Financial Freedom Blueprint (eBook)

Ahead of the Herd

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The secret of change is to focus all of your energy, not on fighting the old, but on building the new.

—Socrates

When I got out of college in 1994, I quickly learned that following the established rules of Wall Street and the academic community can be hazardous to your investment performance. When I started my career as a professional investor, the stock market had started to roar higher, and investors saw back-to-back years of banner growth. The world was enamored with the internet and all things dot-com.

My finance training indoctrinated me with the common wisdom taught in business school and the Chartered Financial Analyst (CFA) curriculum. That wisdom asserted that you should focus your attention on trying to value companies and invest in stocks that had excellent valuation based on detailed fundamental analysis. This way of thinking is still the predominant method used on Wall Street today.

At first, this method worked very well in the market for me. But then something strange happened—something that was never taught in business school or the CFA curriculum. My stocks, which had great fundamentals, started heading down hard, while poor quality stocks with no earnings skyrocketed. This continued for a couple of years. My firm started losing assets as people began to move their money to mutual funds that were investing in everything dot-com. Investors were hypnotized by greed and throwing out the fundamentals. Many of the best, strictly fundamental managers saw their portfolios get slashed in value. In fact, Warren Buffett, one of the most famous value investors, saw his portfolio in Berkshire Hathaway crash in value, going down over 50 percent during this period of time. It was brutal.

Then, everything reversed. In the year 2000, all of the poor-quality dot-com stocks crashed while stocks with good fundamentals moved much higher. If you were a buy-and-hold index investor who followed the conventional wisdom, you would have suffered losses for well over a decade because most of your stocks would be invested in the companies that crashed!

I estimate that 80 percent of investors are following the established rules that were invented and promoted by Wall Street. I believe that investors will do much better if they step away from products sold to the masses. Mass-marketed products tend to water down your ability to generate solid, risk-adjusted returns. I also believe that investors should take a different approach than the buy-and-hold convention.

Instead, I support not conforming to the established rules that have been preached by the financial services industry, but to think independently based on a formula that I will introduce. I’m talking about changing your habits and not following the herd.

This is Not Your Parents’ Economy

As I write this, in 2021, we are in a completely different economic and political environment. This world is nothing like that experienced by your father or your grandfather, and for that reason, the opportunities are completely different. We are making way for new innovation and leaving the old economy of the past behind.

What has changed? Much of the change is driven by technology and innovation. But what is more important is that the current change is affecting virtually all industries. But there are a couple of headwinds we must overcome: poor government management and social unrest. If I had to encapsulate it in a nutshell, these are the changes that will have the most significant impact on your future returns:

• enormous innovation spurred by technological developments in many industries
• huge debt issuance by governments and deficit spending around the world
• enormous increases in the money supply by global central banks in most developed countries
• a widening gap between the rich and the poor
• corrupt government behavior

The Bright Future

The world is experiencing an explosion in new companies with new products and services. It’s an exciting time for investors, filled with opportunity. As technology has sped up, it is affecting virtually all sectors of the economy. This innovation will continue to lead to big winners and losers.

The goal is to be in a winning position during great periods of change.

While innovation is encouraging, unfortunately progress is threatened by

• irrational government spending;
• increasing regulation; and
• extreme political division.

Ten years ago, if someone would have told me that the United States would have as much debt and deficit spending as we have today, I would have said they were crazy. If ten years ago someone would have told me interest rates would be near 0 percent in the United States and negative in Europe, I would have said, “We must be entering a depression.” If someone were to tell me that the election process in the United States was riddled with accusations of errors and corruption, I would have said, “That only happens in third-world countries—not the United States.”

Yet, this is the economic and political backdrop we have today.

It will likely have long-term implications, making it more difficult for you to protect and grow your money the same way your parents did. The good news is you can overcome this and be a winner!

Be Aware of the Established Rules

Before I get into the key ways to win, let’s talk about what most of the financial services industry is pitching to American investors and the established policies that they want you to follow. I have an intimate knowledge of how the system works. I learned about it firsthand while working for a large brokerage firm and a large bank as a portfolio manager. Our department managed billions of dollars for high-net-worth people. I advised many different types of investors ranging from mom-and-pops to CEOs of publicly-traded corporations.

One of the things I found out is that we had a tremendous number of resources and access to the best institutional research. Yet, when I looked at the results of our clients, they were lackluster. I was shaking my head all the time, asking, “Why is this happening?” I decided to roll up my sleeves and really began an effort to study the very best investors who did well. Here is the biggest secret I learned: the absolute best investors break away from the orthodox way of doing things.

Wall Street wants to sell packaged products that are cookie-cutter. You are at a great advantage because you can tune out Wall Street’s pitch. Instead, you can be nimble by investing in future innovation, diversifying, and protecting yourself from unruly governments.

Avoid Products to the Masses

There are many advertisements by investment firms that say, “We care about you as an individual.” Most of the time what’s really going on behind the scenes is that they are promoting assembly-line portfolios and selling them through advisors who have no real experience making money in the markets.

This is the type of investing the masses are doing—cookie-cutter and watered down. I believe most investors should go back to basics. Step away from the investing habits of the 80 percent and enter the realm of rational active management where your portfolio is free to invest in attractive opportunities without regard to how the indexes are invested.

What exactly is the product that is being sold to the masses? It is basically a structured product that owns everything in a given market. It is massively diversified and invests in securities with very little discrimination. In this strategy, you own so many securities that your investments are exposed to the whims of the overall stock market.

They are implemented in exchange-traded funds, index funds, and other packaged products sold as active funds, but they are really “closet index funds.” There is little to no customization for the economy or your personal situation. You may hear a salesperson say, “Look how low your fees are,” but you’re basically owning everything, and you are socializing your returns.

Low fees will not rescue you from a 50 percent bear market if you own the S&P 500 Index Fund.

Socialization of Returns

Now the truth of the matter is, statistically speaking, many packaged investment products have very little differentiation because they correlate highly with each other. This is particularly true with stock investments. In many cases, it can be proven that the correlation between these instruments, meaning how much they move up and down together, is approaching .80 to .90 much of the time. In other words, 80 to 90 percent of the variance moves together. This means that when an inevitable bear market happens, which is normal from time to time, most of your investments will fall in value. It also may take a longer time to recover. You think you are diversified because you have many funds, but you may not be because many of the stocks held in your portfolio are the same or very similar, and they are heavily invested in the largest companies. So, there’s no differentiation between many products.

Unfortunately, most of the public is investing by the established rules—the rules set by Wall Street. I am going to propose you invest with a different formula that is more rational. Not in a static asset allocation portfolio with very little adjustment for conditions. Not in wrapped mutual funds with a lot of overlap. Not owning well over 1,000 securities in your stock portfolio.

Differentiate and...