14 years ago. Are youtelling me that’s what’s going to happen to my stocks?”
“Probably,”  I  say  as  I  try  to  get  away  from  them,  “especially  if  thecompanies you have invested in don’t have any earnings or the price of thestock is relatively high compared to the company earnings.”
That’s when they start mumbling about these being growth companies,part of the future, that they will go back where the once were—that thesecompanies won’t go out of business.
I shake my head as I give them my last two cents of advice: “Bite thebullet—these sad sacks are not coming back. The Nikkei, gold, and com-modities are your model to study.”
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6
THE PURPOSE OF INVESTING
Skating on thin ice is better than not skating at all.—John Shanahan
Everyone wants to get rich, to have an ample amount of money whetherto spend or to brag about. Making money has become as popular as Per-rier  water.  A  generation  of  BMW-buying  yuppies  coincided  with  a  bullmarket  that  created  wealth  beyond  many  people’s  expectations  andwildest dreams.
It came so quickly, though, that most investors have not given muchthought  to  the  purpose  of  their  investing.  “Girls  just  want  to  have  fun”;people just want to make money. Exactly how this is to be accomplished isoften  thought  of  more  as  some  chance  phenomenon—something  to  dowith luck, being in the right place at the right time—than as the product ofclear thinking and diligent research.
As far as getting money is concerned, it all begins with your intentionto get rich. Without intention there can be no productive long-term gain.However, the path to hell is lined with good intentions. That’s why I thinkpurpose demands a great deal of our attention, so that we might bring ourintentions to fruition.
If your purpose of investing is to get rich quickly, then a different strat-egy is needed than that of the person who wants to accumulate wealth overa time period. I would suggest to you that getting rich quickly, which can
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happen  in  the  stock  market,  is  not  as  likely  and  carries  with  it  a  muchhigher degree of risk.
Risk,  which  is  what  we  are  all  exposed  to  as  investors,  is  largely  afunction of two ingredients we need to examine. The ﬁrst of these is time,the second selection.
Let’s  ﬁrst  look  at  the  investment  possibilities  that  exist.  There  is  cer-tainly more to the investment world than the stock market. There are othervery good vehicles for investment: bonds, your own business, real estate,and for some investors, gold or precious metals. To this list I would alsoadd art and/or historical artifacts. Each of these has its advantage but onlyreal  estate  and  stocks  have  consistently  performed  and  provided  an  in-vestor with ample data to make intelligent decisions.
I happen to collect art of a particular fashion. The problem with it isthat not only is beauty in the eye of the beholder, but so is price. Plus, thereare  no  daily  or  even  yearly  ﬁgures  published  on  what  is  the  value  of  theitems I have collected. I collect because I love what I collect; this has littleto do with capital appreciation. It is an extremely difﬁcult market to followunless you simply follow your heart.
That certainly doesn’t sound like a way to make money, does it? Yetit  is  not  unusual  to  see  these  rare  old  items  sell  for  10  times  what  onepaid for them. Like any investment, some of these items don’t go up invalue,  and  some  may  even  go  down.  The  best  thing  is  that  there  is  noholding  cost,  no  painting,  mowing,  plumbing  to  ﬁx,  tenants  to  collectfrom, or printed price ﬂuctuations seen daily. There’s just the enjoymentof art . . . pure pleasure.
THE BEST INVESTMENT YOU’LL EVER MAKE
Let’s stop and think for a minute about where all this money comes from.How is it investors have cash to plunk down into mutual funds and/or thestock  market?  It  has  to  come  from  someplace.  Oh,  sure,  it  might  comefrom  a  retirement  plan,  but  what  created  the  money  for  the  retirementplan?  Either  the  private  sector  or  the  government  funds  all  retirementplans. Keep in mind that the government gets much of its money from theprivate  sector  through  income  taxes—taxes  on  salaries  generated  by  pri-vate businesses.
Hopefully, you’ll agree with me, based on this scenario, that the cre-ation of wealth throughout the world comes from businesses. You may de-
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spise  the  giant  corporations,  rail  against  them  as  much  as  you  want,  butyou cannot argue away the bottom line: that productivity and wealth aregenerated  from  the  corporate  sector  or  entrepreneurs.  This  could  be  amom-and-pop  operation  or  IBM.  It  doesn’t  matter—this  is  where  moneygets generated. Governments don’t generate money; they conﬁscate it.
