Being an owner with your long term investment capital is never about following a short path to riches. 

It is nearly always about the compounded power of many market sessions.  Times like these are what challenge investors’ discipline and day by day we hold on past the doom-and-gloomers waiting for the breakout to emerge.

REALITY CHECK:  So here we are near the bottom and it seems that most of our peers have become overwhelmed and left the building.  Today being an owner often leads to second guessing … “you aren’t still investing in the stock market, are you?” … “that isn’t safe” … “I moved my money to cash and bonds” … but the market session that is right around the corner, THE bottom and the rally that follows, reaffirms once again that common stocks, over the long term, are the highest total return asset class of all.    

The below article was written by my colleague Dave Blair and published in our client newsletter this past summer.  In light of public perception, it deserves a second look:

As the markets continue to stumble along driven by fear and emotion, some people have asked if they should be getting out of the market to “protect their investment.”  Note that these are not clients asking the question, our clients already know the answer.

Short term volatility is the price we pay for long term success in building wealth.

You can see this chart in Roland’s new book, Manarin On Money.

Over time equity ownership positions have moved up and down but have always trended up.  Like a yo-yo climbing a flight of stairs.

Market timing requires two perfect decisions, whereas, staying invested in quality, professionally managed stock mutual funds requires only one decision.  Nobody makes two perfect decisions all of the time. 

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Know what it is?  I learned it over 30 years ago the hard way. 

The secret is patience.

Back then I discovered that if I stuck with my ownership-based investment strategy over the long haul and outlasted the quitters and ignored the critics, I would someday be in a better position than the majority of my peers. 

This is why I continue recommending the investment model I’ve used since then:

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The “We are in the worst economic climate since the Great Depression” wackadoos sure put up a good fight.  But now more folks are finally seeing through their flawed logic. 

From a recent Newsweek article: 

The specter of depression stalks America.  You hear the word repeatedly.  Are we in a depression?  If not, are we headed for one?  The answer to the first question is no; the answer to the second is “almost certainly not.”  The use of “depression” to describe the economy is a case of rhetorical overkill that speaks volumes about today’s widespread pessimism and anxiety.  A short history lesson shows why.

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When talking about the stock market these days, it’s easy to be wooed into becoming a long-term pessimist.  Last Friday, the S&P 500 closed at 1239.  Contrast that to where the index was trading at 10 years ago - 1164 - and you end up with a gain of about 6.4%. 

So why am I still so enthusiastic about my “stocks for the long run” philosophy? 

Take a look at history. 

The last time we went through a similar market environment was from about 1969 to 1982.  Not only were the returns middling but inflation wiped out the gains that investors had earned leaving many with a real return in negative territory. 

But people who maintained their discipline and continued acquiring equity positions were rewarded for it. 

From 1983 thru 2001, vast sums of wealth were created because certain people understood the gift the financial gods had given them and knew how to take advantage of it.  Or there were others who prospered simply from dumb luck for being in the right place at the right time. 

You see, tangible assets - real wealth - does not vanish in a market decline.  Instead, uninformed investors panic and sell their wealth while savvy investors go bargain hunting.   

And that’s the way it has been throughout history. 

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A question I often get is, “What, in your opinion, is the biggest threat to the global financial markets?”

The mainstream media never touches on this but I believe that financial derivatives are the biggest threat.  These highly speculative instruments, most often used by big money center banks, are what I think would most likely trigger the collapse of the world’s debt structure.

Here’s the story.

A derivative is simply a man-made bet consisting of two parties.  Party A enters the bet in hopes of earning massive profits but in order to create the derivative, they need a counter party to wager against them.  This is where Party B comes in.  They enter the bet looking to hedge against some form of risk.

Say you are a derivative trader.  You can speculate (or hedge against) the movement of interest rates, commodity prices, exchange rates, or just about anything else you wish to gamble on.

Those who participate in this global casino are required to place only a fraction of their bet down thus enabling derivative traders to control an enormous amount of assets using a tiny amount of money.  This is where the danger comes in.

While traders can make big bucks being on the right side of the bet, there is also the risk of crushing losses.

This is what happened recently when a rogue trader for the second-largest bank in France made a bad bet totaling over $7 billion in losses, the largest in banking history. 

But despite instances like these, the monstrous growth of derivatives continues.

Over 20 years ago, with derivatives trading around $1 trillion on a daily basis, I upped the gold hedge position in our portfolios to offer additional safety.  That decision protected us during the huge stock market crash of 1987 brought on by derivatives.

Today, on the same daily basis, derivatives are trading at $500 trillion.  To put that number in perspective, the U.S. has an annual GDP of $14 trillion.  That means a 3 percent decline in the derivatives market would be greater than the total annual economic output of the world’s richest nation.  Scary stuff.

If the derivative dike ever breaks, a panic would sweep the financial world.  Bonds, money market accounts, bank CDs, cash, and all other dollar-based assets would plummet in value instantaneously.

History tells you that in these cases gold, common stock, and other tangible assets not linked to paper money become a source of value for investors.  Derivatives alone are reason enough to keep a small portion of your wealth in gold-related assets. 

For the remainder of your serious money, globally and geopolitically diversify it across ownership positions for maximum safety.

How large the derivative mess will grow to before the bottom falls out is anyone’s guess.

I predict we’ll continue muddling through just as we always have but just in case this house of cards one day comes crashing down, I know my investments will be safe when the dust settles. 

That’s what I call peace of mind - and real world financial safety.    

