Investing without Wall Street E-Book

Sheldon Jacobs

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 474

Veröffentlichungsjahr: 2012

Beschreibung

Praise for Sheldon Jacobs

"Sheldon Jacobs is a level-headed gentleman who is a cross between Albert Einstein, the Dalai Lama, and Vanguard founder Jack Bogle and who had a solid record editing and publishing The No-Load Fund Investor financial newsletter for over a quarter-century."
—MarketWatch

"King of no-loads."
—Investor's Business Daily

"Dean of the no-load fund watchers."
—USA Today

"Among financial experts who are able to think with a small investor's perspective, no one is more level-headed than Sheldon Jacobs."
—Bottom Line/Personal

In July of 1993, Sheldon Jacobs was one of five nationally recognized mutual fund advisors chosen by The New York Times for a mutual fund portfolio competition. The portfolio that he selected produced the highest return of all contestants for almost seven years, and the Times quarterly publication of this contest helped him become one of the best-known mutual fund advisorsin America.

Investing without Wall Street shows investors how to achieve the greatest wealth with the least effort. It details the five essentials that even a kid could master and shows that they are all you need to be a successful investor. With this knowledge, the average investor can invest on his or her own and make $252,000 more than a person investing the same way who shares his or her profits with professionals. This book will teach you how.

Leseprobe

Contents

Preface

Introduction

Part I: The Five Essentials

Chapter 1: The First Essential: Determine the Right Asset Allocation

The Basics

Learn from the Big Boys

How the Ancients Allocated Their Wealth

Your Most Important Task: Determining the Best Asset Allocation for You

Important Lessons in This Chapter

Chapter 2: The Second Essential: Diversify within Asset Classes

Diversify Stocks with Broad-Based Index Funds

Defining “Broad-Based”

Forget Style Diversification

It’s Hard to Forecast Styles

The Solution

How Many Funds Do You Need?

Do Individual Stocks Have a Place in Your Portfolio? I Say No

Why the Fixation on Individual Stocks?

I Buy a Stock

Important Lessons in This Chapter

Chapter 3: The Third Essential: Understand and Control Risk

Measuring Risk

Betas Are the Most Common Way to Measure Risk

Managing Risk through Asset Allocation

Five Levels of Risk

Important Lesson in This Chapter

Chapter 4: The Fourth Essential: Keep Your Costs Low

A 40-Year Comparison Between Do-It-Yourselfers and Pay-a-Guy (PAG) Types

The Difference Between Load and No-Load Funds

Avoid Taxes as Much as Possible

Important Lesson in This Chapter

Chapter 5: The Fifth Essential: Choose the Right Financial Media to Follow

Where’s the Best Place to Get Financial Advice? A Poll

Important Lessons in Part One

Part II: Actions and Strategies to Implement the Essentials

Chapter 6: Developing Media Expertise

Listening to Individuals May be Hazardous to Your Wealth

The Press Lacks Numeracy

Be Aware of Press Biases

The Hierarchy of Investing Knowledge

Going Beyond Media Recommendations

The Perils of Perma Bulls and Bears

Avoiding Unhelpful Advice

Read About Scams

How to Game Contests

The Selling Advice Myth

Investing Seminars Worth Attending

Important Lessons in This Chapter

Chapter 7: How to Build Mutual Fund Portfolios for Lifetime Profits

Lifetime All–Index Fund Portfolio

Important Lessons in This Chapter

Chapter 8: Index Fund Investing: Beyond the S&P 500

Indexing—Yes; Market Cap-Weighted Indexes—Not Necessarily

The Equal-Weight Alternative

The Fundamental Indexation Alternative

Fundamental Weighting Doesn’t Win Every Time

Which Is Best Over the Long Run?

Some Fundamental Index Fund Choices

Important Lessons in This Chapter

Chapter 9: How to Survive Bear Markets

Too Little, Too Late

Adopt a Conservative Asset Allocation

How to Protect Yourself from the Next Crash

Important Lessons in This Chapter

Chapter 10: The Case for Market Timing

Buy and Hold—Not What It Used to Be

Market Timing Doesn’t Work, So Why Do So Many People Listen to Market Timers?

Where Are We in the Cycle?

How to Use a Timer

Criteria for Hiring a Market Timer

Rebalancing: A Form of Market Timing

Tactical Asset Allocation: Another Form of Market Timing

Strategizing Fund Distributions

Mutual Funds Don’t Market Time

Charts, Schmarts; You Have Facts

Stop-Lossing Stocks and Mutual Funds

Important Lessons in This Chapter

Chapter 11: The No-Work Way to a Comfortable Retirement . . . Maybe

How to Invest without Paying Attention

TDF Alternatives

Important Lessons in This Chapter

Chapter 12: Dealing with Professionals

Bert Jacobs’ Story

Cold-Calling Brokers

Lessons from the Madoff Mayhem

How to Reduce the Chances of Being Scammed

Do You Fit the Victim Profile?

Advice for Those Who Have Been Taken

Independent Financial Advisors

Important Lessons in This Chapter

Part III: Becoming a Well-Rounded Money Maven

Chapter 13: For Clearer Thinking

Correlation Is Not Causation

Are Patterns Projectable?

Some Correlations Make Sense

Why Averages Can Be Misleading

The Best Six Months

The Fallacy of Missing the Best Days

Do You Benchmark Your Performance?

Rules of Thumb

Know What You Don’t Know

Know What Is Unknowable

And Know What Your Advisors Don’t Know

The Difference between Investing and Speculating

Answers to the Clear Thinking Quiz

Important Lessons in This Chapter

Chapter 14: The Psychology of Investing

Anchoring

Randomness in the Markets

Boldness

Don’t Gravitate Toward Round Numbers

Being Too Comfortable

Myopia

Playing with the House’s Money

Buying High and Selling Low

Bull Versus Bear Market Behavior

Why Employees Overweight Their Own Company Shares

What Are Others Thinking?

