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The Failure of Passive Investors! April 13, 2009

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“The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear on his task. The minimum return goes to our passive investor, who wants both safety and freedom from concern.  The maximum return will be realized by the alert and enterprising investor who exercises maximum intelligence and skill.”

Benjamin Graham in The Intelligent Investor

He continues, “In many cases there might be less real risk associated with buying a ‘bargain issue’ offering a chance of a large profit than with a conventional bond purchase yielding 4 1/2%.”

And from his student Warren Buffet we get these ideas:

“Wide diversification is only required when investors do not understand what they are doing.”

“Diversification is protection from ignorance. It makes very little sense for those who know what they are doing.”

“Why not invest your assets in companies you really like?  As Mae West said, ‘too much of a good thing can be wonderful.’ ”

So we see from these highly successful investors that passive investing has from the beginning been a failing strategy.  As Ben Graham instructs us, investing passively in mutual funds [which is what most people do], we should only expect meager returns [that is what the data tells us actually happens].  If we should only expect meager returns, then why expose ourselves to the market risk?

So, the data instructs us, as well as successful investors, on rule #2 for investing; If you want to invest in the equity markets you must become an active [intelligent] investor, otherwise take the conservative route and lower your expectations.

For those who missed rule #1; Build reserves or [financially] die!

What Investment Strategies are the Best in Today’s Environment? January 21, 2009

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I get this question much so I thought I would post on it today.  Research indicates through all the ups and downs going back hundred’s of years, you can make great returns using several strategies.  Now let me be clear, all these strategies we are looking at are long term, greater than 10 years, and require one to accept the actual evidence, not the propaganda.  Any strategy can create losses short term that must be protected against using risk management.

First a listing of the failed strategies.  By failed I mean failure to produce double digit returns, which are required to produce wealth.  Now I have posted on many of these strategies as a way to protect wealth against inflation once it has been acquired.  But what we are analyzing here is wealth creation, not wealth preservation.

Savings accounts, Certificate of Deposits, money market accounts, Bonds (corporate or government), mutual funds, cash value life insurance, cash, and unleveraged primary residences (real estate) all are failed wealth creation strategies that folks flock to in time of fear, like now.

Now on to the successful strategies.  By successful I mean that we have proof that many folks have used these strategies to get double digit returns over more than 10 years and have created wealth (from small to grand) using the strategy.

My favorite for middle class folks is investment real estate.  Why, because it does not involve folks having  to constantly monitor the market or create a set of elaborate rules or to have to be ready to trade on a moments notice.  Here are the facts, most folks can use leverage to create returns that will build the needed wealth investing in real estate without taking great risks.  Over the last 1 hundred  years the average return for real estate has been around 5%.  Truth is you don’t even have to get that return to build the needed wealth because you can leverage it 3 to 1 easily by getting a mortgage at 75% loan to value.  The critical decisions are done up front before you purchase.  The metrics for analyzing the investment are simple enough anyone can learn them.  And there are people out there who get paid to help you by the seller of the property, which gives the rookie a chance to take advantage of their experience at no initial cost.   Now I suggest figuring in the cost of a management company to take the pressure of managing property off of you, but you still will have to deal with many issues.  Having a proper reserve fund is the first rule you need to abide by!  This is an active investing strategy not a passive one!  For more advanced investors there are real estate development companies to invest in, single projects to invest in, etc.  More wealth has been produced by real estate than any other investment class since the beginning of human commerce. 

Next is buy-and-hold stocks or the Warren Buffett way.  Now I suggest folks start by allowing Mr. Buffett to invest for them and use that as a learning tool to expand their investments.  Warren has averaged over 20% for the last 44 years, so he has the system down pretty well and he and his partners have been forthcoming about their methods so one can learn from the master.  Fundamental analysis is fairly easy to learn, and the rules are simple to apply.  This method requires the least time from you, but the best thinking, as you will need to use your imagination and your basic sense.  A good place to start to understand this method is to read the annual letters to investors from Warren Buffett located on Berkshire Hathaway’s web site.  This method appeals to conservative folks who find its primary proponent, Warren Buffett’s values line up with theirs.  

