FSO Editorials: Successful Investing ... by Robert B. Gordon 04/26/2004

Successful Investing May Be Easier Than You Think
by Robert B. Gordon, Sc. D.
April 26, 2004

Huge amounts of Wall Street advertising have been aimed at confusing and misinforming the investing public. They have sold trillions of dollars of stocks and mutual funds at or near market high prices to eager buyers, much of which will be sold later near market low prices.

The brokerage firms and the mutual fund industry have worked hard and skillfully to convince the public that, to assure reaching their retirement goals, they must start early and stay fully invested. They strive hard to prove it with very specially selected statistics and graphs. Shows like Lou Rukeyser’s have a weekly parade of experts, discussing the benefits of specific stocks, but never suggesting it is a bad time to buy. So the general public is fleeced again and only a tiny group of investors understand there is only one sure way to succeed - to buy low and sell high.

The twentieth century was fairly representative of stock market ups and downs. To simplify this discussion we will say there were 3 complete up/down cycles each roughly 33 years in length. There were highs in 1929, 1966 and 2000 and lows in 1900, 1932 and 1974. Any investor who started buying near a low and sold near a top was a very special and very happy investor. Please note that it required buying and selling within perhaps two years of the bottom and top.

This is not at all impossible since all you need is one very available number, the price to earnings ratio of the S&P500 stocks. Buy when it is very low, as in 1974, and sell when it is very high as in 2000. Any high school graduate has the ability to duplicate this result. The major requirement is the will power to go against the crowd, to buy when no one else is buying and sell when no one else is selling. That is a huge problem for most investors, who history tells us, love to act with a crowd. This why very few investors acquire great wealth.

Where is the market now with respect to the S&P ratio - at a screaming high value. No smart investor should be holding or even thinking of buying a common stock. What is going on today in the market? We have an absolute mania, many stocks with no earnings going to new highs daily. These misguided investors are facing financial ruin but are kept in stocks with the skilled help of their broker, advisor or the "experts" on CNBC. This is a tragedy but is perfectly legal. There is no money to be made in preaching Caveat Emptor to innocent investors but all fee-based and commission-based advisors gain their livelihood by continuing to sell their wares regardless of the market position.

I have recently given my readers a very revealing view from inside the mutual fund industry and I would now like to give you an expert’s view from inside the brokerage industry. The writer of these words, a true voice of experience, has been sickened by problems he has personally experienced.

"I have been in the investment business for 40 years, starting as a clerk on the American Stock exchange in 1965. I had the pleasure of learning from some of the trading greats of that time working as their clerk. In 1970 I was fortunate enough to get a position as an institutional sales trader, talking to the major New York banks. I was offered a partnership in 1972 as the youngest partner ever in the firm. I spent time as a manager at another Wall St. firm and in 1986 formed a new firm with my partner. I was fortunate enough to spend some time with Dr. Harry Markowitz as he put together the quantitative theory for our money management firm. In 1993 my wife became ill and I moved to St. George Utah. It was a big change but a pleasant one to gear down. Even in Utah I had a call from a former associate who wanted Amy and me to run his trading operation for his Chicago brokerage firm to our place in Utah I forgot to mention that my wife has also been in the business as a trader for 30 years. Never heard of such a crazy thing but we pulled it off for three years we handled almost all of their trading. We even had one of the first voice over internet systems operating between Chicago and Utah during market hours. In 1996 we were offered an opportunity to move to Chicago with a competitor firm to help fix and grow their institutional brokerage. This meant signing a 2 year contract, moving to Chicago and buying 5% of the firms equity. There is nothing that will make you run harder than having your own money at stake. In any case we were there two years and then were bought out by a much larger firm. We were once again asked to sign another 2 year contract and now owned a substantial portion of this new firm. I was appointed managing director of national trading. This basically entailed the risk management of about 100 million of trading capital a day. and making sure 30 traders in 4 offices did not screw up. This was one of the hardest jobs in my career and soon burnt me out. In 2001 we were bought out by another firm and they weren't looking for any old guys like me so we moved back to our place in Utah and I did nothing for 5 months. It wasn't any fun doing nothing so I took a consulting job with a brokerage firm in Chicago that needed to be turned around. After commuting from Chicago to Utah every other week for a year I had enough. The firm was fixed and profitable. Only thing is that they changed the deal at the end and screwed me out of a lot of money. I am finished working for other people in this business.