For most people, contributing for a company 401k plan or other pre-tax retirement account should be Step 1 when planning a financial future.  Yet it’s amazing to me the number of folks who mismanage their pretax investment options and waste a wonderful opportunity to potentially add hundreds of thousands of dollars to their wealth.

So here are 10 tips on how to be a successful 401k investor:

1.  ENROLL & PARTICIPATE.  This is probably the most important step.  If you don’t start putting a slice of your paycheck in your plan, you will never be given the benefit it offers.  Think about it.  Outside a 401k or other pre-tax equivalent, most people have to earn at least $1.25 to invest $1.00.  For each dollar you invest in your 401k, your take home pay is reduced by only $0.75 (assuming a 25% tax bracket.)

2.  BE AN OWNER, NOT A LENDER.  The mutual funds in your 401k will likely invest in ownership positions (stocks, real estate, precious metals, etc.) or lending positions (bonds, money market accounts).  Conventional wisdom says that you have a mixture of both - a strategy I find absurd.  When you invest in lending positions you are guaranteed to lose buying power.  You will either lose it very slowly through inflation or possibly overnight if the dollar ever becomes worthless.  I recommend keeping your 401k assets fully invested in ownership positions which are not tied to the value of the dollar.  The volatility you will experience is a small price to pay for the long-term returns and the real world financial safety. 

3.  DIVERSIFY YOUR OWNERSHIP.  A diversified ownership portfolio will allow you to own shares of large, mid, and small company stocks.  Domestic and international stocks too.  As a hedge against inflation and geopolitical risk, I’d also keep a small chunk allocated to gold-related investments.  Your 401k may not offer all these asset classes so diversify as well as you can with the asset classes your are provided.

4.  DEMAND THAT YOUR PLAN OFFER THE HIGHEST QUALITY INVESTMENT OPTIONS.  I see the investment options offered in many plans and too often I come away unimpressed.  If your plan doesn’t give you enough asset classes to create a diversified portfolio or if all the options come with high fees and mediocre returns, ask the trustees of the plan to change this.  It’s likely their assets are also in the plan so you’ll be given credit for helping their bottom line as well as your own.

5.  LIMIT YOUR INVESTMENT IN COMPANY STOCK.  This is an easier lesson to swallow following the days of Enron and WorldCom.  So unless you enjoy the thrill of riverboat gambling, I don’t recommend having the bulk of your money tied to the performance of any one company.

6.  NEVER BORROW AGAINST YOUR 401K.  It will defeat the benefit that your plan offers and any loan repayments must be paid back with after-tax dollars. 

7.  DON’T CASH OUT YOUR 401K IF YOU LEAVE YOUR COMPANY.  If you leave a job you will likely have a right to your 401k assets by by taking them in cash means you will be hit with a tax bill and possibly a 10 percent penalty if you are not yet age 59 1/2. 

8.  IF YOU ARE AT LEAST 59 1/2, ROLL YOUR ASSETS INTO AN IRA.  Your 401k may not offer this feature but if it does, take advantage of it while you are still working.  This way you have access to the entire world of investments and not just the options offered in your plan.

9.  REBALANCE REGULARLY.  At least once a year, take a few minutes to rebalance the assets in your plan.  Sit down and calculate the current percentages of the mutual funds you own.  Some percentages may be much higher and some much lower when compared to your initial allocation.  Many plan providers now allow your rebalancing to be done automatically on an annual, semi-annual, or quarterly basis. 

10.  COMMIT TO MAXING OUT YOUR PLAN.  I know not everybody can do this but as the very least, invest the maximum amount you can possibly afford.  Then every time your pay increases, up your contribution amount until you have hit the maximum allowed.  I promise you won’t be sorry.

When asked to state the average return of the stock market, what is your answer?

10 to 12 percent?

It’s true that this falls in the range of historical, long-term average market returns but to me, average is anything but average. 

Let’s say you and are taking a three day vacation and I tell you the average temperature is going to be 70 degrees.  What would you pack to wear?  Based on the information you know, a cotton shirt and a pair of light weight fabric pants would keep you quite comfortable. 

On this trip we start off in Omaha, NE where it is 85 degrees.  Then we head south near the equator where it is 105 degrees.  After that it’s off to the southern tip of Argentina where it is 20 degrees. 

The average temperature of these three locations is 70 degrees but how would this temperature “volatility” make you feel?  My guess is pretty uncomfortable since the actual temperatures were not in line with your expectations. 

The same holds true with stock market volatility and investor expectations.  Non-savvy investors look at the historical market returns and expect to earn 10 to 12 percent most years.  Savvy investors look at the same historical data but understand that “average” does not mean “likely.”

KEY LESSON:  Short term, the stock market is going to be volatile and the returns investors earn will vary considerably.  This will cause market timers and day traders to attempt to make speculative bets and most will lose.  It will also cause the mainstream investor to get greedy or fearful then wind up chasing performance and perceived safety thus ending up with sub par performance. 

But the most successful investors will be those who remain broadly diversified across mutual funds of common stock and maintain a long-term time horizon.  To them, market volatility is a non-issue and most will view market declines as a buying opportunity. 

In the short-term, those investments will bounce around like a handful of yo-yo’s.  But long-term, those yo-yo’s are bouncing up a flight of stairs. 

SO HERE’S YOUR REALITY:  Where does your focus lie?  On the yo-yo’s or the flight of stairs.  Your answer will tell me a lot about your long-term financial success. 

When dealing with the investment markets, there are no guarantees and any investment comes with some level of risk.  The key is to manage that risk and minimize is so that the odds of building and maintaining your wealth are on your side. 

There’s your financial goal.  Mine too!