Own the Field

Have you ever experienced an inflection point in your life?  A recognizable point in time where a decision brought about a significant change in the direction of your life?

I’ve experienced several, both good and bad.

One successful inflection point that comes to mind occurred in 1996 when I stumbled upon two concepts and then applied them in my life.  The first was a newly published book that year by authors Thomas Stanley & William Danko, The Millionaire Next Door.  The second was the work of Earl Nightingale, namely The Strangest Secret and Lead the Field.

As I adopted the principles of Lead the Field into my life, I modified the title substituting “own” for “lead”.  Own the Field became my mantra.  I did this to stress the importance of entrepreneurship over bureaucracy (having spent many years in the military and large corporations).  Bureaucrats attempt to lead, while in reality they control, regulate, restrict, impose, meddle, nitpick…all the while using someone else’s money and resources.

Entrepreneur’s put their own assets at risk to create.  They BUILD it, they OWN it.

If you want to build wealth then you have to get out of the bureaucratic mindset.  Entrepreneurs look for opportunities to serve others- what products or services do people want to buy?  (see Building Wealth)

Nightingale tells the story of a friend that was looking for work during the Great Depression.  He was easily able to find employment when masses were unemployed.  He did it by familiarizing himself with a chosen industry.  Then when approaching a perspective employer, he would go directly to the owner and rather than asking for a job the man would tell the owner an idea to improve the business.  The owner was concerned about the effects of the Depression too, he was looking for ways to increase profits.  Nightingale’s friend got the job.

This method works.  I’ve used it to gain employment and more importantly to build my business.

I use a version of it when choosing stocks.  I look for companies that are like the man in the story-  they’re hungry, they don’t follow the crowd, they do their homework, develop solutions, and take them to market.

You too can use this method to recognize talent.  You’ll be able to identify which companies are innovative entrepreneurs and which are laggard bureaucrat organizations.  Learn to recognize the difference and you’ll increase your profits dramatically.

NO: Buy & Hold…YES: Buy & Hedge

Have you heard the hysteria?  “The market’s back!  At all time highs!  Buy and hold WORKS!”

But you’re smarter than that.  You remember the ups and downs (see charts 1 & 2).  Factoring inflation, the S&P isn’t at an all time high.  The NASDAQ isn’t anywhere close to its high reached 13 years ago.

If you bought and held, depending when and which index was purchased, you could still be significantly in the red.  Since 2000, there hasn’t been a 5 year period without at least a 43% drop in an index.

The intelligent approach is to buy equities and hedge against catastrophic losses.  One method is to use Protective Puts.  This strategy allows reaping of unlimited upward moves in a stock, but limits loss to the premium cost of the option.

Let your gains run but cap your losses.

Applying this strategy over the past 20 years could have allowed an investor to make significant money during the uptrends (which varied 87% to 460%), yet only suffer minimal losses during the downtrends (which varied -43% to -74%).

You say that no one’s smart enough to sell at the top of a market?  One person comes to mind.  Ever hear of Mark Cuban?  In 1999 he sold broadcast.com to Yahoo for $5.9 billion (in Yahoo stock).

You may never be as rich as Cuban, but you also don’t have to be as clever as him to be a successful investor.  Watch the indices, participate in the uptrends, hedge against a major loss.

S&P500 historic trendsNASDAQ historic trends

Advice

Be cautious where you seek advice.  Expertise is not transferable.  If you have cancer you don’t go to a cardiologist.

Seems like a simple concept but smart people frequently seek counsel from unworthy sources.

Consider JCPenney appointing Ron Johnson as CEO.  Johnson is brilliant.  Johnson is so cool. He was the VP of Merchandising for Target before pioneering the Apple Retail Stores concept.  Johnson was hired to transform JCPenney.  And he did, from a market capitalization of $6.84 billion to a paltry $3.49 billion…losing more than 50% of the company’s value.  Johnson is a merchandising expert but he wasn’t a competent CEO.  His expertise didn’t transfer to JCPenney’s situation.

Investors should likewise be cautious when seeking investment advice.  Competent attorneys and accountants may not be knowledgeable about investments.  Real estate investors may not be competent in securities.  Bond strategists may not understand the dynamics of option trading.

As a young investor, I couldn’t afford competent advice.  I didn’t have enough money to attract top talent.  The financial planners and investment advisors that sought me out had less knowledge and a lower net worth than I did.  They weren’t advisors, they were salesmen.  They knew how to build client relationships but for the most part had no idea about building wealth.