Greed

Important Lessons in This Chapter

Chapter 15: Integrity, or the Lack of It

How the ICI Fought the Banks—and Won

The Mutual Fund “Market Timing” Scandal

John Bogle

Mark Hulbert

Chuck Schwab

Robert L. Rodriguez

Integrity in the Media

How to Go from Best to Worst in Five Years

I Don’t Know

I Was Wrong

Important Lessons in This Chapter

Chapter 16: Women Aren’t Different; They Just Live Longer

Profiles in Success

Important Lessons in This Chapter

Chapter 17: Adventures in Collectibles

Why I No Longer Collect Stamps

I Love Art

Important Lessons in This Chapter

Chapter 18: Vanity Investments

How to Invest in a Broadway Show without Having to Mortgage Your House

Don’t Invest in Anything That Eats

Important Lesson in This Chapter

Chapter 19: Increasing Your Workplace Income

Own Your Own Business

Don’t Leave Your Business to Your Children

Really Going Your Own Way

Advice from Jonathan Clements

Die Broke

Important Lessons in This Chapter

Epilogue

Appendix

Glossary

Acknowledgments

About the Author

Index

A wise man should have money in his head, but not in his heart.

—Jonathan Swift

Copyright © 2012 by Sheldon Jacobs. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data:

Jacobs, Sheldon.

Investing without Wall Street: The Five Essentials of Financial Freedom / Sheldon Jacobs.

pages cm

Includes index.

ISBN 978-1-118-20464-1 (cloth); ISBN 978-1-118-22839-5 (ebk); ISBN 978-1-118-23927-8 (ebk); ISBN 978-1-118-26560-4 (ebk)

1. Investments. I. Title.

HG4521.J2534 2012

332.6—dc23

2011045566

To my wife, Betté, who has enriched my journey with love.

Also by Sheldon Jacobs

Put Money in Your Pocket: The Art of Selecting No-Load Mutual Funds for Maximum Gain

The Handbook for No-Load Fund Investors (20 annual editions)

Sheldon Jacobs’ Guide to Successful No-Load Fund Investing (2 editions)

How to Pick the Best No-Load Mutual Funds for Solid Growth and Safety

Preface

With some books the Preface is unimportant. That’s not the case with this book. This preface provides an overview of what investors really need to know to prosper in today’s markets, which are so very different from the ones we loved in the 1980s and 1990s. But first, I need to quickly touch on two money-making basics.

1. Do-it-yourself is the real key to lifetime profits.

First of all, you need to appreciate the huge difference between doing-it-yourself and hiring professional guidance. Although there is value in a book explaining the best ways to work with a broker or professional investment advisor, the real benefit comes from a book that teaches you, simply and clearly, how to do it yourself.

The wealth difference is overwhelming. Over a 40-year investing lifetime, an average earner can make $252,000 more doing it him or herself than a person who has to share his or her profits with professionals. That’s a lot of money going to advisors, not you. That’s why this book is titled Investing without Wall Street! (See Chapter 4 for the computations.)

Achieving this wealth increment is within everybody’s ability and takes very little time. In addition, by doing it yourself, you will know your self-interest has always been put first. That’s no small thing in an era where crooks like Bernard Madoff stalk uninformed investors. Investing without Wall Street gives you control of your finances.

2. Savings are crucial.

All the advice offered in this book is academic if you have no money to invest. Money is accumulated by saving. Savings are not just a good idea; they are crucial.

There is no need for this book to discuss the mechanics of saving. You simply spend less than you earn. If you don’t already have savings, start saving. Start as early as you can, the earlier the better. If you have some savings, save more.

A 12-Year-Old’s Commentary on Saving

The top reasons why I think it is important to save are:

1. To help me tell the difference between my needs and wants

2. To gain interest on my money

3. To save for larger things such as a bicycle

4. Currently I am working to raise money to go to camp next summer.

Sarah, Shepherdstown, WV. Reported by Michelle Singletary, WashingtonPost.com.

As Bill Donoghue, the money-market maven, once said, “If you can’t live on your income now, you can’t live on 10 percent less. So save 10 percent.”

Here’s a summary of the book’s investing advice and philosophy.

Today’s Times Call for More Conservative Strategies

In the 1980s and 1990s, the buy-and-hold investing strategy superseded all others. You didn’t have to be a brilliant stock- or fund-picker; all you had to do was buy-and-hold stocks, and you could have earned 18 to 19 percent a year.

The market is unlikely to achieve gains of this magnitude again in my lifetime, and possibly yours. That’s because secular bull markets, the long-lived megatrends that last 5 to 20 years, usually occur only when there are dynamic new, giant growth industries such as computers, information technology, the Internet, and in earlier eras, canals, railroads, electricity and automobiles. They provide the basic foundation. All these advances had myriad applications over a broad range of industries. I don’t see anything comparable on the horizon. Technological advances since the computer and the Internet became mainstream have been more evolutionary than revolutionary. The new social media are evolutionary, even though they have produced several billionaires.

For many years to come, I believe stock markets will be in a secular bear market. They will move up and down, not basically up as in the 1990s. I expect average gains over the next decade or more will be in the neighborhood of 6 to 7 percent annually. That’s because I don’t see any reason for the price/earnings (P/E) ratios of stocks to expand significantly in the coming years, and they may possibly contract. (In the 1980s and 1990s, 43 percent of all gains came from P/E expansion, as investors paid more and more for a dollar of corporate earnings.) I believe stocks, over the next decade or more, will at best gain pretty much in line with their earnings increases (which will depend to a greater extent on the economy than has previously been the case).

The good news is that this means stocks can still deliver returns superior to bonds or cash, albeit with greater risk (which I’ll show you how to control). The best news is that since stocks declined 38.5 percent in 2008, they could easily have double-digit gains over the next five to six years, and return to that estimated long-term average.

