The Smart Investor's Survival Guide: The Nine Laws of Successful Investing in a Volatile Market Paperback - 2003

First line

C'MON, ADMIT IT.

Excerpt

Chapter One

Law # 1: Know Your "Enemy" --Understanding Volatility

Those who cannot remember the past are condemned to repeat it. --George Santayana

C'mon, Admit it. For most of you, your portfolio got slaughtered in 2000 and 2001. A millennium mauling. At best, it went into a serious retraction.

Remember all those tech stocks that made you think "early retirement" in 1998 and 1999? They suddenly turned against us in 2000. Yahoo!, Broadcom, Sun, Amazon. Hundreds of stocks falling 50 percent, 70 percent, even 90 percent. And many others going belly up.

And most of 2001 wasn't much better. Those hoped-for rebounds in the techs never materialized. And many stocks that held up reasonably well in 2000 decided to take the plunge in 2001, too.

And just when you thought things couldn't get worse, they did.

September 11.

The Saturday after the terrorist attacks in New York City and Washington, DC, I was scheduled to speak to a gathering of individual investors in Chicago. I didn't give too much thought to my scheduled talk immediately following that tragic Tuesday. I, like everyone else in America, had freeze-framed my own life to focus on this National horror.

But as the weekend drew closer, I began to wonder whether there would be any speech at all. Many gatherings were being canceled throughout the country in the wake of the awful tragedies; not many people wanted to talk about stocks just days after such unprecedented destruction to our country's collective psyche.

Truth be told, I wasn't sure if I wanted to talk about stocks either.

So when I received a call on that Friday from the individual who had asked me to speak, I was expecting to hear from her that my gathering had been canceled or postponed.

Instead, what I heard was the following: "We have been getting a very strong response."

That my talk was still on surprised me; that many people wanted to venture into the country's third-largest city--where skyscrapers would serve as reminders that what happened in New York could easily have happened in Chicago--to talk about stocks surprised me even more.

But I was surprised for only a moment. Life really does go on, I thought to myself.

Actually, life can't help but go on. Life is what all of us do. We live. And living, ultimately, is not a spectator sport.

That's why people showed up for my talk. That's why I showed up. That's why you showed up at work on the Wednesday and Thursday and Friday following the attack. That's why you took your clothes to the cleaners, dragged your garbage to the curb for pickup, ran your kids to soccer practice, played with your grandkids after church on Sunday.

Life goes on.

To be sure, I know there were people who came to my talk who probably felt guilty about attending. After all, it doesn't seem right that anyone should care about something as "trivial" as a stock portfolio when thousands of people are suffering physically and emotionally. But you know what: It's OK to care about your stock portolio. Or your job. Or your pet. Or your refrigerator that's on the blink. Or your car that's running rough. That's all about the process of living, of moving from one day to the next and to the next and to the next.

Yes, there is an investment message in all of this. Much is being made about how our own private worlds will be changed forever. I'm not so sure about that. That process of living is tough to disrupt for long.

Whenever I'm confronted with the notion that bad times are irreversible, I think back to how people must have felt during the Civil War. Think about that period of history for a moment. A nation under siege from itself. States against states. Families against families.

And yet our nation survived. Life did go on.

As it will this time.


But while I'm optimistic about the long-term prospects for the market and, indeed, our country, I can't help but feel that the roller-coaster existences investors have been living over the last few years will become the norm, not the exception. I say this not as an alarmist, but as a realist.

Yes, volatility is unsettling. Yes, volatility can be destructive. But volatility can also be harnessed and used to your advantage. But you need to get back in the game, to deal with volatility head-on.

I know many investors who are numb to what has happened in the world and the stock market over the last two years. They sit with portfolios that they thought were sure things in the late '90's but now are huge question marks.

And they just don't know what to do.

Don't feel too bad. I guarantee you that the guy sitting in the office next door, the woman in the cubicle down the hall, the car-pool colleague who suddenly stopped talking about all the money he was making in the market, your golfing buddy who never seemed to get around to buying that boat he was coveting--all of them got chewed up over the last two years.