Accordingly,  the  best  investment  you  can  ever  make  is  in  your  ownbusiness. Admittedly, some people don’t have the desire to have their ownbusiness;  they  would  rather  work  for  somebody  else  than  take  the  risksthat go with creating an entity, an enterprise that assumes huge responsibil-ities  and  obligations.  But  the  old  adage  will  always  hold:  Without  riskthere can be no gain. It is far less risky to take a job than it is to create yourbusiness; hence business owners, if they’re lucky, are rewarded more thantheir workers are.
So, if you have some spare change you are seeking to invest, I wouldﬁrst encourage you to seriously consider the creation of a business enter-prise as opposed to investing in Wall Street or any other place. With thatbehind us, I’m now assuming you have created your wealth through yourjob or career and have that base in order. Typically, people say you shouldhave insurance and real estate as the basis of your investment. I think thatis totally incorrect. Holding onto real estate does not generate cash; buyingand selling it does. An insurance policy pays off only if you die, and doesn’tstrike me as a very smart investment scenario.
I believe people have realized this at some cosmic level, which is onereason why so much money poured into the stock market in the late 1990s.Real estate can be an extremely good investment. Typically, people think ofreal estate as an investment to protect them from inﬂation. In times of aninﬂationary  economy  real  estate  appreciates  and  immense  fortunes  havebeen made in this fashion.
I believe it is safe to say that real estate is not a better long-term invest-ment than common stocks. This is for two reasons. First of all, usually realestate investment means taking on debt. The debt is a large cost of doingbusiness, so while your friendly real estate agent can show you that priceshave appreciated X percent over the prior 20 years, he or she neglects topoint out that there was a cost of holding onto these properties. That costmay have been a lot more than just interest rates. The actual amount paidfor a house is usually three times the sales price due to interest charges onthe debt. What’s more, that house had to be painted, mowed, trimmed, in-sured, and otherwise kept up, and, of course, taxes had to be paid. Whenyou deduct the cost of holding the asset as well as a commission structure
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of 6 percent to buy and another 6 percent to sell, the numbers don’t looknearly as good as on the surface.
Again,  that’s  not  to  say  there  isn’t  money  to  be  made  in  real  estate.Fortunes have been made there. But for the most part, these fortunes weremade by investors who understood the marketplace. What I see is that inmost instances, these investors had a substantial amount of capital or supe-rior  lines  of  credit.  Even  these  people,  however,  have  run  into  ﬁnancialproblems.  But  if  you  know  your  area  where  you  live,  and  have  a  greatsense of the future growth direction, then there surely is money to be madein real estate.
Some  of  the  things  I  like  so  much  about  the  stock  market  are  thatthere is very little cost of doing business, commissions are low, no insur-ance is needed, I can sell in an instant, and I don’t have to worry that mystock  will  burn  down,  the  plumbing  might  break,  or  the  tenants  won’tpay me. It is pretty cut-and-dried, I can monitor my investment from any-place in the world, thanks to the Internet, as well as a plethora of stockmarket publications.
This same advantage exists for those who want to invest in preciousmetals. You don’t have to take delivery of gold. You can simply hold ontoa certiﬁcate of ownership. Yet a study of the very long-term price apprecia-tion  of  gold  shows  that  it  has  substantially  underperformed  not  onlystocks, but real estate as well as Treasury bonds and Treasury bills. In fact,on a long-term basis gold has not kept up with inﬂation! Yes, there havebeen some great rallies in gold, but I’m talking long-term here.
While I am on that subject let’s point out that long-term governmentbonds, while they have beaten Treasury bills for a total return from 1925to  1999,  have  barely  kept  ahead  of  inﬂation,  especially  relative  to  thestock market.
Had you “bought” inﬂation in 1925 your total return by the start ofthe  next  century  would  have  been  an  appreciation  of  9.2  times  yourmoney. That means an item that cost one dollar in 1925 cost about $9.20in  2000.  Had  you  bought  Treasury  bills  your  investment  of  one  dollarwould have grown to almost $15. Had you bought long-term governmentbonds your return would have been much better: $44 on that one dollar in-vested all those years ago. Had you purchased real estate, on average, onedollar  of  real  estate  would  have  returned  approximately  $100,  a  proﬁtmore than double the return on long-term government bonds.
However, had you purchased blue-chip stocks your one-dollar invest-
ment would have become worth more than $2,000!
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You would not have needed great expertise to have purchased qualitystocks, and you could have begun with any amount; ﬁnancing was neverrequired, and you never had to walk into a bank to beg for a loan.
