Jay Pestrichelli - Buy and Hedge: The 5 Iron Rules for Investing Over the Long Term

The 5 Iron Rules for Investing Over the Long Term

Jay Pestrichelli
Wayne Ferbert

Vice President, Publisher: Tim Moore
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2012 by Jay Pestrichelli and Wayne Ferbert
Publishing as FT Press
Upper Saddle River, New Jersey 07458

This book is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this book. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly from the use or application of any of the contents of this book.

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All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

Printed in the United States of America

First Printing October 2011

ISBN-10: 0-13-282524-4
ISBN-13: 978-0-13-282524-5

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Library of Congress Cataloging-in-Publication Data

Pestrichelli, Jay, 1970
Buy and hedge : the 5 iron rules for investing over the long term /
Jay Pestrichelli, Wayne Ferbert.
p. cm.
ISBN 978-0-13-282524-5 (hbk. : alk. paper)
1. Investments. 2. Portfolio management. 3. Hedging (Finance) I.
Ferbert, Wayne, 1971- II. Title.
HG4521.P424 2012
332.6--dc23
2011029879

To my girls: Abby, Ella, Grace, and Linda

Wayne

To my wife and son, Lynn and Zander

Jay

Investing on your own can be intimidating. But remember when you were seven? So was learning to ride a bike. How did you feel about learning to drive? I remember when I moved to Chicago from Nebraska to start college; the thought of driving in Chicago traffic was mind-blowing. A few years later, I had a sales job in Chicago and was driving all over the city, focused on my next sales call and not the traffic. You could add flying for the first time, buying your first home, and a whole list of other things you have never done before. Or even if you have done them, you know you need to continue to learn to advance. You must play against a better racquetball player to improve, not against inferior opponents. The key to all these activities is that someone who knew what he or she was doing taught you the skill, and then you practiced it.

My family has been involved in the securities industry for more than 40 years. I grew up with it around the dining room table. I worked at our family company, Ameritrade, as a summer job and then for more than a decade. I am still on the board of directors. When I was the Chief Operating Officer for Ameritrade, Jay Pestrichelli and Wayne Ferbert worked for me. Jay oversaw our largest client segment and came to Ameritrade through one of our many acquisitions. Wayne ran our product development efforts. For years they were responsible for developing, building, and rolling out many of the products we delivered to our clients. They were a great team and always focused on putting the clients first. Wayne was so focused on his projects that, more than once, he forgot to change his bonus goals with me before the end of the bonus period when our priorities changed, to the detriment of his income. When Jay and Wayne approached me with the idea for this book, I was not surprised. Both had always been extremely interested in helping our clients learn how to invest more effectively.

The product of their collaboration is this book, Buy and Hedge , and it is a great one. I wish I had this book when I was learning to invest. It would have saved me a lot of money. It also would have been especially useful these last three or four years. At its simplest, this is a guide to how you can insure your portfolio against downturns in the market. That makes a tremendous amount of sense. We insure many of our large, important assets. We insure our car, our house, and even our lives. Why wouldnt we want to insure our nest eggs, retirement, savingsour securities investments?

I was educated at the University of Chicago, where Modern Portfolio Theory was born. The basic idea of Modern Portfolio Theory is diversification to reduce risk. This book takes that idea one step further. Yes, you want to diversify your investments, but you also want to hedge them against a downturn or insure them. Having been in the industry for so long, I have seen numerous ups and downs. The strategies that this book teaches are straightforward and essential to the self-directed, individual investor.

Two key themes are important in this book. The first, and most important, is discipline. Jay and Wayne state that the only successful investors they have seen are the ones with discipline, and I wholeheartedly agree. Discipline is the prerequisite for success. The individual investor who has a plan and follows it will have the best opportunity to acquire great returns. If you dont have a plan, or if you let your emotions influence your portfolio management decisions, your investment decisions will end up following the crowd. Following the crowd is a recipe for selling low and buying high and will lead to poor performance. The second key theme of this book is risk. Too many investors, including myself, fail to appreciate the times when we take on too much risk for the expected returns. This is, of course, understandable. As Jay and Wayne point out, it is relatively easy to measure the return, but getting a handle on the risk is something else entirely. The authors will teach you new ways to measure and monitor risk in your portfolio. This is truly a lost art in the world of retail investing. Too many other sources, and investment advisors, fail to even address it. The last few years have demonstrated this. You need to take risks to get a return, but too much risk leads to volatility in your portfolio and the potential for sleepless nights. Jay and Wayne help you think about how much risk you are taking and how to limit the volatility in your portfolio. This book is worth reading just for the methodology of thinking about risk.

Finally, this book is about not just theory but practical application. Although you might enjoy the intellectual stimulation that the market can provide, you invest to preserve and grow your capital. To help you reach your goals and implement their advice, the authors offer the Immutable Laws of Investing. These may seem like common sense, such as After-tax returns are the ones that matter, but it is certainly worthwhile to articulate them and be reminded of them. Jay and Wayne also describe the Five Iron Rules (see, I told youdiscipline!). These rules include how to hedge your investments, a detailed discussion of risk metrics, and how to calculate the risk in your portfolio. I guarantee you very few individual investors do this precisely. If you are one of the few who do, you will have a huge advantage over everyone else who doesnt. This part of the book alone is pure gold (which, if you havent noticed, is going up like crazy!). In addition, the authors provide tactics and advanced tactics to make it all work. Have you used a married put before? What about a collar or a diagonal spread? One of the best features of their strategy is that you can implement it gradually, one position at a time if you like, and get a feel for how to use options to hedge a stock or ETF.