A study by Capital Guardian funds found that when the S&P 500 Index had an annual return of 2 percent or less over a decade, stocks gained between 10 percent and 17 percent annually in the ensuing decade. The annualized return for the 10 years ending 2008 was −0.93, and the S&P 500 gained 23.5 percent in 2009 and 12.8 percent in 2010.

Regardless of the volatility, equities must continue to have a place in your financial planning, particularly if you are young.

Sheldon Jacobs’ Statement of Purpose

Investing books are commonly written to enhance authors’ careers. However, that was not my motivation. I’ve had two successful careers, each a quarter-century long, and I have no desire for a third go-to-the-office job. I didn’t write this book to sell newsletters or obtain managed account clients. I sold both my money management business and newsletter a few years ago, but I continue to work as a contributing editor of the Investor newsletter. In addition, I am on the Finance Committee of the Westchester Community College Foundation, in New York, where I help to manage a multi-million dollar institutional portfolio. And lastly I manage my personal investment portfolio.

The purpose of this book is to share with others the important lessons I have learned over a lifetime. I have always written about what interests me. And right now, what interests me is making my investing as simple as possible. Investing without Wall Street is a guided tour based on personal experiences. Most of the strategies that I offer in this book, I have tried myself. I know they work.

I am not a genius. I have always looked for ways to make money without being a Goldman Sachs-level expert, and I promise you that any ordinary person will be able to implement the profit-making recommendations in this book.

There are two reasons for this. First of all, investing literature commonly attempts to tailor advice by investor demographics (age, wealth, time horizon) and risk preferences. Investing without Wall Street does this too, but in addition, it offers advice by degree of desired investor involvement. It speaks to investors who are willing to spend time to obtain the best results, but mostly to the more numerous investors who are simply seeking a comfortable nest egg while getting on with their daily lives.

Secondly, the specific advice offered takes into account what I think investors will actually do on their own, since no matter how wise the advice, it’s not productive if investors don’t follow it.

Finally, you’ll quickly see that I don’t always agree with the conventional wisdom, and as you discover how much about investing there is to learn, you also may find you have even more to unlearn.

In November 2010, the Bottom Line Personal publication observed, “Among financial experts who are able to think with a small investor’s perspective, no one is more level-headed than Sheldon Jacobs.”

My Approach to Financial Profits

Between 1974 and 2004, I wrote 24 books as well as The No-Load Fund Investor, a top-ranked monthly, mutual-fund newsletter that I founded to provide specific investing advice, recommendations, and model portfolios. The books and newsletter basically offered advice within the framework of a secular bull market. Because investor interest was concentrated almost exclusively on profit seeking in those bull market years, like virtually every investing publication in those decades, I placed greater emphasis on profits than on risks. Even though my recommendations in those years were conservative compared to most of my colleagues, long-term bearishness would not have served my readers.

But times have changed, and so has my advice.

In Investing without Wall Street I have expanded on the tried and true wealth creation programs to take into account the challenges of the new market climate. Investing without Wall Street emphasizes both risk control and profits by zeroing in on five “essentials.”

The Five Essentials

The book is divided into three parts. Part One (Chapters 1–5) discusses five principles that are the essence of the knowledge you need to be a successful equity investor. Master these five “essentials” and you’ll have the wherewithal to be a successful investor without the need of professional assistance. They are your priorities.

1. Determine the right asset allocation.

2. Properly diversify within asset classes.

3. Understand and control risk.

4. Keep your costs low.

5. Choose the right financial media to follow.

I suspect that at this point some of you are thinking, “I’ve heard most of these principles for ages.” And probably you have, but I will bet that a good number of you have never really understood their importance, or how best to apply them.

You will also notice that security selection (choosing specific stocks or funds)—most advisors’ favorite recommendations—is not one of the five “essentials.” Notwithstanding its ubiquitous coverage by the media, it’s a myth that you need a lot of knowledge in this area.

Security selection can be simplified to the point where you can make good selections effortlessly. Equally important, if you follow the five essentials, security selection won’t be a make-or-break factor in your investing efforts. The purpose of this book is to make you a better investor, not to load you up with tips about specific investments.

In the 1980s and 1990s, investors achieved success by mostly just being in the market. Over the next decade, I believe the key to success will be you—how you approach investing, how clear-headed is your understanding of the market’s underlying realities, and whether your skills and attitudes are right for the times.

Part Two (Chapters 6–12) refines and provides specific ways to implement the five “essentials.” Included are my “takes” on surviving bear markets, the latest advance in index fund investing, and model portfolios that put into practice the “essentials.” In Chapter 10, I make the case for market timing.

Part Three (Chapters 13–19) discusses important and timeless lessons that I have learned over the years as an investor, investment advisor, money manager, editor, entrepreneur, and observer of human nature. These chapters show how you can profitably expand your general money knowledge. They will give you an overview of personal money management situations seldom, if ever, covered in other personal finance books or periodicals.

Here are some of the topics covered:

Acknowledging that investing is a science dealing with uncertainty, Chapter 13, titled “For Clearer Thinking,” shows that it’s just as important to learn how to think, as it is to learn what to think. It offers lessons in clear and critical thinking. Similarly, Chapter 14 discusses behavioral finance, now an important frontier in investing knowledge. With a few exceptions, my take on the subject ignores the academic approach, concentrating instead on practical applications.

The purpose of these two chapters is to help you acquire the skepticism and creative thinking that are important to financial success. Again, “The key will be you” is not just an empty phrase. This adage is just as important as the fundamentals.

Chapter 16 aims to help women achieve their investing goals, and in Chapter 17, I briefly discuss owning collectibles for profit. Another chapter tells you how to invest in a Broadway musical with a relatively small outlay. Few readers are likely to make such a high-risk investment, but my experience as a backer of Hairspray was fascinating and brought me so much enjoyment I had to share it with you.

