INTRODUCTION
BEYOND BLIND FAITH— THERE IS CLARITY
AS A SOCIETY, we have placed our faith, hope, trust, and dreams in the upward movement of future stock prices. The wisdom of tying 50, 60, 70 percent or more of our financial net worth to this mechanism is based on the unquestioned underlying assumption that over the long run an investment in stock—a percentage share of ownership in a corporation—is the best place to put our money. As you will discover, this is a myth that we individual investors have come to blindly believe.
As investors we have experienced the jubilation of a roaring bull market and the horrible carnage wrought by a grisly bear market accompanied by colorful corporate scandals. This occurred during a time when our retirement plans accounted for about half of the country’s traded stocks. Many investors feel “wiped out” by the experience and swear never to be fooled again.
Yet others, who had a solid respect for the risk of tying their savings to the market, captured much of the tremendous gains of the late 1990s and gave little or none of it back when the bottom fell out in the early 2000s. These “protected” investors recognize that at times the market is a money-generating machine and at other times a destroyer of wealth. This simple realization, that the market can move dramatically and unpredictably both up and down, calls for an investment plan that works in this perpetual high-risk environment. This book lays out that plan.
If unprotected against loss, an investment in stock or an equity mutual fund is nothing more than a gamble. Just as a 2fortunate few at the casino will walk away winners, while the majority of the players lose, the rules of this game favor the “house.” The people at the top rake in obscene truckloads of money in frenzied rising markets and even make carloads when the market is going down.
Investors have every right to feel taken advantage of as they discover that the playing field was never level. High-profile corporate and accounting scandals provide a target for our anger and frustration as we attempt to make sense of it all.
Despite everything that has happened, financial books, magazines, and advisers stick with the same old tired line: buy and hold stocks. We need a radical diversion from this traditional investment counsel. Blind Faith presents an unorthodox view that will forever change your belief about the wisdom of gambling your hard-earned dollars in the stock market.
THE FOUR MAIN MESSAGES
This book has four essential messages summarized as follows:
1.The risk of placing money into common stock or equity mutual funds has evolved to the point where this process, commonly referred to as investing, can now be more accurately described as speculation or gambling.
2.The people who place money into the stock market take on most of the risk but receive only the “crumbs” of a market advance. The real winners are the executives, the corporations, and the brokerage industry. The rewards are so great that the behavior of these “beneficiaries” of market advances can range from unethical transgressions to outright fraud.
3.The traditional measures for dealing with market risk—asset allocation and diversification—do not adequately3 address the problem. This book presents a new philosophy and strategy for dealing with the inherent dangers of stock market investing.
4.There are ways to participate in market advances while protecting the underlying principal against loss. These “protected” investment alternatives are available today and are evaluated as a means for intelligently dealing with market uncertainty.
These four messages are pertinent to anyone concerned about the risk associated with investing in stocks. This includes individuals, fiduciaries, and financial professionals, both foreign and domestic.
An underlying theme is that there is no certainty when it comes to predicting how the market will perform during a specific period of time in the future. It may turn out to be the best place to put money or the absolute worst. Investors don’t know. Investment advisers don’t know. Nobody knows!
Given that the future is completely uncertain, there is a better way to plan and invest that goes far beyond placing our blind faith in the expectation of an ever-rising stock market. Speculating in the market may be stimulating entertainment, but the risks associated with investing in stock are incredibly high. Investments that protect our principal yet allow for participation in the upside of the market eliminate the gambling facet and allow us more control over our future financial health.
The book is divided into three parts. Part I outlines the problem and the tremendous risk associated with stock market investing. Part II presents a logical strategy as well as a philosophy for dealing with our uncertain financial future. Part III describes specific types of investment products that can be utilized to implement the strategy, gives pointers on how to invest for retirement, and offers suggestions for improving the current capital system.
THE AVERAGE INVESTOR SHOULD STEER CLEAR OF STOCKS—HERE’S WHY
Individuals who invest in stocks and managed mutual funds do not achieve returns that even come close to the overall market. In Part I, you will see that professionals can’t beat the market either. You will also discover that certain hazards, rarely considered, create uncertainty with stock market investing. Hazards increase the risk of investing in stocks and reduce the chances of winning.
