Basic Fundamentals of Successful Investing
by Robert B. Gordon, Sc. D.
March 29, 2004
I began writing on the Internet in August of 2001 and have been busy warning my readers that we were in the process of undergoing the world's greatest and most damaging stock market crash and economic depression. We are now in the fifth year of what may turn out to be a very long, difficult experience and far beyond the expectation of most of our readers and experts. Even the youngest readers of this essay may not be alive at the end of this great world-wide disaster.
I have given information earlier on my investment education in the school of hard knocks. It should be possible for anyone eager to learn with modern computer graphics technology, to do it in a tenth of my 64 years and reach a high degree of confidence in their ability to select and manage a serious investment portfolio.
For the many readers, both men and women, who are still not invested safely, this essay will give you the incentive to get off of the couch and into the business of making your money grow. Let me start with a personal story of a plunge I made at age 11. My parents sent me to summer camp in Algonquin Park in Canada which involved taking a number of overnight canoe trips. I had not finished my swimming lessons and was at the stage of doing a "dead man's float". Somehow I got on the first overnight camping trip. At the end of the day we made camp on a large flat rock about 10 feet above the large lake. The leader and the boys all dove off the rock into the lake. Guess what, so did I, and I had my first swim in deep water. Sending a small first check to a mutual fund should be easier than that. At least it should not involve any threat to your life.
IT'S FUN TO WATCH YOUR MONEY GROW
Let's start with the two rules of the world's greatest investor, Warren Buffett.
Rule 1. Don't Lose Rule 2. Never Forget Rule 1
If your fear of losing is holding you back, then let's adopt a plan to limit your losses:
- Choose two stable funds from one of my essays.
- Go to www.bigcharts.com and make sure their one year charts are in a smooth price up trend.
- Purchase $1,000 of each fund.
- Check the two price charts monthly. Sell either fund if their price drops more than your designated loss percent below your purchase price. You should permit a price drop similar to those that have occurred earlier, say 10%. Your object is to remain invested and at the same time you have to accept small price fluctuations.
- If you do sell, select and buy a new fund and continue until you feel comfortable with the results.
LESSON NUMBER 1
The history of the stock market is filled with tragic stories of the inability of millions of ordinary investors to sell and limit there losses on a decline. Every fledgling investor must keep Buffett's Rule 1 in mind.
New investors have got to avoid any emotional attachment to their purchases. They were bought to grow your assets. When they do not do that you must sell to preserve your capital for another day.
There are only 2 rules of the world's best investor and both of them involve selling. Once a new investor can sell when necessary, he or she will have learned the most important lesson.
THE GREAT MUTUAL FUND TRAGEDY
Long before the current revelations of serious criminal violations involving client's money, I have been aware of serious problems caused by actions and inactions in the mutual fund industry. Here are just a few of the industry practices that hurt their clients.
The Lack of Emphasis on Capital Preservation. The overemphasis on Growth above all other objectives has done and will do severe harm to client's capital during the coming bear market phases. Even the industry giants like Fidelity and Vanguard do not offer enough asset classes to build an effective Fund of Funds to preserve capital. Just one fund of ten thousand is offering a "Permanent Portfolio" with that objective. There should be dozens of them as we enter a severe bear market. Later, we'll be suggesting a really permanent portfolio you can use for building capital.
Overemphasis on Narrow Sector Funds. The largest mutual fund group was recently forced to drop its 3% sales charge on specialized sector funds, presumably due to lack of sales. There is a surprisingly low number of hybrid stock and bond funds with excellent long term performance and, as a result, a major shortage of funds with outstanding long term stable performance records.
Too Many Run-of- the-Mill Growth Funds. The fierce performance advertising by funds for investor dollars must be doing a great disservice to the nation's investors. Right now, there are trillions of investor dollars at high risk in growth funds. An investigation asking tough questions is urgently needed to put the spot light on dangerous industry sales practices.
Horribly Misleading Fund Advertising. The industry wide ads promoting Buy and Hold investing for the long term will cause millions of investors to lose trillions of dollars in the current bear market and will also lead to many company failures in the mutual fund industry. Failure of ads to stress the cyclical nature of the stock market to new investors should be a large part of a future industry investigation by Congress and the SEC.
STABLE AND VOLATILE FUNDS
In the two years I have been publishing on the internet, nearly everything I suggested for investors was an original idea that I learned thru my own efforts to build and manage a depression-proof portfolio. It very definitely did not come from a book but from my own experimenting in the Wall Street laboratory. Ever since my years in graduate school, I have been doing things for my employer that had never been done before. And, on weekends and evenings at home, as an avocation from stressful work I read and worked on new investing techniques. It was pretty slow going before the computer became available, but since my retirement in 1980, improving my investing techniques has been a major activity.
Right now, I get new ideas at different times and sometimes get out of bed to write them down. Everything I write in my essays comes from my own recent work. For example, my use of the words stable and volatile asset classes arose from the need to get easily understandable words for my readers. They are common words but, as i use them, they have specific meanings. Stable assets have smooth, gently rising price curves over recent years. Since future prices are always unknown, we have to assume they will behave in the future as in the past. We expect that general rule to apply until we see a change on our computer screen.