Integrity is so important when you are giving your hard-earned dollars to impersonal businesses or total strangers that I have devoted an entire chapter to it.

Because almost everybody makes far more money in the workplace than they make from investing, I offer advice in Chapter 19 to both employers and employees, based on my personal experiences as the owner of a small business, and as an employee of two large corporations.

Although there is a chapter titled “The No-Work Way to a Comfortable Retirement—Maybe,” don’t be misled. Investing without Wall Street is not a “lazy man’s” guide, or even a “permanent” portfolio strategy. Quite the contrary, it’s for people who want maximum results for the time and effort they spend investing. It’s for young investors who want to learn it right the first time.

Investing without Wall Street also shares stories of interest. As Adam Smith said in the Preface to the Money Game, the classic tale of Wall Street in the 1960s, “Enjoy the stories, they always teach more than the rules.” That’s what Wall Street does to sell stocks to investors. That’s what I have done in Investing without Wall Street: recounted stories that will “sell” you investment strategies that are profitable for you, not for Wall Street’s promoters.

Although I favor funds, the insights I offer are relevant whether your preference is mutual funds, exchange traded funds (ETFs), stocks, or anything else. And for those of you who are wealthy enough to have personal money management, Investing without Wall Street provides a valuable guide for riding herd on these advisors, something that every managed account client should do.

Finally, this book contains many of the usual investing and Wall Street terms. If you don’t know a particular term, there is a glossary at the back of the book that will make you an expert on this jargon.

Introduction

Take a Journey with Me

You might think that there is only one investing world, but there are many, and their differences go far beyond investing strategies or financial products. There are the separate realms for hedge fund operators, stockbrokers, commodity traders, gold bugs, and day traders. There are perma bulls and perma bears. There are also the worlds of investors who rely on advisors, the do-it-yourselfers, the stock-pickers, asset allocators, market-timers, trendsetters and trend-followers, the involved and the uninvolved.

My foray into a different world explains these distinctions. Back in the 1990s, I was invited to make a speech to the subscribers of an Internet stock market trading system. I knew that investors who traded on the Internet were not the audience for my style of moderate risk, diversified investing. But the invitation had come through a friend who had recommended me, and the sponsor offered me a substantial fee, so I accepted.

Before I was called to the podium, the president of the Internet trading company jumped up and said he wanted to poll the audience, about 100 strong, to ascertain their risk preferences.

Using a scale of one to ten, with ten being the most aggressive investing and one being the most conservative, he asked, “How many people are tens?” About five people raised their hands. “How many are nines?” About 25 people raised their hands. “Eights?” At least 50 responded.

I thought to myself, “Good grief, I’m a four, and this audience wants advice that will make them a killing in the market tomorrow.” Well, I delivered my usual speech and only one person walked out. Although I considered it a moral victory, I tried hard never to repeat that experience again. And, thankfully, I never did. Time is precious and I hate to waste investors’ time with advice they are unlikely to accept.

This book is for investors with risk tolerances ranging from about three to seven. It’s not for eights, nines, or tens. If you’re an eight or higher, and are perusing this book in a bookstore or library, put it back on the shelf. This book is not for you and I don’t want to waste your time. By my standards, you are not really an investor. You should be in a casino playing the slots.

On the other hand, if you are a one or two, stick with your bank CDs, savings accounts, or e-bonds, unless you want to learn how to increase your wealth with only a moderate increase in risk.

My world is primarily the world of diversified, low-cost, no-load mutual funds that you invest in for the long-term. I first ventured into no-load funds because I figured that any financial product that is always on sale had to be the right world for me.

A four is right for me, and some other number may be right for you. That’s okay—people are different.

In this book I would like to take you on a journey through my world of investing. It will be fun, and you’ll find it worth your time. But before we get down to the main business of this book—improving your investing skills—I want to briefly tell you about the town I grew up in, since it has a strong bearing on who I am and how I came by the advice I will be dispensing.

How My Journey Began

I grew up in Deadwood, in the Black Hills of South Dakota. If you drove through Deadwood back in those days, you might have thought it was an ordinary small town. But Deadwood was unlike any other small town in the United States, and everyone living there knew it. Deadwood had been the scene of one of the country’s most notable gold rushes, and the town never lost its frontier spirit.

In the forties, when I grew up there, the town had a population of 4,000. There are many small towns where people live because they can’t make it in the big city. But that wasn’t true of Deadwood. Some of the sharpest people I have ever met lived there. They could have made it anywhere, but they preferred Deadwood because of the breathtaking beauty of the Black Hills, its heritage, its sense of small town intimacy, and its proximity to Mount Rushmore. There was great hunting, fishing, skiing, camping, and mountain climbing, all within an easy drive. For climbing, there was Devil’s Tower, which later on gained fame in the Steven Spielberg movie, Close Encounters of the Third Kind, and Harney Peak, which at 7,242 feet is the highest peak between the Rocky Mountains and the French Pyrenees.

The town had a strong Libertarian bent. Its Main Street, filled with prosperous stores, was the shopping center for 40 miles around. It was home to seven churches and seven bars, and each bar had a room in back for gambling, usually slots, blackjack, and crap tables. There had always been gambling in Deadwood, ever since the gold rush days. Technically, it wasn’t legal, but the state never bothered to enforce the law.

In those days (the 1930s and 1940s) Deadwood also had three houses of prostitution. All were on Main Street on second floors, above the bars. And they all had neon signs at street level advertising their presence. The signs read: Ma’s Nifty, the Cozy, and the Shasta.

Everybody in town favored these businesses, including the clergy, because they brought in tourists, which were one of the two lifeblood industries of the town. “Everybody” certainly included my dad, who was born and raised in Deadwood, and was totally accustomed to this environment. He approved of anything that brought in business. The “girls,” as everybody called them, did a lot of shopping in my dad’s ladies ready-to-wear store.