Superior intellect and a logical mind can’t offset the irrational behavioral and emotional factors that go into investment decision making. The risk of investing in corporations goes far beyond normal business and economic risks because the pressures for short-term positive stock performance create a myopic view of the future. These risks became very apparent during the early 2000s as many companies imploded under dark clouds of unethical transgressions.
As investors, we have discovered that much of the research and advice distributed by the brokerage industry was totally self-serving and worse than worthless. Those who followed the advice of the large brokerage institutions during the collapse of the market bubble in early 2000 suffered big-time losses as analysts privately called the same stocks they were recommending pieces of junk.
We buy stocks and equity mutual funds with the realization that there is some risk but that the risk can be offset by higher returns. But the risks, compared to the potential rewards, are totally out of proportion. We risk losing our entire investment, while stock options grant high-paid executives a free lottery ticket to riches beyond imagination. Corporations use stock to make boneheaded acquisitions that make our share of the company worth relatively less. Brokerage firms rake in high underwriting commissions on companies they recommend to their customers. We the investors continue to provide the fuel 5for this ongoing plunder of our own hard-earned dollars by continuing to believe that the potential rewards of investing in the market more than offset the risk.
STRATEGIES FOR DEALING WITH UNCERTAINTY
The primary objective of an intelligent investment strategy should be to preserve capital and build upon it at a consistent, moderate rate in both bull and bear markets. Our personal definition of risk is simple and understandable: we don’t want to lose money. But many of us are shooting at the wrong target.
Beating the market averages or matching the market is a common objective of equity mutual funds and investment advisers who seek to justify their own existence. Many of us buy into the industry’s definition of risk, which views a 20 percent loss in a market that is down 25 percent as a success. This makes no sense!
Part II develops a unique but sensible means of handling investment risk. Even though the risks of investing in the stock market are tremendous, it still may provide superior returns relative to other investment options. Ideally, we could time the market and be invested during the boom times and on the sidelines during the bust times. However, since it’s impossible to time the market, we need another way to deal with investment risk.
Investment advisers have traditionally dealt with stock market risk by diversification, asset allocation, and a long-term outlook. These strategies help to reduce risk when investing in equities but do not eliminate it. But are investments in equities a sensible way to provide for the future? Not when there are alternatives that allow us to participate in market gains while protecting our investment principal. We can avoid unprotected investments in the market by transferring the risk of loss to a third party.
Most of us use this technique when we purchase comprehensive and collision coverage on our automobiles. We assure that our home is protected against loss by perils we hope never happen, such as fire or natural disasters. Yet we rarely consider transferring the risk on our stock-related investments, which are subject to a long list of hazards. In addition to the dangers discussed in Part I, these hazards include political, economic, and business factors that also increase uncertainty and our chance of loss.
MAXIMIZING RETURNS WHILE MINIMIZING RISK
Part III reviews protected investments and how they work to safeguard our principal while providing a return that is tied to the market. Protected investments include market-linked certificates of deposit, market-linked notes, equity-index annuities, and equity-linked life insurance. Our principal is guaranteed and/or insured by major financial institutions that are able to provide these assurances. Our risk of loss in the stock market is effectively transferred to a third party.
For most people, the bulk of their financial investments are held in retirement plans, including 401(K), 403(B), and IRA plans. Incorporating protected investments into these plans will increase the probability of securing a comfortable retirement. A separate chapter is devoted to the challenges of investing for retirement.
Part III also addresses the problems and issues outlined in Part I, as well as key corrective actions that our society needs to consider right now.
EXTREMIST VIEW OR LOGICAL CONCLUSION?
At first glance it may seem like this book promotes alarmist thinking with an extremist view of avoiding stocks and mutual funds in favor of more predictable and controllable investment options. However, it all boils down to a simple matter of evaluating risk versus reward. When you consider all the facts, it is just plain common sense that most people should avoid unprotected investments in the stock market.