Your articles have helped inspire me to put a program together, a newsletter aimed at helping people learn how to invest themselves. Along with this I will be going through our church and others to organize seminars on the subject of self investing. I'm not sure how this will turn out but I believe there is a great need to inform the general investing population and in particular the baby boomers, how to deal with their investments. Lord knows my experience in dealing with brokerage firms for so many years gives me first hand information about how many of these firms bend the truth and the numbers to suit their own needs not the needs of the investor. My biggest concern is this tremendous down cycle that we are going into and how many will lose much of their retirement money as they did in 2000 because once again the government, brokerage firms, analysts, economists and news media have not the slightest idea of what is going on. I also think if they did know they wouldn't tell anyone the truth. After all they are in the business of making money for themselves not their clients. I have lost my taste for the investment business as it stands today and am almost ashamed to tell people what my occupation was for 40 years. With all of the thieves in this business I'm surprised that more of them haven't been put in jail. For years the specialists on the NYSE have been robbing the public by stepping in between trades. Believe me I worked with them and know how they do it. Problem is that they get fined 142 million after stealing billions and no one goes to jail. Worst of all are the Mutual funds that allowed trading in their funds by big hedge funds. It makes me sick that there is so much greed in this business.

Your approach to investing is right on and is a simple way for ordinary people to get a portfolio set up for what is coming in the future. Our own portfolio has had short mutual funds in it for a couple of years and we intend to add more as this market completes it's topping process and heads for wave 3 down. I know you are trying to get the word out to the public. I think very highly of your essays and would like your permission to use some of their content in my seminars and news letter. The more outlets for the public to gain information about investing and the problems that are around the corner, the better their chances will be of avoiding a disaster. I believe in fate and that the good lord is calling me to do this work. Any suggestions you might have would be very welcome. We are working on our first news letter and web site and will let you know when they are complete."

The individual quoted above is a man with intimate experience from the inside of Wall Street’s vast selling machine. His words should be taken very seriously. We wish him the best of success in his new venture. And of course, we encourage all readers to copy and circulate our essays to as many others as possible. But the probability of reaching and convincing bullish investors is very low.

Among the standard investment recommendations of Wall Street is one that is partly right, namely, that young investors should assume more risk than their elders. They are advised to buy common stocks for the "long haul". At a market low point, as in 1974, this would have been excellent advice. But near the recent market high in 2000, it could be very dangerous.

The history of past market crashes, is that prices have always dropped below their starting point at the final bottom. In the present case, this means that prices on the Dow would drop below the 1974 low of about 500. Very, very few investors know this fact and most of them would get a good laugh from such an outlandish prospect. But, the historic facts are there for anyone who cares to look.

We agree with Wall Street that young adults should assume more risk than their parents but it should be done with full knowledge of the many dangers that lie ahead. We will go into this in more detail later.

The lesson that I draw from market history is that no investor at any age should own a portfolio exclusively of "growth" stocks as we move into a great bear market. In contrast to the conventional wisdom, I will later recommend "anti-growth stocks" in the form of funds that are short the stock market.

Please do not expect the next century to be like the last. The magnitude of the recent bull market exceeded any that have occurred in the past 4 centuries and this is also true of the future bear market that will follow it. In other words, it is very unlikely to have just 3 lows and 3 highs. The final number might turn out to be either less or more. But the lows and highs will be measured on the same old scale of the S&P 500 P/E ratio with lows in the 6 to 8 range and highs in the 25 or higher range.

The great uncertainty of what lies ahead in the stock market, poses a huge problem to investors of all ages. Anyone who is within 20 years of retirement cannot wait until we get a major market low. It might be twenty years away. That is why we suggest serious consideration of short funds which are the only major asset class expected to make money in a long bear market. But success requires a balanced portfolio and regular rebalancing.

Couples nearing retirement with substantial assets are in a somewhat better situation if they take action immediately to sell their very risky stocks and bonds and adopt a tight discipline of capital preservation. Since the yields on very short term Treasuries are currently so low, even they need to think seriously of holding short funds to protect other holdings.

Our young wage earners may, with proper selection of asset classes, be the best situated to build capital over the next 40 years. Unfortunately, they are typically, so immersed in their career, that they are apt to choose any of the currently popular ways to invest which may not be very helpful. If we were able to move the clock back 60 years to our youth, we would probably now start long term accumulation of natural resources, precious metals and short funds.

This age group needs to have a very stable foundation for their assets. So we created a group of very stable asset classes to help safeguard their savings:

Annual Gain from 9/18/2002 to 4/23/2004
Allocation	Percent	Fund	Weighted %
Very Stable Assets
U.S. Treasury Money Market Funds	11%	1.5%	0.16%
U.S. Treasury Short Bonds	11%	2.5%	0.27%
U.S. Treasury Target 2005	11%	2.5%	0.27%
Total	33%		0.70%
Stable Assets
Hussman Strategic Growth Fund	11%	15.0%	1.65%
Hussman Total Return Fund	10%	7.2%	0.72%
Prudent Global Income Fund	10%	10.2%	1.02%
Total	31%		3.39%
Volatile Assets
Permanent Portfolio Fund	9%	16.1%	1.45%
Leading Energy Fund	9%	31.2%	2.81%
Total	18%		4.26%
Short Fund Assets
Prudent Bear Fund	9%	-12.1%	-1.09%
Reverse 30-Year Bond Fund	9%	-1.5%	-0.13%
Total	18%		-1.22%
Grand Total	100%		7.13%

For all our readers, not near retirement, please do not be shocked by our placement of the Permanent Portfolio in the Volatile Category. That is only for investors in their 60’s. This is a great fund for the long haul for younger investors but it has a permanent position of 25% in gold and silver and 30% in common stocks that have never been tested in a huge bear market. In an earlier essay we have suggested ways to improve the safety of Permanent Portfolio in combination with several other funds.