Doesn’t this all sound good? If only it were that easy—buy somethingand hold on to it. The problem that stockbrokers neglect to tell you is thatwhile their total return tables show that $2,000 of proﬁts, that is your re-turn only if you had the wisdom to purchase the blue-chip stocks that sur-vived through all the years. Many of them didn’t! So what we have here isa selective process that assumes you bought stocks that were the winners.But that may not have been the case. Most investors, most of the time, domostly the wrong thing.
FALLACY OF LONG-TERM INVESTING
There’s a common myth, when it comes to stock market investing, that allone needs to do is purchase quality stocks and hold onto them for the longpull. That simply is not the case; it is a very misleading position. The onlything we can say for sure about the long run is that in the long run mostpeople die.
Let  me  point  out  some  speciﬁc  examples  for  you.  Ford  Motor  Com-pany has always been a major blue-chip stock, and in recent years it hasfared well. However, if you purchased it in the late 1970s, as many did forthe  $2.60  a  share  dividend  it  was  paying,  you  would  have  received$26,000 a year in income from an investment in 10,000 shares.
By  the  time  1984  came  around,  the  long-term  buy-and-hold  strategywasn’t working so well as the dividend was cut to $1.73, reducing your in-come to $17,300; and of course the price of the stock declined. Things didn’tget much better. In 1981 the dividend was cut to 80 cents, so instead of re-ceiving  the  $26,000  a  year  revenue  on  the  10,000-share  investment,  youwere  now  getting  $8,000.  The  trends  persisted.  In  1982  the  Ford  MotorCompany paid no dividends at all. An investor who had purchased Ford, atypical blue-chip stock, was left holding the bag. The long-term strategy, aspracticed  during  a  15-year  waiting  period,  had  not  been  successful.  In-vestors were severely burned by the strategy.
Stocks  don’t  always  go  up—even  blue-chip  stocks.  There’s  a  reasonfor  this.  As  I  see  it,  long-term  investors  are  the  biggest  gamblers  in  themarketplace; they make their bet and stay with it. If they are wrong theycan lose it all, as they never change their chips on the table of speculative
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investments.  You  bet,  there  are  lots  of  examples  where  the  strategy  haspaid off. Those are the ones you hear about, but there are a heck of a lotmore  instances  were  the  strategy  did  not  pay  off,  where  the  long-termbuy-and-hold  strategy  was  a  failure.  Such  stories  don’t  make  for  verygood cocktail conversation. Investors are unwilling to discuss these occur-rences. That’s why you never hear about the negative side of long-term in-vesting in stocks.
Here’s a list of blue-chip stocks I’d like you to take a look at. Would
you like to have been a long-term holder of this portfolio?
American ExpressAvon ProductsDisneyRCAWestinghousePolaroidHoneywellHoward Johnson
What we have here is an excellent list of proﬁtable corporate giants—but not a good group of stocks to own in the 1972 to 1974 time periodwhen, as a group, they declined in value more than 80 percent!
Yes, you read that correctly. Had you purchased at the wrong time, the1972–1973 high, you would have seen your investment dollars diminish byover 80 percent as these issues made their lows. Wow, that’s pressure to sitthrough as you wait for the long-term trend to bail you out of your prob-lems! Having second thoughts about the wisdom of the long term, the no-tion of buy and forget it? Good, you should.
Some  lessons  are  never  learned.  While  the  supposedly  blue-chipstocks of 1972 and 1973 certainly had their comeuppance, it was noth-ing  compared  to  what  happened  in  2000  and  2001.  One  of  the  moreprestigious ﬁnancial publications was the very popular Worth magazine.Their  editors  came  up  with  stocks  that  they  identiﬁed  as  “the  best representatives  of  the  new  economy. . . .  The  editors  chose  the  com-panies  listed  here  on  the  basis  of  their  sound  of  business  plans,  high-quality  products,  solid  ﬁnances,  efﬁcient  operations,  and  capable  man-agers.  The  companies  must  also  operate  in  markets  with  the  potentialfor explosive growth.”
The editors of this magazine must have had at least a modicum of mar-
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ket savvy and experience to have landed their editorial positions. I doubt ifthese writers were fresh off the ﬁrst train into town. They had some veryglowing  commentaries  about  these  stocks  and  the  new  economy.  Here  istheir list with the prices of their recommendations in August 2000 as wellas the prices in August 2001 and at the end of 2002.
Applied Materials
Broadcom
Cisco Systems
CMGI
eBay
Enron
August 2000
$
81
$ 259
$
$
$
$
65
37
56
88
Millenium Pharmacies
$ 111
News Corp.
