The Indomitable Investor

Why a Few Succeed in the Stock Market When Everyone Else Fails

Steven M. Sears

• Publisher: Wiley
• Year: 2012
• Print ISBN: 9781118934043, 9781118110348
• eBook ISBN: 9781118237397
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

A new approach to investing based on how Wall Street insiders approach the market

The Indomitable Investor deconstructs the stock market as the public has come to know it and reconstitutes it from the inside out from the perspective of the fortunate few who dominate Wall Street. By revealing how top investors and traders think and act Steven Sears shows the stock market to be an undulating ocean of money, with seasoned investors reading the waves others cannot.

Teaching readers to think about the market in radically different ways, The Indomitable Investor shows how to improve returns—and, just as importantly, avoid losses—with disciplines deployed by people who almost always do exactly the opposite of what Wall Street says to do.

Laying bare great fallacies, the book explains that non-professional investors wrongly think the stock market is a place to make money, which is what Wall Street wants them to try to do. The Indomitable Investor says otherwise and shows how Wall Street's best investors have a completely different focus.

• Explains the critical ideas and insights of top traders and investors in language anyone can understand and implement
• Packed with material rarely shared off Wall Street that is used every day by professional investors
• Introduces the 17 most important words on Wall Street
• Teaches critical skills, including: How to increase returns by focusing on risk, not potential profits; how to use the stock market's historical patterns to optimize investment decisions; understanding key relationships between stocks and the economy that predict what will happen to stocks and the broader market; how to increase mutual fund returns with an easy adjustment that redirects the bulk of profits to you—not mutual fund companies, and how to analyze information like seasoned investors to move beyond "statement of the obvious" news reports that turn ordinary investors into Dumb Money

Accessible to readers of all backgrounds, including those with a limited understanding of investing, The Indomitable Investor will change how investors view the stock market, Wall Street, and themselves.

Chapter 1
Risk

It is a dirty fact, but everyone on Wall Street knows the stock market could not function without Dumb Money. Dumb Money—and that is how Wall Street classifies outsiders—always 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 children’s 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 Europe’s sovereign debt crisis that sparked in 2009, have unleashed new financial realities that are likely to prove true Wall Street’s 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. Mill’s man has persisted ever since like some financial Frankenstein even though the financial markets are so complex—especially in the past 40 years—that it is increasingly apparent that Mill’s man, today known simply as John and Jane Investor, has great difficulty profitably navigating the stock market.

In sharp contrast to Mill’s incarnation is a small group of people who make more money than they lose. In keeping with Mill’s 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 market’s 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 market—even though they were, and often remain, effectively financially illiterate. These new investors use ideas that work on Main Street—but not Wall Street. The disconnect is now lethal. Rather than simply hoping the economy improves, or that another bull market erases people’s 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.

If you think people learn anything from losing money, you are wrong. The people who lose the most money, at least in the stock market, are often the most anxious to recoup their losses. The reasoning is fascinating, and it is a key to understanding why investors are stuck in a boom-and-bust cycle. “If someone had a lot of money in the market, and then loses it, they respond by jumping back into the market because the risk of not making money is greater than the risk of losing what they have left,” says Mark Taborksy, a former portfolio strategy chief at PIMCO, one of the world’s largest money-management firms, who now works at Blackrock, another major firm.¹

Gib McEachran, a financial planner in Greensboro, North Carolina, regularly deals with investors who have fallen off the risk ladder, and are eager to get back on. In late 2009, a retired couple with a $1.6 million investment portfolio came to his office for help. At the height of the Internet bubble, the couple’s account was worth $2.3 million. Rather than focusing on how the money could be managed to provide them with retirement income, the man, a former engineer, wanted to know how McEachran would recoup the lost $600,000. His wife eventually told him to be quiet and listen. (Women, studies show, are more risk averse than men.)²

Even though there is so much anger toward Wall Street in the wake of what is now called the Global Financial Crisis that started in 2007, and that is now enveloping Europe, there is no escaping the market—only learning how to deal with it. But before learning how to deal with the market, it is important to understand how Wall Street came to Main Street.

A Nation of Stock Market Junkies

America’s relationship with the stock market is actually a relatively recent phenomenon that took off in the 1990s when technology accelerated, automated, and coalesced major policy developments that had occurred over the preceding 15 years to let Wall Street invade Main Street. In isolation, none of the events seem epically important, but the sum is greater than the parts, and the succession of events, and scope of innovation, are stunning.

