Steven M. Sears - The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails

Contents

I must create a system, or be enslaved by another mans.

William Blake

Copyright 2012 by Steven M. Sears. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Sears, Steven M.

The Indomitable investor : why a few succeed in the stock market when everyone else fails/Steven M. Sears.

p. cm.

Includes bibliographical references and index.

ISBN 978-1-118-11034-8 (cloth); ISBN 978-1-118-22433-5 (ebk);

ISBN 978-1-118-23739-7 (ebk); ISBN 978-1-118-26239-9 (ebk)

1. Stocks. 2. Risk management. 3. Speculation. 4. Portfolio management. I. Title.

HG4661.S36 2012

332.6322dc23

2012004096

For Kitya, Onward, to Ithaca

Chapter 1

Risk

It is a dirty fact, but everyone on Wall Street knows the stock market could not function without Dumb Money. Dumb Moneyand that is how Wall Street classifies outsidersalways does what most benefits Wall Street. Dumb Money buys stocks when it should sell, and panics and sells when buying makes more sense. This is a primary reason why Wall Street makes so much money when most everyone else fails, or inches forward, in the stock market. If not for the positive effect of inflation, and corporate stock dividends, which represent more than 45 percent of historical stock gains, most investors would have sharply smaller investment portfolios.

Now, as Baby Boomers confront retirement, and younger generations worry they will not live as well as their parents, millions of people are beginning to understand that they must get much smarter, much faster, about the stock market if they ever want to retire, pay for their childrens college educations, or lead lives that eventually bear some semblance of financial ease.

The old ideas of coasting toward retirement by regularly investing in stocks and effortlessly doubling stock portfolio values every seven or so years as the stock market advanced are no longer valid. The Credit Crisis of 2007, and Europes sovereign debt crisis that sparked in 2009, have unleashed new financial realities that are likely to prove true Wall Streets adage that the stock market hurts the most people, most of the time.

Yet, the future need not be as difficult as the recent past.

A well trod path exists that anyone can follow to better deal with Wall Street and the stock market. This path has quietly existed for centuries. The path was carved out, and continually refined, by a small group of people who typically avoid the financial calamities that ensnare everyone else. This group of investors has historically dominated the financial market, and quietly snickered at the widespread idea, birthed in the late nineteenth century by John Stuart Mill, that people can make rational financial decisions.

Mill called his idea Homo economicus. He declared his Economic Man capable of making decisions to increase his wealth. Mills man has persisted ever since like some financial Frankenstein even though the financial markets are so complexespecially in the past 40 yearsthat it is increasingly apparent that Mills man, today known simply as John and Jane Investor, has great difficulty profitably navigating the stock market.

In sharp contrast to Mills incarnation is a small group of people who make more money than they lose. In keeping with Mills use of Latin, think of people in that group as Homo Indomitabilis .

The Indomitable Man is different than everyone else in the market. He leads a life of counterintuitive thought and action that is perhaps best summed up by a simple idea: Bad investors think of ways to make money. Good investors think of ways to not lose money. Those 17 words are the most important words any investor can know. Learn the meaning of those words, and you have a chance of real success in the stock market.

The difference between the idea of the good investor and bad investor is profound. One idea ensures you eventually give back profits, and likely some, or all, of your initial investment, to Wall Street. The other one lets you keep much of what you make. Though the good investor rule seems like common sense, it is not well known off Wall Street. This is one reason why so many people fail in the market, or are swept along with the crowd, because they lack a simple, proper, disciplined framework to make investing decisions. Most people are interested in getting rich, and getting rich fast. They try that approach again and again and again, often taking on more risk to make profits and recoup losses. Often, this ends poorly. Still, they continue to climb back up the stock markets risk ladder, chasing the higher returns of riskier investments without truly understanding the risks they are taking, or even why they failed.

The issue is not necessarily that people are too greedy for their own good, or not smart enough to understand how to navigate the stock market. The issue is that the United States very quickly morphed from a nation of savers to investors. People who once saved money in passbook savings accounts have since the mid-1970s been increasingly thrust into the stock marketeven though they were, and often remain, effectively financially illiterate. These new investors use ideas that work on Main Streetbut not Wall Street. The disconnect is now lethal. Rather than simply hoping the economy improves, or that another bull market erases peoples financial problems, it is better to focus on the facts and ideas on Wall Street that are made truer by time, and that have long kept the best investors safe when others have stumbled.