Finally, is trend following.  This is by far the most risky of the three strategies but allows for very rapid build up of capital.  Many famous trend followers have made fortunes for themselves and people who allow them to invest for them (Dunn, Sekoya, Henry, etc.).  This strategy involves setting up a strict set of trading rules, usually set up on a computer which alarms when trades are to be made.  The trend follower does not care  about anything except the pricing trends and allows for nothing other than that data to disturb his trading.  This is not day trading as a singular trade, on average, will be held for 18 months.  They trade stocks, currency, options, commodities, anything that has constant pricing that can be turned into a trend.  They spend as much time short as long, meaning they could care less if the trend is going up or down. The key is to set up risk management rules and to not try to out think the rules, just abide by them.  The folks whom developed this strategy (1970s) back tested their rules for hundreds of years before they settled on them.  Most of them had strong math skills to use in creating the rules.  A good book on this is Trend Following by Michael W. Covel.  Be  forewarned this takes extreme dedication and is a very active investment strategy.  But it has shown to provide excellent returns over the long run. 

Finally, are some hybrid strategies.  For example, if you are practicing the buy-and-hold strategy for stocks you can sell covered calls on those stocks to up the overall return.  This is a conservative option strategy that fits well with the conservative nature of the buy-and-hold strategy.  Or you can use real estate as a way to gain cash flow which you then use for the buy-and-hold strategy.  Or you can use real estate in conjunction with selling covered calls like Alan Ellman over at Blue Collar Investor.  Or you can do what I do and invest in Berkshire Hathaway, REITs, and a real estate developer and add in small investments like selling covered calls.

All of these strategies have been proven to give double digit returns to their adherents.  But they all require active participation and constant surveillance along with using one’s brain. Yes, and they all have risk associated with them because assuming some risk is the only way to get to a comfortable retirement unless you are born into wealth!

*****Remember this is only the rantings of someone who has done the research into wealth creation, not someone that is licensed to sell securities or real estate or one that the SEC would consider appropriate for giving out specific investment recommendation.  Before making any decisions regarding your money, do the research yourself, learn about yourself, and learn to be comfortable making your own decisions and living with them. ******

More media attention to the failure of 401Ks! January 15, 2009

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First the Wall Street Journal and now the LA Times have published articles about the failure of 401Ks as a retirement vehicle.  You know the media, it loves to print articles about terrible events!  Yes, I have been telling folks this for a long time now, unfortunately the reality is so bad after 2008 that it can’t be ignored.  I’m sure there will be much teeth knashing about how corporations have screwed the  American public by ditching those defined benefit plans and putting the 401K plans in place.  However, companies that have the defined benefits in place are paying a steep price now (see GM) and are mostly underfunding those plans.  And the next wave to hit  is the public arena, where towns and municipalities are having huge issues balancing current taxing revenues with expenses.  Expect public employees to start to feel the pressure as states, towns and municipalities deal with the loss of tax revenue ongoing!

Social Security will become even more depended on by the baby boomer generation as they retire with even less in their retirement plans!  Seniors will need to get their cash out of their homes, so you can bet on more crisis down the line as seniors fall for the reverse mortgage products in a last ditch effort to not have to sell their homes.  No it is not going to be pretty for the baby boom generation’s retirement.  

This keeps the pressure on, to set myself up with enough assets to go it alone through retirement without depending on social security or other government programs.  Knowing full well that Wall Street isn’t going to bail me out, like we did them, and not wanting to be dependent on a meager social security check I am left with only one position, do it myself.  Ten years ago I started to become an active investor (instead of a passive mutual fund  investor), three years ago I was laid off from a job and truly became dependent on myself, so when I talk to people about changing their approach, I speak from experience. Ten years and I am 1/4 of the way to my goal, despite the poor 2008 and starting from a negative net worth.

If there was ever a time for the lights to go on for people, it is now!  Become an active investor and/or start a business, join the investor/banker crowd, it’s not too late. 

Hope to have the new website up for the Shafer Wealth Academy  by next week.  Remember my book launches at the end of the month!

Have a great weekend (its a long one for us with my son off from school), sit down and consider what you are to do about your retirement!  The time to make changes is now!