The other lifeblood was gold mining. The fabled Homestake Mine, once owned by George Hearst (William Randolph Hearst’s father) at the time the largest gold mine in the Americas, was located in Deadwood and in nearby Lead, South Dakota. The mine was listed on the New York Stock Exchange (NYSE) in 1879 and continued producing gold for more than 120 years. Homestake became the longest-listed stock in the history of the NYSE and brought millions of dollars of revenue into town.

Deadwood’s liquor laws were loose, to put it mildly. Of course, South Dakota had laws regulating drinking, and I guess they applied to Deadwood, too. But the reality was that liquor was regulated in Deadwood not so much by age as by height. If you were tall enough to stand at the bar and pound it with your fist, it was likely you would be served. You could even drink 3.2 beer legally at age 15.

Another convenient thing about Deadwood, and actually the entire state of South Dakota, was that you didn’t need a driver’s license to drive a car in those days. The sole requirement was to be 15 years old. Consequently, when we all got to be about 14 and a half, we badgered our fathers to teach us how to drive so we could drive on our own as soon as we reached 15.

During my lifetime, things changed radically in Deadwood. In 1947 the state of South Dakota finally decided to enforce the gambling laws, and that had a crippling impact on commerce. The brothels were closed in the late 1970s in an action that drew national coverage. Then one day right after the last brothel closed, hundreds of people paraded down Main Street holding up banners reading BRING BACK OUR GIRLS!

In 1989, Deadwood got a new lease on life when the state of South Dakota made the town an exception to its gambling laws, just as New Jersey did for Atlantic City.

Main Street, which used to have regular stores catering to families, is now wall-to-wall gambling casinos its entire length—139 in all if you count the stores with slots. The ladies ready-to-wear store, once owned by my dad, is now a casino called the Midnight Star, owned by the actor Kevin Costner and his brother.

The new gambling money has spruced up the town. The streets have been repaved, and almost all of the storefronts are new. There are several new hotels and restaurants.

And it was just in time. Two years later, the Homestake Mine, its gold finally exhausted, closed for good. If it hadn’t been for the gambling dispensation granted by the state, Deadwood would have become a ghost town. Even with the gambling, the town’s population has dwindled to 1,270 according to U.S. 2010 Census. Deadwood will be around for a long time, but it’s not the same town now that it was for my generation.

In 1964, Deadwood became the only city in the United States to be named a National Historic Landmark. In 2004, it received a new measure of fame when HBO launched a western TV series, Deadwood, set there. In 2009, ForbesTraveler.com selected Deadwood as one of the twenty prettiest towns in America.

And now you need a license to drive in the state of South Dakota, including Deadwood.

When gambling closed in Deadwood, many of the town’s gamblers moved to Las Vegas. So the first time I went to Las Vegas I looked up two of them, Virgil Rakestraw (Rakie) and Eli Gasson.

I found Rakie, a big hulk of a man, dealing at a roulette wheel at the Stardust casino. When he took a coffee break, we discussed gambling. “Never gamble in Vegas,” he admonished. “It’s different than Deadwood.”

I knew what he meant. In Deadwood, if the casino saw a local man gambling away the rent and food money, they made him stop for the sake of his and his family’s well being. That didn’t happen in impersonal Las Vegas.

I found Eli working as a pit boss at a small casino. Over coffee, he also warned me not to gamble in Vegas, though he made an exception for poker. I politely accepted his advice, but it was meaningless to me.

I knew Eli was a world-class poker player. According to legend (probably Eli’s), he was the champion poker player of the Pacific fleet during World War II. How he came by this title I never understood, although I believe there was some legitimacy to the claim. If he were around today, I’m pretty sure he would be earning big bucks on TV.

Poker is a game of immense skill, not luck, although in the short run, luck can temporarily overcome skill, just as it can in economic life. I am sorely lacking in the skills needed to win at poker. (I know, because I learned how to play the game at Boy Scout camp—and never won.) In addition, poker, too, is a zero-sum game, and finally, in poker if you lose there is no TARP to bail you out.

For many years I went to Vegas once a year to speak at the Money Show (see Chapter 5). I always heeded Rakie’s and Eli’s advice, although the real reason I don’t gamble is that gambling is a zero-sum game less the house edge, meaning for every winner there’s a loser. Stocks, on the other hand, are a positive-sum game. By that I mean it’s quite possible, and often likely, for all the players to win, since they can participate in earnings growth over time. I don’t like to lose, so I prefer the far better odds of long-term investing.

When I asked my eight-year-old granddaughter, Sarah Jacobs, if she knew what a casino was, she said, “Sure, it’s a place where you play with real money.”

I have often thought that the world of gambling I had grown up with led me to the world of investing. I bought my first stock, Homestake Mining, when I was still in high school. The money came mostly from summer jobs. I held it for three years and sold it for a small loss. In retrospect, my mistake was confusing familiarity with knowledge. Just because I could see the mine from my house, it didn’t mean I had sufficient knowledge of the politics and economics of the mining industry. I didn’t even know Homestake’s earnings. And even if I had known Homestake’s earnings, I would not have known how to interpret them.

I left Deadwood to attend college, and I never did go back to live there. Had I, I would have become the third generation of my family to operate the family stores.

During the Korean War, the Army called me up and, in its infinite wisdom, stationed me in Times Square. New York hooked me. I liked the theater, museums, and most of all its restaurants, which were far better than Deadwood’s. Upon discharge, I decided to stay in New York. Much as I liked Deadwood, New York was my kind of town. But even with my parents now gone, I still return to Deadwood for short visits every few years or so.

Chance made me a New Yorker. But I probably always was.

New York, New York

I have had two careers in New York. The first career was in broadcasting. I worked 25 years for ABC-TV and NBC-TV doing media research. I became an expert in TV ratings. I studied and forecast audiences (which ironically was good training for forecasting mutual fund performance).