Of course, we also know the elements in a mutual fund that lead to stability.. They are selected U.S. and foreign bonds and a bond fund and a stock fund managed to have hedge protection of profits. After months of hard work, we only have about 15 funds in half a dozen sub classes. Stable asset classes are rare and are very special for any portfolio expected to sail thru some rough seas in the future. They make a large contribution to the overall stability of any portfolio.
With volatile funds, we have a few more candidates to work with but the ones you can reliably count on for the future may be even more scarce. We choose volatile funds whose future volatility can be estimated in advance. They are intended to produce profits from systematic portfolio rebalancing. When their price is near the top of its normal range, temporary profits are made permanent. These volatile assets receive asset transfers from stable components when they are near the bottom of their normal price range. They are not an essential part of a portfolio intended primarily for preservation of capital. The percentage allocation to volatile asset classes may vary from zero to a limit of 50% for aggressive investors.
Investors desiring to start a long term portfolio may choose to start with zero or modest amounts of volatile assets and add them later if desired. In our own portfolios, we stress the need to build a solid core of stable assets with a widely diversified list of stable funds. We like diversity in both major asset classes, even to the point of using quite identical funds with different managers. Our rationale is that the future market action is unknown and we feel better with more than one manager in each class. Our success is always a summation of the actions of our selected fund managers.
LETTER FROM A YOUNG READER
I recently received and replied to a young reader who wrote: "I read your most recent article as I have read many of the articles that you have posted to financialsense.com. Like many of your readers, I have been paralyzed with fear about making any kind of an investment in the stock or bond markets, so I am sitting on cash. I am an engineer by profession (fortunate to still be working) and not an investor. I do know the difference between a stock and a bond but I don't really know what a "short fund" or a "total return fund" is. So I need to find books/articles that explain this. Also, you described Stable asset classes and Volatile asset classes. Do you mean to infer that stable = "good" and volatile = "bad"?"
PLEASE DO NOT SIT THIS ONE OUT
From my reader mail, I know there are many thousands of men and women of all ages who are unable to build a more active life as an investor. Every one has reasons of their own for not acting. I cannot do anything to help except write and hope something will help them decide to act.
I have had a wonderful life because my professional work was complimented by my love of investing and classical music. And I am able to enjoy them both at the same time. My wife shared my interest in music and we enjoyed symphonies in every place where we lived on both coasts. Very fortunate for her, was the fact that she will not suffer from her lack of money management ability. She is now receiving full time care in our care center using funds accumulated from my efforts. Despite my best efforts, I was unable to interest her in investing. And to help our two sons when we are gone, they are now receiving regular statements of the portfolios in our estate that will be their responsibility some day.
As I have tried to convey in all my essays, I did not learn to invest because I thought I would need extra money but because I was having so much fun learning and investing. But, today, things will be very different. We have both been receiving Social Security and Medicare since age 65 and my employer pensions still arrive every month. My sons and my grandchildren will not be so lucky and neither will most of my readers. Today, with the experience of a serious bear market, everyone one will have to acquire the skills to grow capital.
For all younger people in the U. S., saving for retirement will be an absolute necessity. To make things much worse, we are now facing by far the worst economic crisis in the history of the world. This is why I have devoted most of my time each day for several years to reading and writing and warning of the problems ahead.
My own work in investing is recreation, a real joy, not a necessity. Would it be any different if I were in absolute need of doing it? I do not think it would. Please think seriously about making your investing a "fun" part of your life.
A SIMPLE EXPANDABLE PORTFOLIO
I cannot end this essay without making a major effort to convince readers to start a small ultraconservative portfolio that is capable of changing your whole life for the better. In addition, we suggest a wonderful way to get your spouse involved in a friendly competition that will help greatly in your later life.
In a very small recent time period we have made some valuable improvements in designing practical portfolios for the difficult markets that lie ahead. We are suggesting as a base, use of the 33 year old Permanent Portfolio fund and adding equal amounts of two younger funds managed by a brilliant manager who is empowered to use option hedges to prevent losses. These younger funds, Hussman Total Return and Hussman Strategic Growth funds are establishing very fine records in the current bear market. We own and highly recommend all 3 funds. The new 3 fund portfolio and its 1 year performance is shown below. In the last 12 month period, this ultra conservative portfolio gained 17% with all 3 funds making a major contribution as seen in the table below:
|PRPFX Permanent Portfolio||33.4%||20.1%|
|HSGFX Hussman Strategive Growth||33.3%||19.8%|
|HSTRX Hussman Total Return||33.3%||11.0%|
It will be very interesting to see how this portfolio behaves over coming years. My best guess is it will be very rewarding. Someone will have to find a way to send me the results because my investing fun in this world has a limited time length.