This portfolio can be started with slightly over $10,000 in a tax free account which is possible in a single account at discount brokers like Scottrade where there are no commissions on mutual funds held for at least 3 months. Buying the ten funds separately from their fund companies would involve much paperwork plus a very difficult time when the portfolio is rebalanced.

This portfolio will do even better with rebalancing, say once a year. This will do three things, all desirable over the long run:

If rebalancing is not done periodically, then the temporary profits from market volatility are lost for good. For more information on the advantages of rebalancing, please consult earlier essays.

We need to provide greater earning power and ease up a little on capital preservation, so we will modify our first portfolio to gain those objectives.

Annual Gain from 9/18/2002 to 4/23/2004
Allocation	Percent	Fund	Weighted %
Stable Assets
Hussman Strategic Growth Fund	20%	15.0%	3.00%
Hussman Total Return Fund	15%	7.2%	1.08%
Prudent Global Income Fund	15%	10.2%	1.53%
Total	50%		5.61%
Volatile Assets
Permanent Portfolio Fund *	15%	16.1%	2.41%
Leading Energy Fund	15%	31.2%	4.68%
Total	30%		7.09%
Short Fund Assets
Prudent Bear Fund	12%	-12.1%	-1.81%
Reverse 30-Year Bond Fund	8%	-1.5%	-0.12%
Total	20%		-1.93%
Grand Total	100%		10.77%

This seven fund portfolio does not require a capital preservation component and is primarily concerned with growth of principal. It will almost surely receive greater benefits from rebalancing than the ten fund portfolio above because of holding 50% stable and 50% volatile and short assets.

We need to provide even greater growth potential and less stability, so we will modify our second portfolio to gain these objectives.

Annual Gain from 9/18/2002 to 4/23/2004
Allocation	Percent	Fund	Weighted %
Stable Assets
Hussman Strategic Growth Fund	22%	15.0%	3.30%
Hussman Total Return Fund	16%	7.2%	1.08%
Permanent Portfolio Fund	10%	10.2%	1.02%
Total	48%		5.40%
Volatile Assets
Leading Energy Fund	10%	31.2%	3.12%
Leading Gold Fund	10%	26.1%	2.61%
Major Silver Stock	6%	56.2%	3.37%
PCL Timber REIT	6%	20.7%	1.24%
Total	32%		10.34%
Short Fund Assets
Prudent Bear Fund	10%	-12.1%	-1.21%
Reverse Nasdaq Fund	10%	-32.7%	-3.27%
Total	20%		-4.48%
Grand Total	100%		11.26%

These portfolios contain the results of my full lifetime experience, coupled with detailed studies of a variety of asset classes in recent years. I would be very happy to buy any of the three portfolios if I could turn the clock back.

Any experienced investor could use the data given above and proceed to build a portfolio customized to his or her situation. But this could be a disaster if attempted by anyone else. Please note the carefully selected totals for each of the asset classes. Any one who chooses to change them has to assume responsibility for the results. The dollar balance of the asset classes is much more important than the individual funds in each class.

We assume that the second and third portfolios above will benefit from the dollar cost averaging of periodic investments. This should greatly add to the overall returns, and especially so with the volatile and short asset classes. That is true today for anyone starting now. The short funds are at very low prices and the gold and silver prices are now in a sharp decline to lower prices. So now it would be a very favorable time to start a program.

Any of these funds should be started by buying the very stable and stable funds, and then adding a volatile and short fund as a pair. This will help stabilize the performance of each of the portfolios while they are being built. Remember that we are expecting a very volatile stock and bond market.

The e-mail response to my recent essays has been overwhelming, a huge number from here and abroad, that I have been unable to answer immediately while writing this essay. I will start to catch up as soon as this piece is posted. Although some of your words almost make me blush, it is good to know that my hard work is being appreciated. My goal from the start has been to get my knowledge and experience into your hands. The great thing about writing a series of essays, rather than a book, is that the writer continues to learn along with the readers.

You may be surprised to learn that my job of writing is one of sheer pleasure, since I am highly motivated to pass on my experience. So I try to be at my computer about 8 hours a day, but my aging body is making it very difficult to sit that long, even on a pile of foam rubber. I guess the only solution will be to get the capability to dictate directly to the computer while I recline at ease. But how do I do the tables? Does anyone have an answer?