof Investor is a lifesaver.
- Holt, Henry & Company, Inc.
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Read an Excerpt
The Bear-Proof Investor
Prospering Safely in Any Market
By John F. Wasik
Henry Holt and CompanyCopyright © 2002 John F. Wasik
All rights reserved.
Dancing Bubble Bears: A Brief History of Bear Markets, Booms, Busts, Risk, and What to Expect
Prosperity is not without many fears and distastes; and adversity is not without comforts and hopes. ... Certainly virtue is like previous odors, most fragrant when they are incensed, or crushed; for prosperity doth best discover vice, but adversity doth best discover virtue.
— Francis Bacon
The bubble bear danced in my head more than once over the past few years. Its growl, however, sounded like celestial music when the market soared, making me giddy with the thought of making more money in the stock market than working for an employer. She was wearing a tutu, dancing on floating bubbles, light as a cloud, soaring up higher and higher until ... reality hit about two years ago. My 401(k) account balance fell precipitously. Instead of making $1,000 a day, I was losing $2,000 a day. My wife's SEP-IRA accounts — all in technology and sector funds — didn't drop as much, but they made her sick with anxiety.
"Stay the course," the bear in the pink tights sang to me. And I did. Stayed in the high flyers whose upside at one time knew no bounds. She was a bear in my dreams, but she was a ballerina, pirouetting with each new market high. In my subconscious, I never questioned why she was a bear and not a bull, but dreams always speak truth in the form of images, if not borderline hallucinations.
Stock-market investing in the late 1990s was a hypnotic dream from which we've only begun to regain consciousness. Like the mythical dancing bear, it rarely stumbled, but mostly ascended on a bubble; it was the cherub of the new economy because everything had changed. It had to go up, it was the granite base of the info economy. What was the downside if everyone was investing in info technology at the same time? Could millions of investors and trillions of dollars be wrong?
I lost $30,000 on paper before I bailed out of my high-technology funds. Further market declines eroded my wealth by another $30,000. My wife lost the $10,000 she contributed to her SEP-IRAs before we "reallocated" into more conservative mutual funds (see chapter 11). That was how I stopped thinking about the dancing bubble bear. I no longer felt wealthy. The ballet was over. It was time for lower-risk investments, something safe and sustainable. And so the story begins of how I learned to ignore the dancing bubble bear and get on with my life.
Why You'll Have Some Fun
Although my family and I came out just fine in the dot.com crash — better than ever, in fact — I had a great time tracking down some of the most durable investment strategies of all time. Some of the techniques are familiar to anyone who's dabbled in investing. Others are not so familiar and deserve a closer look. In any case, this book is an exploration of ideas and philosophies of investing based on my idea that you need a sound "personal ecology" in your life, meaning a harmonious balance among the different facets of daily living (work, family, community, spiritual, and material needs).
My investing philosophy, however, goes beyond this short list of life tasks. We need to know when we are out of balance with all of the parts that make up our whole. In an ecological sense, if there are too many predators and not enough prey in an ecosystem, then there's starvation or migration.
The same principle applies to our money lives. If we are placing all of our bets on a small part of the stock market, we are taking undue risks that throw our entire material life out of balance. With the ideas I'll be discussing, you can reexamine your whole portfolio with an eye on risk while gaining sustainable returns.
All of the fine money managers I've interviewed have an impeccable sense of balance. They know where they need to be and where they shouldn't. That isn't to say they haven't made mistakes or had bad years in which very little they tried worked. Although they all need to make educated guesses about where they think the market may be headed, they don't try to predict the market in the short term. They spread their money out among hundreds of securities to blunt the effect of being in the wrong place at the wrong time. By diversifying among a broad variety of securities, they lower their overall risk, or the possibility that their securities will suddenly drop in value. The best managers are buying quality stocks, bonds, and real estate when others are selling. In this way, they are true investors, putting their faith in the market's ability to realize the true value of an investment over time. This is a perfect principle for any investor, no matter how sophisticated.
Discovering that it's relatively easy to create a portfolio that is adjusted for risk is the most satisfying part of what I am about to reveal. It works for anybody and you don't need to have an Ivy League degree to appreciate how it will enrich you. It can also be fun, when you realize that you can make money in down markets when others are losing their shirts.
Back to the Bear and Bubbles: Some History
So where did this $3 trillion go that went scurrying away in the night? Why did 401(k) assets drop an average $4,821 in 2000, the first decline in twenty years after a decade of unprecedented growth?