The table below gives a rough total of the fixed assets in the Permanent Portfolio fund and the estimated totals for all 3 funds. We end up with a total of 9 asset classes providing a fairly good distribution for the coming bear market. There does not seem to be a need for a short fund at this time. A small short fund addition could be made at any time in the range of 5 to 8% if needed to take out the effect of the 5% of aggressive stocks from the rigid PRPFX portfolio.
|Asset Class||Permanent Portfolio||New Portfolio|
|Foreign Government Bonds||0.0%||16.3%*|
|Real Estate & Natural Resources||15.0%||7.0%|
|U. S. Treasury Bond||35.0%||16.7%|
|Aggressive Growth Stocks||15.0%||5.0%*|
|* Also holds gold|
Please note that this portfolio contains 4 stable asset classes totaling 76.3% and 5 volatile asset classes totaling 23.7. The 3 fund portfolio is quite well balanced right now. The six asset classes in the Permanent Portfolio fund are fixed by its prospectus and have provided a very stable 33 years of performance - a remarkable achievement. The two Hussman funds have considerable flexibility in their charter and with a unique ability to provide a 30% hedge against loss in the Total Return fund and a 100% hedge against losses in the Strategic Growth fund. Their brilliant manager has done a marvelous job of piloting these great funds thru the bear market to date. Their portfolios make a fine combination to get us thru a long bear market. It's time for all readers to join us watching their prices going up while the market is going down. It is a great feeling.
Let us remind you that PRPFX has a fixed amount of 6 different asset classes with their amounts rebalanced frequently. It has an unequalled record for stability in the entire industry. The two funds managed by Dr. Huffman have wide flexibility in selection of asset classes which makes the total portfolio very attractive and able to cope with almost any new problems. In addition, they are unique in having the ability to protect their gains with protective option hedges when needed.
I make a point to read Dr. Huffman's market comments posted on his website before each Monday market opens. I know of no other fund manager who has a better grasp of market action and the ability to meet it's challenges. So, in conclusion, this 3 fund combination offers an attractive asset balance with the extra advantage for the Hussman funds to add gold and foreign bonds if and when needed. I have looked hard for any weakness and have been unable to find any. I think they offer a wonderful opportunity for both new and experienced investors to enjoy an opportunity for worry-free ownership and learning.
This portfolio will need an occasional rebalancing over the years so that it will retain its original composition. This is discussed in the section below.
START A FAMILY INVESTING COMPETITION
In tax-free accounts Hussman funds can be opened with just $500 each and $1000 for taxable accounts. Permanent Portfolio charges $1,000 for both. It is not only feasible but desirable to teach young adults and spouses the joys of successful investing, Using just these three great funds in different proportions will make a significant addition to the learning experience. There will be sizable differences at times due to their quite different compositions, two variable and one fixed, and also due to major changes in the stock and bond market. No doubt, 99% of investors will be totally at a loss in trying to understand the huge market swings. So will most of the experts without Elliott Wave knowledge.
Let's plan an educational contest for husband, wife and two children by opening a long term competition. It will definitely not be as exciting as a contest between a tortoise and a hare. But please stay awake till the end because the results will be very gratifying and could have great impact on the rest of your family's financial life.
We are going to build 4 portfolios with variations in the percentages of the same three funds as described above. I can guarantee that the race will be exciting up to the end. There will be differences between the 3 funds during market ups and downs but do not bet too much money on your portfolio winning. My very best guess is that all 4 will do well and that no one will be able to pick the winner. The big winner will be the entire family because at the end of say 5 years, the entire family can switch their money into the winning portfolio and do even better in the future. You will not read about this contest in any book, but I am still learning at a greater rate than any other time in my life. So can you and your family by starting right now. Here are my suggested portfolios.
|Hussman Strategic Growth||33.3%||20.0%||40.0%||40.0%|
|Hussman Total Return||33.3%||40.0%||20.0%||40.0%|
The time to manage this family contest is so small as hardly needs to be mentioned. These are 3 superb funds picked out of a sea of 10,000 also-rans. The oldest and best is managed not to change but to remain fixed while the two new ones are being skillfully managed to change daily and weekly with the market action determine by a brilliant Ph.D. manager.
I would suggest that the job of keeping score be given to a child instead of a wage earner. The easiest way to do that is online at www.bigcharts.com where the price history of the 3 funds can be put together on a chart. Prices are available daily by entering the fund symbol in one of many internet sites. In addition to periodically viewing the price charts, the total dollars of each fund and the portfolio total should be recorded in a record book.
How does one learn from this "game". If your family sticks with it for just a few years, you and the children will acquire more knowledge about the stock and bond markets than 95% of the adults in this country. And, if you keep up the experimental approach I am recommending you will soon be in the 99th percentile of useful investing knowledge. There are no mysteries and secrets that cannot be learned by persons of average intelligence. It just takes a small amount of conscious effort. Here I am, going on 89, learning about new ways to make money with mutual funds, and enjoying passing it on to others.
You will never read a suggestion like my "do it yourself program" from your stock broker or mutual fund because their one aim is to get your money and then keep you as dumb as possible so they can get their hands on the rest of it. Let's face it, there is only one person you can trust to build your financial future and you better start right now.
© 2004 Robert B. Gordon, Sc. D.
Dr. Robert B. Gordon
c/o Roger Gordon
1488 Cynthia Lane
El Cajon, CA 92019