I resisted the sale prodding and decided to learn how to invest my own money.  As my net worth grew, so did the appeals from financial advisors.  The pattern continued, I was always one step ahead of the talent that I could afford.  I had more investment knowledge and a higher net worth than the salesmen that were courting me.

Seeing a void in the marketplace, I founded Investable Wealth, LLC as an alternative to “relationship” firms.  Our business model is not based on personality, we actively manage investment portfolios to help our client’s build wealth.

Can you time the stock market?

QUESTION:  What do you call an “expert” that claims to know where the market is headed?

ANSWER:  A liar.

Don’t trust anyone that claims to know what’s going to happen in the future.  The world is too complex.  The stock market, the weather, the mood of your spouse…there’s no telling.

Recall back to September 10, 2001.  Do you remember anyone predicting a terrorist attack the following day?  That’s an extreme example, but on 9/11 it only took nineteen hijackers to change modern history.  Now consider how one small insignificant event could cause your stock portfolio to drop 10%.  During any given minute, there are 7 billion people on earth whose actions could impact the market.  Factor in natural occurrences and it’s evident that long term predictions are futile.  It doesn’t matter how “super” the super computers get or how sophisticated the algorithm, the world is too complex.  Too chaotic.

The proper course of action is to make near term forecasts that are protected against catastrophic loss.  To paraphrase Ronald Reagan’s “trust but verify”, as investors we want to “forecast and hedge”.  (See prior article on the use of Protective Puts.)

As to near term forecasting, on an elementary level it’s comparable to observing the weather.  In San Diego if it were sunny and warm yesterday, and it’s sunny and warm today, there is a high probability it will be sunny and warm tomorrow.  If a stock had increasing earnings last quarter, and increasing earnings this quarter, there is a strong probability that it will have increased earnings next quarter.  Simplistic?  Yes, but that’s the essence of securities analysis.

Near term forecasting consists of two basic elements.  Fundamental and Technical analysis.  Fundamental refers to the stock’s underlying value- for example, a strong balance sheet and multiple quarters of increased earnings.  Technical refers to the stock’s price and volume action.

Combining the two elements, an investor can make near term forecasts on the direction of a stock.

As an example of near term forecasting accuracy, consider Investor’s Business Daily (IBD) market outlook.  Chart 1 is derived from IBD market outlook commentary superimposed on the SPY S&P500 index exchange traded fund.  Over the 21 month period IBD was directionally accurate in their outlook.  This type of forecasting is especially effective for a disciplined investor.  One that is patient and waits for the market to prove itself, thus avoiding market turbulence.

IBD UpDown Trend Chart

Being right even when you’re wrong…protecting your position with options

At Investable Wealth, LLC we strongly believe in protecting our equity positions with options.  A well researched position can fail for many reasons.  Stocks with excellent fundamentals and “proper” charts usually fail 30-40% of the time.  Add to that the threat of unforeseen news/events, a flash crash or just plain bad luck- no stock is immune from a dramatic price drop.

One method we use to help minimize losses is employing a “protective put” strategy.  Protective puts are sometimes referred to as “married puts” because both a stock and its put are purchased together.

The put’s value will move inversely to the stock’s…thus acting somewhat like a short term insurance policy for the equity.  If the stock increases enough to cover the premium of the put, then you’re in the money.  If not, your loss is limited to the cost of the put.

Here’s an example.  Let’s say that an investor was contemplating a position in gold following the Presidential election of 2012.  The investor is not concerned with a gloom & doom end-of-the-world scenario but is taking a prudent position (one taken by hedge luminaries like George Soros and John Paulson).  With the re-election of President Obama there are many concerns, including the implementation of Obamacare, Bush era tax cut expiration and the much overblown “fiscal cliff”.

Our investor in this example is forecasting uncertainty and turbulence in the market.  Rather than just wait things out in cash, he decides to invest in gold- anticipating at least a short term pop.  Gold has just broken through the 10 week moving average and he feels the technicals look favorable (see Chart 1) for at least a 12% upside.

IAU Protective Put EXAMPLE Chart1

He purchases IAU gold exchange traded fund (ETF) for a price in the mid to high $16’s and an April 20 $17 put for around a 3% premium.  Our investor is now able to sit back for the next 4.5 months anticipating his forecast of a 12% gain confident that a loss will not exceed 3%.

Over the ensuing months gold plunges more than 22% (see Chart 2).  The protective put limited the loss to about 3%.  Although the forecast was horribly wrong, the investor was still right (equity investments are not guaranteed, a prudent investor limits losses to 8%).

IAU Protective Put EXAMPLE Chart2