This is not the book for broadcasting stories, but there was one time when I was able to combine my broadcasting industry knowledge with my interest in investing.

In late 1965, ABC invited hundreds of advertising executives to a breakfast to preview programming that would premiere in a few weeks. On this morning, a five-minute clip of the show that would become Batman was screened. It seemed to me, and others, that this show was certain to be a smash hit.

Back in the department, we researchers discussed how to capitalize on this early information. Buy ABC? No, we reasoned. A single program, even a major hit, wouldn’t move ABC stock. The production company, Twentieth Century Fox? No, for pretty much the same reason. What about the company that held the merchandising rights to Batman characters? We checked and found these rights were held by National Periodical, the same company that published Batman comic books. We felt the success of the TV show could have a significant impact on National Periodical’s earnings.

Less than an hour had elapsed since we had previewed the film. Several of us bought National Periodical stock at what turned out to be a bottom.

Then, we did a very smart thing. Down the hall from the research department was the ABC publicity department, with about a dozen of the best publicity agents you ever saw in your life.

We sauntered down there and casually mentioned the fruits of our thinking. They bought the stock, too. Then, the most amazing thing happened. Within a week, stories about National Periodical began appearing across the country—in newspapers, magazines, on TV, everywhere. It was incredible.

The stock jumped 50 percent in a few weeks and eventually doubled in the midst of the 1966 bear market. It wasn’t the most money I ever made, but it was surely the most satisfying. We had received good information, and we analyzed it correctly. Not bad for a bunch of amateurs.

In January 1979 I launched TheNo-Load Fund Investor in what newsletter people call a “kitchen-table” operation. That is to say, I wrote the newsletter during evenings and weekends while still keeping my day job at NBC. My timing was good. Investors were just getting over the severe bear market of the early 1970s. I published the newsletter quarterly for more than three years, and watched it grow into a real business. Then, in August 1982, a new bull market began with a vengeance. I knew my day had come. When the bull was a week old, I quit my day job at NBC.

I was 51 at the time. Most of my colleagues thought I had been fired. They couldn’t imagine anybody quitting a good job (I was a director) so close to early retirement age. But for me it was the moment to go full-time on a lucrative second career as a newsletter editor and publisher.

About 15 years later, the Sunday morning TV show, The Wall Street Journal Report, profiled three people who had created notable second careers. The three were Ray Kroc, the founder of the modern McDonald’s, Colonel Harland Sanders of Kentucky Fried Chicken fame, and me, Sheldon Jacobs, editor of The No-Load Fund Investor.

PART I

THE FIVE ESSENTIALS

CHAPTER 1

The First Essential: Determine the Right Asset Allocation

Now let’s turn to improving your investing skills.

Chapters 1 and 2 are the most important in this book. To give you an idea how important they are, over 2,500 books and countless magazine and newspaper articles have been written on the subject of how to spread your money among—and within—classes of assets.

Given its fundamental nature you would think that virtually every investor would be well acquainted with the principles of diversification. Yet I find that such is not the case. I continually run across investors who have only the haziest idea of how to correctly implement an asset allocation and diversification strategy. I use a quick test to gauge their competency in this area:

Question: Do you know what percentage of your portfolio is currently invested in equities? Yes, no, without looking it up? If you don’t carry that number in your head, you may not be applying whatever you do know correctly.

There is a tendency to ignore diversification, perhaps because it is so basic. And a fair number invest with the belief that they already know it all. But that’s not usually the case. So let’s start at the beginning.

The Basics

Asset allocation basically means holding various asset classes whose performance is uncorrelated; that is, they fluctuate independently of each other. That’s the whole point. If two investments fluctuate in tandem, they won’t provide diversification, or reduce risk.

The three most important asset classes for individuals are: stocks, bonds, and cash. At the institutional level there are many more. For convenience’s sake, I’m going to call these classes of assets baskets.

The following statistical table shows that there is virtually no correlation among the three basic baskets. Zero is no correlation; 1.00 and −1.00 are perfect positive and negative correlations. This is critical. You want zero correlation, or better yet, negative correlation. If two asset classes have a high positive correlation, then they are really variations of the same asset class, and don’t increase diversification.

Source: Capital Guardian, Sept. 17, 2010 presentation to Westchester Community College Finance Committee.

Asset ClassCorrelationWorld equity vs. U.S. investment-grade bonds0.15World equity vs. cash and cash equivalents*−0.02U.S. investment-grade bonds vs. cash and cash equivalents0.03

* Short-term investments, such as short-term bonds.

Now you see why spreading your money among stocks, bonds, and cash gives you superior diversification and risk control. You are always at risk no matter what you do, but with this approach you have dramatically reduced the likelihood that all your investments decline at once. How you allocate these baskets in your portfolio can determine up to 90 percent of your returns. This alone tells you where you should be spending your investing time.

If you own your own business, though, diversification may not be an option. You will probably have all your money in it. But that’s not the case when you invest in other people’s businesses—that’s what you do when you buy listed stocks. There you may have the choice of diversification or concentrated investing. Some people follow the concentrated path in investing—and some of these people become very, very wealthy. But in all likelihood, you will never know enough about the workings of publicly traded companies, or how the actions of other investors will impact your holdings to be comfortable putting all your money in one, or even a few, stocks. This also applies to investing in companies you work for, if they are large enough to have publicly traded stock. Let me be very specific: Diversification is not about maximizing profits; it’s about reducing risk. And there is no better way to reduce risk. It’s not just for individuals, either. Many hedge fund and mutual fund pros have dispensed with diversification and come to grief because it is impossible to be expert in every holding. Expert or layman, when bad things happen there is really no protection other than diversification.

Diversification is not about maximizing profits; it’s about reducing risk.