Yes, 2008 was ugly….but what are you going to do about 2009? December 30, 2008

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For passive individuals, 2008 was a very scary year.  It seemed there was danger everywhere.  From massive layoffs, to a greater than 40% drop in the S & P 500 stock index, to drops as high as 30% in real estate values, and the $50 Billion ponzi scheme of Madoff,  the financial news was ugly.  There was no where to hide, yet folks did indeed try.  Looks like mutual fund investors could have been better off putting their money underneath their mattresses for the entire decade!  In case you hadn’t noticed, the obituary for the passive investing tribe was written this year.  All those smart physics graduate students that ended up working on Wall Street, and then went on to tell the individual investors that their only chance was to buy and hold index mutual funds have now seen the failure of their advice.  The very same math models they used to give individual investors advice, were used to give risk advice to Wall Street firms on the derivatives they designed.  How that work out for folks????  All the while folks like Warren Buffett and George Soros (along with literally hundred of thousands of smaller investors) used commonly known investment strategies to dramatically beat the market performance over this decade.  They did this investing in real estate, stocks, options, commodities,  currencies, etc.

Now here is a question for the good readers of UFW.  Who is happier at the end of 2008, mutual fund investors or folks like me who have taken control of their finances from the so called experts?  Now it is true that my portfolio is down this year, but it is down nowhere near that 40% number for the stock index.  However, there is something comforting about looking in the mirror and knowing that the person you see is responsible for beating the stock index by over 20%!  And there is something wonderful about watching your wealth go from negative to seven figures in the course of 10 years.  The internet is a wonderful world  and I get contacted by many people.  I have talked to scores of people who have had the same experience as myself by taking control of their finances, so I know I’m not a lone wolf out here screaming into cyberspace!  And by talking with all these folks, I know that no matter how well or poorly they did in 2008, they are all looking forward to 2009 with wealth building plans in hand.  How about you?

The last week I have been posting on psychological factors that affect our financial lives.  Here is perhaps the most important one I haven’t mentioned; confidence.  Not overconfidence as anyone that has done even a small amount of investing has been humbled by the market at times.  No, just plain confidence obtained by taking control from others what you were fearful to do for yourself.  Those with confidence do for themselves and happily live with the results.  Those that lack confidence trust others to do it for them and find themselves very unhappy at times (like now).  I have clients in a variety of financial positions.  Some are getting themselves out from a mountain of debt, others from bad investments, others are trying to figure out how to get control of their wealth from their jobs 401Ks.  And of course some are further along, investing in real estate, stocks, options, businesses, etc. and setting themselves up for a successful 2009.  I ask all of them this question; are you excited about 2009?  Emphatically, they all are.  Yep, confidence is a great trait to possess.  As my friend Alan says, become the CEO of your money.  And I add, NOW. 

Here’s to a great 2009 for all of you!

Yours in wealth creation,

David Shafer, Ph.D.      

CEO of My Money!

CEO of My Money!

The Four Key Financial Behaviors to Building Wealth! November 12, 2008

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I will keep this simple:

1. Cash Flow Management.  Whether you are an employee or commission salesperson or own your own business, this is critical.  There should be a permanent space between cash flow coming in compared to what is going out. Once this difference is an established habit, then you can weather the bad times with the good times.  With this habit, you can understand and use debt as a tool.  All those debt is bad folks miss this point.  Good cash flow management leads to lowered risk leading to successful leverage leading to wealth.

2.  Learn to become an active investor.  No matter what your investing medium (real estate, stocks, options, stamps, etc.) become an expert in that field.  Read everything you can find dealing with that investment.  Learn how others have made money investing.  Learn to ask the questions that amatuers don’t even know enough to ask.  Don’t turn over your investments to anybody else, no matter how well they dress or how nice their office is or how big the companies they work for are.  Only you will have your best interest at heart.  Virtually everybody is intelligent enough to learn how to invest.  No excuses, no fear!

3.  Learn how to reduce your tax liability legally.  I believe we should all pay our fair share of taxes.  However, the key to wealth is to keep as much money as possible.  There are multiple strategies and products that will allow you to avoid overpaying the tax man, use them!

4.  Build a cash flow machine.  Whether you are a life long employee (or plan to be), you need to build a cash flow machine.  This can be a small internet based business or income producing real estate or stock/options trading or investment in a closely held business or consulting.  The possibilities are endless.  But discovering it should be your number 1 wealth building priority.  

  cash-machine