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Wednesday, January 30, 2013
Today, I'm going to tell you an unpleasant truth...
Most of you reading this note will not make money with your investments this year... or next year. Most of you, in all likelihood, will never make money in the stock market.
It may shock you to hear it. It might make you angry. It might fill you with strong doubts about my credibility.
I'm telling you anyway because I'm convinced the only chance you've got to become a successful investor is to start by acknowledging that reality. Once you know that individual investors generally fare poorly in stocks, you can begin to examine why...
We know most individual investors don't make money in the stock market from Dalbar... a Boston-based consultancy that studies actual mutual-fund returns. We know from the investment-management firm BlackRock, whose study is shown here...
We also know from discussions with dozens of certified public accountants that almost all their clients lose money in their personal brokerage accounts.
Let's start with the most obvious reason: The financial industry does not exist because it enriches its clients. The clients provide all the wealth required to maintain the financial industry.
The profits that power the branding and the marketing of mutual-fund companies and big investment banks came out of the pockets of their clients. Think about that. Think about it carefully the next time you consider following any financial institution's advice about what to do with your savings.
Investment banks exist to raise capital for corporate clients. They do not exist to give you a good stock tip or put you in a safe bond. (If you need a refresher course on the way Wall Street really works, read the famous book Liar's Poker.)
The other main reason people, on average, tend to fare so poorly in stocks is that very few individual investors know anything about how to value a security – a stock or a bond.
Let me give you a vital tip: If you don't know more about the value of something than the person who is selling it to you, the chances of you profiting from the transaction are extremely close to zero.
We've written volumes about how to value stocks and bonds. But... the writing is boring. It requires careful thought and attention. Most people, it seems, would rather trust some lines on a chart... Yes, sometimes these guides will work. But if you believe charts can compensate for a complete lack of basic financial skills... you will soon go broke in the stock market. That, my friends, is a fact. If you don't know how to value the business you're about to invest in, don't make the investment.
The last nail in the coffin of the failed individual investor is a complete lack of risk management. We've talked about the importance of exit strategies over and over in DailyWealth. (Review the idea here and here.)
Catastrophic losses happen for the same reason, every time. They don't happen because an investment idea didn't work out. Even great investors are only going to be right about stocks roughly 60% of the time. Catastrophic losses happen because people can't stand to take small losses. They allow them to grow into big losses.
There are two good ways to make sure this never happens to you. The first way is completely foolproof: Never invest more in any individual stock than you're OK losing. If it goes down 100%, it shouldn't matter to your financial well-being. That means if you're investing a total portfolio of $100,000... you'll limit your position sizes to $2,000 (or maybe $5,000 at the most). Worst-case scenario, you lose 5% of your portfolio. That's not going to kill you. With some kinds of companies (risky biotechs and mining stocks, for example), this is the only kind of risk-management technique that really works because the shares are too volatile for trailing stops...
The other way to prevent catastrophic losses is to simply decide, in advance, when you will sell. It might be on the basis of negative price action (a trailing stop). Or it might be at a fixed price – you'll sell if shares drop to less than $10, for example. Or you can use charts to find points where you no longer want to risk owning the stock.
I don't really care what kind of risk management you use... so long as you use something. I can guarantee that if you don't have your risk strategy figured out, sooner or later, you will suffer a catastrophic loss... and it will completely wipe out all your previous gains. That's just what happens.
This is the most important information I can possibly give you.
You need to realize that most investors will fail. You need to understand why they fail and how they fail. They fail because they allow their emotions to overtake their reason. They fail because they don't have the most basic tools – they don't know how to value stocks. And they fail because they eventually suffer a catastrophic loss.
I truly hope you'll take this essay to heart. I hope you'll look back on the investment mistakes you've made and think about why they happened. It wasn't just because you bought the wrong stock.
Find a way to eliminate these mistakes and you'll be on your way to becoming a more successful investor.
Even if you're a smart investor, you may easily fall into traps that prevent you from becoming a world-class investor. But as Porter showed readers earlier this month... with a little common sense and a little discipline, these traps are easy to avoid...
"I believe most investors think the strategy is simply too boring... or too good to be true," he says. "But almost no matter what else you decide to do, you will NOT beat these results." Learn more here: The Best Investment Advice You'll Never Take.
THIS LONG-TERM UPTREND IS CRUSHING THE MARKET
Today's chart shows how our colleague Dr. David Eifrig was really, really right on "Big Pharma."
Longtime DailyWealth readers are familiar with Dr. Eifrig's urging to take a position in Big Pharma stocks like Pfizer, Abbott Labs, and Eli Lilly. For years now, "Doc" has noted how aging Baby Boomers are driving pharmaceutical and medical-service consumption. Plus, government programs like "Obamacare" will drive increased demand for drugs.
Doc nailed his call. It's been an amazing run for Big Pharma over the past few years. The sector isn't just beating the market... it's crushing it. For example, consider the returns of the PowerShares Dynamic Pharmaceuticals Fund (NYSEARCA: PJP). This fund is a "one click" way to buy a diversified basket of drug stocks.
Over the past three years, PJP is up more than 100%. That's nearly triple the performance of the broad market. As you can see in the chart below, shares of PJP just hit a fresh all-time high last week. Big Pharma's market-beating uptrend is still going strong.
– Larsen Kusick
In The Daily Crux