I think one of the reasons the Investor newsletter led the nation in risk-adjusted returns for so many years (we were number one among all newsletters for the 20 years ending June 2008) is because we had the best asset allocation. We were one of the few newsletters that routinely allocated part of our model portfolios to bonds. Most newsletter portfolios recommend stocks only, or even higher risk securities such as options.

Learn from the Big Boys

Even though you may never be an institutional player, it’s useful to know what the big boys do. Here’s a comprehensive allocation developed by David Swensen, who manages Yale’s multibillion dollar endowment. He suggests six baskets with no asset class greater than 30 percent, or less than 5 percent:

1. Domestic stocks:30%2. Foreign stocks:15%3. Emerging-market stocks:5%4. Real estate:20%5. Treasury bonds:15%6. Treasury inflation-protected securities (TIPS):15%

For individuals with substantial assets this allocation makes a great deal of sense.

Another asset class to consider is commodities, which are much simpler to invest in nowadays with the advent of sector exchange-traded funds (ETFs).

How the Ancients Allocated Their Wealth

Many contemporary investing strategies such as random walk, modern portfolio theory, index funds, and even growth stock investing were developed after World War II and are relatively new. But asset allocation is not new. It’s been around as long as people have had wealth.

The oldest recorded asset allocation advice may be from biblical times. The Talmud, a record of rabbinic discussions pertaining to Jewish law, ethics, customs, and history (circa 1200 B.C.–A.D. 500) recommends: “Let every man divide his money into three parts, and invest a third in land, a third in business, and let him keep a third in reserve.” Today we would call these three baskets real estate, common stocks, and money funds. You can clearly prosper with that advice right now.

Jumping to more recent history, the fabled Rothschild family had an asset allocation formula that worked well for over a century and, amazingly, remains totally relevant today. The Rothschilds placed one-third of their wealth in each of three baskets: securities, real estate, and art.

It’s interesting that both historic examples allocated wealth into three baskets and that’s basically what most individuals do today, except that our baskets are slightly different. Today, we categorize the baskets as stocks, bonds, and cash, but the principle of three endures as a sound minimum.

And here’s another historic example of diversification. In Shakespeare’s Merchant of Venice, Antonio declares, “My ventures are not in one bottom trusted.”

And, of course, that’s what insurance is all about—spreading the risk through diversification. Lloyds of London was founded around 1688 to insure shipping, so a shipper could put all his cargo in “one bottom.”

It’s not known when American investors began to allocate their assets to both stocks and bonds, but the first balanced fund, Vanguard Wellington, was launched in 1929. Vanguard Wellington utilized a 60/40 distribution (stocks to bonds), which is still basic today.

Of course, we are more sophisticated now and at the institutional level, some large portfolios have as many as eleven baskets. That’s too much for most individuals, but you can certainly consider commodities, timber, foreign bonds, inflation protected bonds, gold, real estate, art, collectibles such as fine wines, rare books, classic cars, jewelry, and memorabilia. Still, the “big three” are all you absolutely need.

Your Most Important Task: Determining the Best Asset Allocation for You

First of all, there is no single “right” allocation. It’s essential to choose an allocation that works for you, considers your current holdings and, most importantly, takes into account a long-term market forecast and your personal risk profile, which depends on your financial ability to tolerate risk, and your willingness to do so.

Regardless of what you choose, the important thing is to know your target asset allocation and either stick reasonably close to it, or have logical reasons for not doing so.

There is no single “right” allocation.

Here are some of the factors you need to consider to reach your own personal allocation:

How many years before you need the money, either for retirement or for other purposes such as college?How long does the money have to last in retirement? An estimate is helpful.How easily can market losses be replaced?How much inflation protection do you need?Age: Generally older people should take less risk, but there are some significant exceptions. For most people age is closely linked to the time horizon.

These factors are really all facets of what is called your time horizon. For most people that’s the bottom line. In addition consider:

Wealth (more important than most realize): It’s dangerous to take substantial equity risks if you don’t have a cushion.Family: How solid is your marriage? What child rearing expenses are you likely to incur (including college costs, and possible wedding expenses)?Are there any circumstances under which you would wind up being financially responsible for any other members of your family? Have you ever co-signed a loan?Income (if you are still working; or cash flow if you are not): How great is it? How stable is it? The more you have, the easier it is to accept risk.How much to set aside for emergencies?How much money do you want to set aside for charities?Equity market outlook: Are you long-term bullish or bearish?Are your stocks or equity funds more or less risky than the market?How much are you willing to lose without cutting your losses?How much volatility can you accept?What is your current allocation, and how happy are you with it?How closely are your earnings linked to the stock market? If you are an investment professional, or work for an investment professional, putting your personal wealth in the market can leave you dangerously undiversified.

Putting all these factors together for optimum results is no small job. I suggest some specific model portfolios later on; however here’s a shortcut for people who want to do it themselves. Go to the Vanguard “Personal Investors” website and, using the “What are you looking for?” search box, type in “investor questionnaire.” Answer the questions and submit. The program will suggest an allocation that might work for you:

Vanguard Investor Questionnaire (summary of multiple-choice answers in italics)1

1. When making a long-term investment, I plan to hold the investment for: (# years)

2. From September 2008 through November 2008, stocks lost over 31 percent. If I owned a stock investment that lost about 31 percent in 3 months, I would: (If you owned stocks during this period, select the answer that corresponds to your actual behavior.) (sell, hold, buy)

3. Generally, I prefer investments with little or no fluctuation in value, and I’m willing to accept the lower return associated with these investments. (agree/disagree)

4. During market declines, I tend to sell portions of my riskier assets and invest the money in safer assets. (agree/disagree)

5. I would invest in a mutual fund based solely on a brief conversation with a friend, co-worker, or relative. (agree/disagree)

6. From September 2008 through October 2008, bonds lost nearly 4 percent. If I owned a bond investment that lost almost 4 percent in 2 months, I would: (If you owned bonds during this period, select the answer that corresponds to your actual behavior.) (sell, hold, buy)