It is the nature of bubbles and bears — especially those that involve dancing — that few participants know what is happening until the bubbles burst. The dot.com blowout is really nothing new. Other bubbles have burst and people have survived them. The following are a few notable bubbles from the past that are worth revisiting:
Tulip Mania. The normally astute and commercially minded Dutch launched a fever called "tulip mania" in 1634 in the time of Rembrandt. Charles MacKay detailed the craze in his 1841 classic Extraordinary Popular Delusions and the Madness of Crowds, which is still in print. Tulip bulbs were the rage and investors were willing to pay almost any price for them. Some of the bulbs were rare; some were not. A speculative hysteria took hold. As MacKay recounts: "People of all professions turned their property into cash; houses and furniture were offered at ruinous prices; the idea spread throughout the country that the passion for tulips would last forever; and when it was known that foreigners were seized with the fever, it was believed that the wealth of the world would concentrate on the shores of the Zuider Zee, and that poverty would become a memory in Holland." Like those who bet on Cisco and Lucent going up forever, this fad came down hard and fast.
The Mississippi Scheme. A self-styled Scottish "economist" by the name of John Law talked the French court and thousands of French investors into investing in a bank that supported trading companies in then-untested frontier colonies of Louisiana and Mississippi. A handsome gambler and murderer, "Beau" Law eventually gained the support of Louis XIV, who was swimming in debt from wars and his own profligate living. In 1718, Law's scheme was declared a royal bank by the king and operated under the protection of the Duc d'Orléans, the regent of France. This decree caused the stock in the bank to rise twentyfold, so that by 1719 the bank was worth more than eighty times all of the currency in France. A shortage of shares then created a speculative frenzy. French bankers decided that they could pay off the national debt of France with shares from Law's company. The only problem was that Law's scheme was backed by false credit and the whole affair came tumbling down, plunging the government into bankruptcy and ruining tens of thousands of families. Law barely escaped with his life, eventually dying in poverty in Venice in 1729 and insisting on his deathbed that his bank was sound.
The South Sea Bubble. This British trading company had a monopoly over the new trade routes to the South Seas in 1720. Shares of the company were trading wildly in London's "Exchange Alley," climbing as much as 1,000 percent. Someone asked Sir Isaac Newton how high the shares could climb and he retorted, "I cannot calculate the madness of the people." The shares finally crashed.
The "New Technologies." Can you name a dozen railroads, steel companies, telegraph operations, and teletype concerns? Remember the New York Central or Western Union? How about linotype manufacturers (the hot type used by newspapers before lithography and computerized typesetting), Hollerith adding machines, and steam-powered factories? All attracted the speculative dollars of investors over the last 150 years or so. Take a look at the following list of companies that were the top companies in terms of stock-market capitalization (share price times outstanding shares) in 1912 at the height of the first information revolution, when electric appliances, lighting, telephones, and automobiles thrust the world into the modern age:
SURVIVORS AND SO-LONGS: TOP COMPANIES OF 1912
Market Value ($ in Billions)
U.S. Steel $0.74
Standard Oil $0.39
J&P Coates $0.29
Royal Dutch $0.19
General Electric $0.17
American Brands $0.17
International Harvester $0.16
TOP CORPORATIONS OF OUR TIME
Market Value ($ in Billions)
General Electric $409
Exxon Mobil $284
Royal Dutch/Shell $196
NTT DoCoMo $189
BP Amoco $188
Exxon Mobil was partially formed from two companies from the Standard Oil breakup early in the century. International Harvester shed its agricultural-implement and construction businesses and became Navistar, a truck manufacturer. General Electric has added hundreds of businesses since Thomas Edison founded it largely to manufacture electrical-generating and distribution equipment. Market caps as of 4/01. Source: The Economist.
As you can see, capitalism is an ever-dynamic force that is shaped by markets, consumer demand, economies of scale, and technology. As humans with brains that run on emotions as well as reason, we get caught up in the latest technological revolution. Think of how the world was captivated by mass installations of electric lighting. Our days became infinite inside our own homes. Or when we could call across the ocean at the speed of light or make the kind of structural steel that could support a hundred-story building. Who would not be moved by these great accomplishments the way we are awed by stem-cell research, computers that fit on your wrist, and drugs that cure nearly every infectious disease?
Although much of this may sound familiar — and the consumer/business press has regurgitated this history of manias many times by now — investors generally have short memories. We still are motivated by broker and brother-in-law tips or "somebody who works for the company." And this mentality has been in place as long as anyone can remember. We did not outgrow investing by rumor over the last several years as we progressed from the age of "Greed Is Good" to "Where's Mine?" Not that I find anything wrong with making money when the market is moving up. You'd be a fool not to participate (many didn't and lost ground to plain old inflation and stagnant wages). After all, you didn't have to dig ditches or clean toilets to make money in a market that couldn't lose. How do you avoid bubbles and manias when so many are convinced that it's the right thing to do? How do you avoid being slaughtered as part of the herd? You need to be realistic about long-term returns.