Nokia
Oracle
Charles Schwab
Sun Microsystems
Sycamore Networks
WorldCom
Total value
$
$
$
$
52
41
83
38
$ 122
$ 154
$
35
$1,222
August 2001
December 31, 2002
$ 48
$ 44
$ 20
$ 2
$ 61
$ 45
$ 31
$ 37
$ 21
$ 18
$ 15
$ 17
$ 7
$ 14
$380
$ 11
$ 16
$ 13
$ 1
$ 67
$ 0
$ 8
$ 26
$ 15.5
$ 11
$ 17
$ 3
$ 3
$ 0
$185.5
Now you see how expensive chasing high-ﬂying growth stocks can be-come. Investors who followed the editors of Worth magazine (perhaps itshould be dubbed “Worse magazine”) would have lost almost 85 percentof their money. I don’t know what you think, but I suspect it will be yearsand  years  before  this  list  of  hotshot  stocks  comes  even  close  to  thebreakeven  point  for  investors  who  thought  they  had  such  a  sure  thing.That  was  a  rather  expensive  subscription,  proving  my  point  that  marketeducation is either worthless or invaluable; there are few in-betweens.
In the August 2000 issue of Worth the editors touted the 31.8 percentyear-to-date  gain  this  list  had  made  as  well  as  the  116  percent  gain  forprior 12 months. That doesn’t mean much now. What it does mean, or
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what  we  should  learn  from  this  experience  (other  than  canceling  yoursubscription  to  the  magazine)  is  that  it  is  a  precarious  and  dangerousgame to play catch the leader. Most often the leader ends up at the rear ofthe  pack,  and  you  become  the  one  who  has  been  caught  holding  a  bagfull of busted hopes. It’s a simple fact of investment life that once the ma-jority of investors catch on to what the hot stocks have been, the game isjust about over.
It is best expressed in this fashion: Once the average Joe investor learnsthe  key  to  the  combination  of  unlimited  stock  market  wealth,  somebodychanges the combination!
LEARNING IT ONE MORE TIME
The  infamous  speculator  Jesse  Livermore  summed  it  up  best  when  hewrote, “I believe it is a safe bet that the money lost by short-term specula-tion  is  small  when  compared  with  the  gigantic  sums  lost  by  so-called  in-vestors who have let their investments ride. The intelligent investor will actpromptly, thus holding his losses to a minimum.”
You may want to think of it in this fashion: Betting on tomorrow is adicey deal full of risk and chance. Now, imagine making that same bet on aday 20 or 30 years into the future. Can you see the craziness of thinkingyou can see that far into the future? People are lured into the idea of long-term investing because they don’t have to make many decisions, don’t haveto work at it, and love the idea of a long-term nest egg. Thinking they havesome type of long-range plan gives people a cozy, warm feeling—they havetheir lives all ﬁgured out.
A good investment can turn into a long-term investment, which is whyeach and every investment we make needs to be constantly reevaluated inlight of changing circumstances in your life as well as the marketplace.
So,  the  time  frame  an  investor  chooses  is  equally  important  to  thevehicle he or she chooses to invest in. If you recall, when we looked atthe seasonal patterns of the Dow Jones Industrial Average, we saw thatit has major ups and downs usually lasting from six months to a year orso.  But  clearly,  there’s  no  straight  up  path  to  stock  market  investing.Never has been, never will be. Thus it seems to me that the purpose ofour investing should be to get in at the right time and get out at what isalso the right time.
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Admittedly, we can never do this in a perfect fashion, but the data is  very  clear  that  even  partially  succeeding  at  this  on  an  intermediatetime  frame  is  much  more  successful  than  the  long-term  “buy  and pray” strategy.
If your purpose is to buy stocks for gains of six months to a year or so,
I think you’ll do far better than short-term traders or long-term holders.
WHAT STOCKS TO INVEST IN
I think it is safe to say we can break down virtually all stock market invest-ment strategies into one of two categories. The ﬁrst is the one that appearsto be the most popular; it consists of buying the hot stocks, the in voguestocks, the ones people talk about after work and during work and that arebandied about in the news media.
There will always be hot stocks—some group of securities outperform-ing another group. That’s just the way it is. Given some 7,000 stocks, restassured there will always be some leading the pack, but that doesn’t meanthey  will  continue  leading  the  pack.  My  experience  with  this  group  ofstocks—let’s  call  them  the  highﬂiers—is  that  they  run  very  hot  and  verycold. Virtually all highﬂiers that I have seen over all these years of tradinghave crumbled at some point. That’s a point where I don’t want to be, apoint where I don’t want my money.