7. The following chart shows the greatest one-year loss and the highest one-year gain on three different hypothetical investments of $10,000. Given the potential gain or loss in any one year, I would invest my money in: (low-, medium-, high-volatility investments)

8. My current and future income sources (for example, salary, Social Security, pension) are: (unstable/stable)

9. My previous investment experience and satisfaction with the following six asset classes are: (See website for list.)

10. The information you enter in the following grid will determine your time horizon (how long you plan to hold your investments). Your current allocation is: (percent stocks, bonds, cash)

I keep my personal asset allocation on a spreadsheet, and recommend you do so, too. It can be updated any time by just punching in a few closing prices, which you can get online. It doesn’t take any time at all. I do mine in less than five minutes. If you are not computer-literate, use a calculator. Check your allocations regularly. This discipline is far more important than keeping track of your favorite stock or fund.

Also, by including cash in a spreadsheet, you are able to take personal spending into account. I suggest benchmarking total financial assets to the previous December 31, so you know at all times if you are spending more than you are making and appreciating.

For an in-depth professional look at asset allocation, read the second edition of The Art of Asset Allocation by David M. Darst (McGraw-Hill, 2008). Darst is a managing director at Morgan Stanley. Another good book on the subject is All About Asset Allocation by Richard A. Ferri, CFA (McGraw-Hill, 2006).

Important Lessons in This Chapter

There is nothing more important than asset allocation. Do it first, and check it the most often. Change it when necessary. Your asset allocation should be foremost in your mind at all times.Above all, when you get your asset allocation right, you’ll be around to invest another day. See Chapters 3 and 7 for specific advice.

1 ©1995–2010. The Vanguard Group, Inc. All rights reserved. Reprinted by permission.

CHAPTER 2

The Second Essential: Diversify within Asset Classes

After you’ve established your asset allocation, the next step is to diversify within each asset class, sometimes called sub-asset allocation or second-tier diversification. In the equity allocation, for example, it means diversifying among large- and small-cap stocks, U.S. and international, and so on. These definitions are not hard and fast. Many people, for example, would consider international stocks a separate asset class.

Sub-asset equity allocations have totally different characteristics than asset allocations. In this case, there is a substantial long-run correlation between most sub-asset class correlations. One institutional study found that when correlating five sub-asset equity classes, the lowest correlation of U.S. core stocks to emerging market stocks was a very substantial 0.82. Most correlations ran in the high 0.90s. The following table shows the sub-asset class correlations within the equity asset allocation.

What these facts mean is that determining sub-asset allocations is far less important than determining asset allocations—and probably even less important than selecting individual funds.

This is the part of investing where you can take shortcuts, and do it the easy way.

Equity Correlations, Sub-Asset Allocations

Source: Capital Guardian, Sept. 17, 2010 presentation to Westchester Community College Finance Committee.

Global includes U.S. and developed countries. All country world adds emerging markets. Non-U.S. is EAFE (no emerging markets).

Diversify Stocks with Broad-Based Index Funds

The best way to begin the sub-asset allocation process is to pick a broad-based index fund for your core holding. Index funds, compared to the alternatives, are no-brainers. Here are some of their advantages:

Index funds are easy to select.Index funds have lower costs because their portfolios are traded infrequently and they don’t incur management and research costs.Index funds, which track a known index, are not dependent on managerial expertise the way actively managed funds are. It doesn’t matter if an index fund manager leaves his fund; it may matter greatly if the manager of an actively managed fund quits. That means index funds have a more consistent performance.You don’t get fooled into buying because of great performance, and then find out the active manager just had a hot streak.Index funds have less of a problem with assets growing to an unwieldy size.

Still, in this business all the good reasons in the world don’t mean a thing if the investment doesn’t perform. Great risk-adjusted returns are pretty much everything. Forget the concept, forget the academic theory—the proof is in the performance (see the following table). The fact is that over any decent period, indexing outperforms the average mutual fund.

Percentage of U.S. Equity Funds Outperformed by Benchmarks

Source: Standard & Poor’s, periods ending December 2010.

One major disadvantage of index funds has become less significant over time. Index funds are always fully invested so they have no bear market protection. It used to be that a sizeable number of actively managed funds would go to cash in bear markets, so their bear market performance could be considerably better than that of index funds.

This isn’t true any more. After the secular bull market of the 1980s and 1990s most actively managed funds found that they had to stay reasonably fully invested at all times to be competitive. At year-end 2008, a very bearish moment, the average stock fund had only 5.2 percent of its assets in cash, and a good part of that was necessary to meet redemptions, not because of an investment strategy.

Let me conclude with a story that brought home the advantages of index fund investing to me. In the late 1980s, I received a call from Jonathan Clements, then a columnist with TheWall Street Journal.

“Sheldon,” he said, “If you could only recommend one fund, which one would it be?”

I tossed out a name and forgot about it. Five years later Jonathan called me again and said, “Congratulations, Sheldon, you’re in second place.”

“Second place in what?” I asked.

“The contest,” he replied. “Don’t you remember I asked you to pick one fund?”

I should have asked, “What contest?” But instead I asked, “What fund did I pick?”

“The Vanguard Total Stock Market Index Fund.”

I breathed a sigh of relief.

Sequel: In late December 2009, the results of a different year-long contest in the Chicago Tribune (and syndicated elsewhere) were announced. I came in second out of eight contestants. My picks? Two index funds: PowerShares FTSE RAFI US 1000 ETF (PRF) and Vanguard Total Stock Market Fund (VTSMX). I beat six pros—with index funds! Only one beat me. The most surefire way of participating in any up market is VTSMX (or VTI, the ETF version).

I am frequently asked to recommend a fund for a child. I always suggest a total stock market fund. It’s the best single investment you can find for the kid.