Being Realistic: The Age of Reduced Expectations
Despite the technology-heavy NASDAQ Index losing up to 60 percent of its value during the dot.com crash, investors remained unusually optimistic about the stock market. After all, in an age of elevated ego space, we've come to expect double-digit returns in the market. It's become an accepted fact in the information economy. So it wasn't surprising that the Wall Street Journal reported in a survey of investors in April 2001 — after a solid year of declines — that "the average American investor still expects double-digit future annual gains ... about one American in five, in fact, expects stock investments to gain more than 20% in a normal year."
I hate to disagree with the Bard, but when it comes to stock and bond markets, "past is not prologue." Just because stocks returned an average 16 percent a year for the fifteen years ending in 2000 doesn't mean that will always be the case. As historical data from Ibbotson Associates points out, if you take sixty-one rolling periods (of fifteen years each going back seventy-five years), there were just thirteen occasions when stocks generated 16 percent a year or more. Two of those periods, surprisingly, were in the late 1950s and early 1960s when most people weren't investing in the stock market en masse and mutual funds were a spark of what they are today.
Based on the unlikely scenario of double-digit returns continuing, Jonathan Clements of the Wall Street Journal warns, "Think you will earn 16% a year over the next 15 years? I wouldn't bank on it. For starters, you probably don't keep 100% of your portfolio in stocks and bonds."
Clements has plenty of company when it comes to predicting an era of diminished returns. Academics and industry experts who have been charting the market's progress and history their entire careers are stating their case for single-digit stock returns. Professors Eugene Fama and Kenneth French, two highly respected researchers from the University of Chicago and Massachusetts Institute of Technology, respectively, have studied stock returns over the past 130 years. The annual average stock-market return from 1972 through 1949, for example, was 8.8 percent. From 1950 through 1999, the postwar expansion boosted stock returns to the 14.8 percent annual average return. The two professors lean toward the earlier period as being the normal range of returns. They contend that in the expansion following World War II, investors were willing to pay a higher premium for taking more risk, not surprisingly called "the risk premium." Figuring out the risk premium is rather easy. It's any return above the "risk-free" rate you'd received on a U.S. Treasury bill, which is guaranteed by the full faith and credit of the U.S. government. (Well, virtually risk free, anyway.)
Being academics who know that history is a guide to future events, Fama and French claim that investors will only receive a 3 percent to 4 percent return above T-bills in the coming decades because stock returns are more likely to return to a long-term historical average, also prosaically called "reverting to the mean." That means stocks will return anywhere from 6 percent to 8 percent in the Fama/French model.
Robert Shiller, the Yale University economist who penned the bestseller Irrational Exuberance (Broadway Books, 2001) — the title is based on a pessimistic Alan Greenspan utterance — concurs with Fama and French for much the same reasons: "The evidence that stocks will always outperform bonds over long time intervals simply does not exist. Moreover, even if history supported this view, we should recognize (and at some level most people must recognize) that the future will not necessarily be like the past."
There are a number of reasons why the relentless surge of the postwar era may not continue. Stock-price increases are often a vestige of mass psychology. When the American public is mostly employed, making money and elevating its standard of living by buying things, corporate profits rise, which propels stock prices higher. If nobody bought — or felt they needed — Microsoft's products, for example, Microsoft would've gone the way of Western Union a while back. When consumers pull back, two-thirds of the economy retreats. That's what happens in a recession. Expectations are lower across the board and stock prices follow in lockstep. No corporate profit increases, no stock price ascent.
For all of the naysayers, however, there's an entire industry built on optimism, starting with Wall Street and its army of analysts. Author Harry Dent, a self-styled economist, for example, has made millions convincing people that the boom of the 1990s will extend into the first decades of the new millennium. His best-selling book The Great Boom Ahead (Hyperion, 1994) predicted that baby boomers will fuel unprecedented growth in the economy simply because they are in their peak spending years, which will be reflected in a surge in stock prices. Others joined the bandwagon of demographic prosperity, notably James Glassman and Kevin Hassett with their Dow 36,000 (Times, 1999). While the Dow Jones Industrial Average keeps shrinking as I write this, there's little doubt that a bright future for the stock market was shared by millions in the ebullient 1990s.
Excerpted from The Bear-Proof Investor by John F. Wasik. Copyright © 2002 John F. Wasik. Excerpted by permission of Henry Holt and Company.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Meet the Author
John F. Wasik is the author of The Kitchen-Table Investor (0-8050-6623-3), The Late-Start Investor (0-8050-5502-9), The Investment Club Book, and Retire Early-and Live the Life You Want Now (0-8050-6349-8). He is an award-winning special-projects editor of Consumer's Digest magazine and a lecturer at the University of Chicago. He lives with his family in Lake County, Illinois.
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