What  rises  rapidly  doesn’t  stay  there,  so  while  some  investors  mayget  aboard  these  rapid  rises,  and  have  exceptional  proﬁts,  it’s  a  bit like  playing  Russian  roulette.  If  there  is  a  bullet  in  the  chamber  and you  spin  it  often  enough  one  will  come  up  and  you  lose.  Since  it  is  a safe  bet  to  say  that  all  high  ﬂying  stocks  eventually  have  their  downdays,  and  years,  I  have  chosen  to  avoid  the  fads  of  the  day  because  Iknow these stocks are in actuality being set up for substantial declines. Itis not unusual to see high ﬂyers in bankruptcy . . . to see the ﬂyers de-clining  from  $100  a  share  to  $15  a  share.  That’s  an  absolute  circum-stance,  it  is  irrefutable,  it  is  the  key  problem  that  is  part  and  parcel  ofbuying what’s hot. High ﬂying growth stocks are a bullet in the chamberof investing.
It’s just like the Bible says, “The ﬁrst one now, shall later be last”. Ido  not  want  to  take  a  chance  of  buying  stocks  that  suddenly  slip  intolast place.
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CONSISTENCY HAS ITS REWARDS
I’m more than willing to let the crowd chase the hot issues of the day, makingwhat they call “momentum plays”—hoping there’s a greater fool out there tobuy what they bought at a high price at yet an even higher price. That is reallythe heart and soul of their game; they seek whatever is moving, with somejuicy provocative story, which usually simply separates investors from theirhard-earned cash. There’s only one way to get that cash back, which is for thestock  to  continue  its  parabolic  up  move.  Although  that  can  happen,  whenthese babies crack they break badly. In one day many stocks have given back20 to 30 percent of the entire gains they had made for investors. When theybreak like that, investors become locked into the stock feeling they can’t getout because it has declined so much. They have no alternative; what began asan investment is now forced upon them as a long-term hold.
I  want  a  safer  bet  than  that.  My  bet  is  on  consistency.  What  we  doknow for sure about the long term is that value ultimately prevails; it is re-warded.  But  we  also  know  the  long  term  is  ephemeral;  the  long  term  ismade up of chunks of good times and of bad times; our focus is the goodtimes. That’s why our vehicle for investments is that of the more secure andless  speculative.  We  will  gladly  leave  the  prospect  of  substantial  gains  toother investors. They may get them (I hope they do), but the reality is theyprobably won’t. It is tempting to think of those large gains, but if we lookat the performances of the top 25 growth funds, for example, we can seehow difﬁcult it is for professional investors, people who manage billions ofdollars, to achieve exponential gains in their portfolios.
Keep  in  mind  that  these  are  the  people  who  are  right  on  top  of  thehighﬂiers. They have the best research in the world at their disposal, it istheir business to catch highﬂiers. Can it be done? It doesn’t appear so, notwhen we see that they don’t do a very good job, judging from their pub-lished performance records. If they can’t do it, how could we possibly ex-pect the average Joe to succeed at this obviously difﬁcult game?
There is a real lesson to learn from the interesting data shown in Table6.1. What is shown here is a tally of the 25 top-performing growth fundsfrom  the  market  high  of  October  1990  through  mid-August  2001.  Thelargest percent gain was racked up by Smith Barney with a 567 percent in-crease, while the fund in the 25th place gained a healthy 368 percent. Onthe surface that sounds most impressive.
But we need to look a little bit further to see just how good this perfor-mance was. Had one simply purchased the Dow Jones Industrial Average
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Table 6.1 Top 25 Growth Funds, October1990 through August 15, 2001
Mutual Fund
Percent Gain
Smith Barney A AggressiveVan Kampen Funds AVanguard Funds Prime CapAIM Funds AggressiveWaddell and ReedFederated Institutional, KaufmanRS Funds Emerging GrowthDreyfus FoundersWM Group NWestLiberty AcornFidelity Inv GrowthAmerican Funds A GrowthOne Group CI Mid CapOppenheimerInvesco Funds DynSeligman Captl ADelaware Class A TrendGS Elfun TrustsMFS Funds A Cap OptyFederate A Captl ApprcBrandywineMFS Funds A MAParnassus GrowthAlger Funds B Large CapGabelli AssetDow Jones Industrials Average
567%554%516%499%492%491%480%450%444%443%437%431%417%413%411%403%390%387%383%381%374%374%374%371%368%352%
in  1990,  and  keep  in  mind  this  is  not