In 1974, the U.S. tax code was changed to create Individual Retirement Accounts (IRAs). The launch of IRAs let people invest in stocks and defer paying taxes until the money was withdrawn at retirement. This provided many people with their first taste of investing and sent millions of investors climbing up the risk ladder. The launch of the IRA also marked the end of a bear market. The next year, in 1975, the Securities and Exchange Commission (SEC) deregulated brokerage firm commissions, ending a 183-year-old practice that had protected the profits of stock exchange members and kept investing beyond the reach of many because stock trading commissions were exorbitant. Soon, discount brokerage firms, including Charles Schwab, brought Wall Street to Main Street. To attract customers, Schwab and others dramatically lowered stock-trading commissions. Suddenly, stock trading was affordable to the middle class.

“With the sudden arrival of negotiated stock trades that were less than half the cost they had been, a major barrier to investing went away for the average American,” Charles Schwab, the brokerage firm’s founder, said.³

According to Schwab, in 1975 about $1.75 trillion of investable assets were held by individuals, and less than 45 percent was invested in securities, like stocks. Trading commissions were fixed-price and done through highly paid brokerage firms. By 2005 individuals held more than $17 trillion of investable assets, and 73 percent was invested in securities. In just 30 years, more than half of the U.S. adult population owned stocks in one form or another.

In 1975, John Bogle launched the Vanguard Group. His mutual-fund company is to Wall Street what Walmart is to retailing: low-cost. Around 1980, Ted Benna, a tax consultant, effectively created 401 (k) retirement accounts that would prove to play a major role in how people saved for retirement.

Inevitably, investors who got a taste of the market in IRAs and 401 (k) accounts, found they loved stocks. A massive bull market began in 1982, two years into President Reagan’s first term. Conditions were ideal. It was cheap to buy stocks. It was easy to do. It was tax effective. Standing on the sidelines was inadvisable, and maybe even dumb, as the Dow Jones Industrial Average’s rally would soon demonstrate. On August 12, 1982, the Dow Jones Industrial Average was at 777. The rise of the stock market would soon be chronicled in Technicolor. In 1989, CNBC was launched, which would ultimately help change the public’s perception of the stock market. Prior to CNBC’s launch, financial news was mostly limited to the business press, including the Wall Street Journal and Barron’s. If the stock market was mentioned on TV, it was only to briefly note that the Dow Jones Industrial Average had risen or fallen during the day. Now, stock market news often dominates evening newscasts, and the front pages of many newspapers and magazines.

On Christmas Day, 1990, the Internet was effectively launched, unleashing forces that quickly revolutionized stock investing. The stock market was suddenly accessible to anyone, anytime. Buying stocks was destined to be as easy as clicking a computer mouse. In 1993, the first exchange-traded fund, the SPDR S&P 500 Trust (SPY), was created. Exchange-traded funds (ETFs) are stocks in drag. They trade like stocks, but own a portfolio of stocks like mutual funds. In 1995, as the stock market chugged higher, Dick Grasso, then chairman of the New York Stock Exchange (NYSE), let the first reporter in the Exchange’s long history report live from the trading floor. Soon, reporters from all over the world joined CNBC’s Maria Bartiromo at the Big Board. In 1999, the United States Congress eliminated the historic separation of investment and commercial banks, enabling the creation of mega-banks, like Citigroup and Bank of America. The late 1990s were heady times on Wall Street.

In April, 1999, the predecessor of TD Ameritrade, an online discount brokerage firm, introduced its now classic Stuart advertising campaign, and other firms followed with similar campaigns that suggested that making money was easy—and fun. Few ads captured the zeitgeist like Stuart.

Stuart was a young dude with spiky, punk rock hair and some vague office job. One day, he was copying his face on the office mimeograph machine when he was interrupted by his boss and summoned to his office. Rather than getting disciplined, the boss asked Stuart to teach him how to buy stocks on the Internet.

“Let’s go to Ameritrade.com,” Stuart tells his boss. “It’s easier than falling in love. What do you feel like buying today, Mr. P.?”

He buys 100 shares of Kmart.

“What does that cost me?”

“$8, my man.”

“My b...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Dedication
• Preface
• Chapter 1: Risk
• Chapter 2: Greed
• Chapter 3: Fear
• Chapter 4: The Anatomy of Information
• Chapter 5: Chaos
• Chapter 6: Diogenes’ Lantern
• Chapter 7: Cycles
• Chapter 8: Behavior
• Chapter 9: Watchman, What of the Night?
• Acknowledgments
• About the Author
• Index
• End User License Agreement