How do I know? From my perch as editor of several financial newsletters and CEO of a money-management company, I see lots of portfolios every year. And what I have been seeing a lot of over the last two years are the portfolios where the owners eschewed diversification. Portfolios where the owners chased hot stocks in 1998 and 1999 only to get smoked in 2000 and 2001. Portfolios where the owners didn't have a clue what their portfolio companies really did. (Seriously, do you honestly know what a router is or does?)

And the pros were just as bad. Indeed, mutual fund managers, fearing for their jobs and tired of hearing from their shareholders that not owning tech was stupid, caved and bought the highfliers. Heck, some of the most acclaimed investors of our generation got fed up missing out on the party and started buying tech--right at the top.

Like everyone else, I was not immune to the tech bug either. I bought tech and Internet stocks that, in hindsight, I had no business buying. And I held some stocks (Lucent comes painfully to mind) way too long, even when problem signs were evident.

Fortunately, however, I didn't own just tech. I also owned banks and restaurants and information-services companies and oil stocks and drug companies and financial-service companies and drugstore chains and consumer-products companies and payroll-processing companies. In other words, I had a reasonably diversified portfolio of some 25 stocks and several mutual funds. Consequently, while I got hurt in 2000 and 2001, I didn't suffer the kind of mind-boggling losses that many pure technology investors did...

In fact, investors who saw their portfolios plummet over the last two years may be surprised to realize that some areas of the stock market actually hung in there pretty well. While much attention was given to the Nasdaq Composite's record decline of 39 percent in 2000, the Dow Jones Industrial Average fell only 6 percent for the year. Other major indexes showed similar resiliency. The S&P 500 fell 10 percent in 2000; and if you excluded technology stocks in the S&P 500, that index would have actually increased 6 percent in 2000. The Russell 2000, an index of small-cap stocks, dipped just 4 percent in 2000. And the Dow Jones Utility Average skyrocketed 45 percent in 2000.

I know this may be hard to believe, but more stocks on the New York Stock Exchange actually advanced than declined in 2000.

And while the Nasdaq Composite continued its nosedive in 2001--down TK percent--the Dow turned in a much better year, declining a scant TK percent.

The upshot is that even with certain market indexes and individual stocks registering huge price swings, investors could still have survived--and even thrived--in 2000 and 2001 with the right game plan.

Now, I realize that talking about how you could have avoided getting stomped in 2000 and 2001 doesn't help you much today. After all, you can't relive the past, you can't undo your mistakes.

Fortunately, Wall Street is the land of second chances. I once worked for a man who compared Wall Street to horse racing, "with a new race running every day," he'd say. That's the beauty of investing. Second chances do exist. Fresh opportunities come along every day. Despite the pounding you may have taken in 2000 and 2001, if you are like most investors, you probably have a good 10, 20, maybe 30 years or more of investing ahead of you. That's more than enough time to make serious money in the market, more than enough time to make the last two years a dim memory.

In order to do that, however, you have to stop managing your portfolio using a rearview mirror. I can't tell you how many people I talk to who still believe that tech stock they bought at $100 and now trades for $20 will get back to $100 "in a couple of years." Sorry, but that's not going to happen.

Do the math. A stock that falls 80 percent from its high (for example, falling from $100 per share to $20 per share--and there are plenty of technology stocks that have done just that) needs to go up fivefold in order to return to its previous level. Stocks don't increase fivefold (that's 400 percent for those of us who are mathematically challenged) in just a couple of years. In fact, most stocks don't increase fivefold in a decade; most never do.

Until investors give up this fantasy about seeing technology stocks regain their glory days in relatively short order, they will never be in the right mind-set to do the things necessary to get their portfolio positioned for better market times.

I know that it's brutally difficult to stop looking backward. Looking forward may mean admitting mistakes, and nobody likes to do that. Looking forward may mean selling stocks today that could come back to haunt you tomorrow. Looking forward may mean locking up big losses.

But in order to move forward, to position your portfolio for the next 20 years--and to avoid making the same mistakes--you have to let go of the past and chalk it up to an expensive learning experience that will pay dividends over the next decade and beyond.

What's important now is to learn from your mistakes, get a good game plan, and position your portfolio for the future.

This book shows you how.


From the Hardcover edition.