A Math Free Guide to Higher and Safer Returns

By Andrey Dashkov

I can make you instantly richer, and safely, by explaining a finance concept with a story about a dog.

There’s a hole in your pocket you probably don’t know about. You may feel instinctively that something is wrong, but unless you look in the right place, you won’t find the problem. The money you’re losing doesn’t appear in the minus column on your account statements, but you’re losing it nevertheless.

Frustrated? Don’t be. I’m going to tell you where to look and how to stop the drainage.

Volatility is every investor’s worst enemy. Over time, it poisons your returns. Unlike a 2008 style market drop, though, volatility poisons them slowly. There’s no obvious ailment to discuss with friends or hear about on CNBC. You only see it when you compare how much you lost to how much you could have earned—and looking back at your own mistakes is not a pleasant thing to do.

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So instead let’s imagine two fictional companies: X-Cite, Inc., an amusement park operator with a volatile stock price that adventurous investors love; and Glacial Corp., a dull, defensive sloth of a corporation whose stock returns are consistent but often lower than those of its more glamorous counterpart.

Average return on both companies’ stocks was 5% for the past five years, but Glacial’s was less volatile. Safety is comfortable, but doesn’t higher volatility mean higher potential returns? Sometimes, but not always. When you accept high volatility, your returns might be higher at times, but they also might be lower. In other words, higher volatility generally means greater risk.

Nothing new so far, but the oft-overlooked point is that boring stocks make you richer over time.
The chart below shows each stock’s annual return over a five year period.

At first glance, Glacial Corp. appears to be the loser. It underperformed X-Cite in four out of five years. Both stocks returned 5% on average during these years, and X-Cite was almost always voted the prettiest girl in town. But for Year 3, it would be easy to persuade investors to buy X-Cite stock. Few would give Glacial a second glance.

Hold for the punchline: X-Cite, the stock your broker would have a much easier time selling you (before you read this article), would actually make you poorer. Let me explain.

I won’t get into any supercharged math here. Glacial is better because it makes you richer eventually. After five years, the total return on X-Cite is 25%. Not bad. Glacial? 27%. If you invested $10,000 in both (assuming no brokerage fees or taxes), at the end of Year 5 you would have earned $2,507 on X-Cite or $2,701 on Glacial.

	Year-End Account Balance
	X-Cite, Inc.	Glacial Corp.
Year 1	$10,500	$10,300
Year 2	$11,550	$11,021
Year 3	$10,164	$10,801
Year 4	$10,875	$11,341
Year 5	$12,507	$12,701
Total return	25%	27%

Where does the extra $194 come from? It comes from lower volatility. Although X-Cite looks like a winner most of the time, it has a higher standard deviation of returns. Note that X-Cite’s stock price dropped 12% in Year 3. The following year it increased 7%, while Glacial Corp.’s stock price only increased 5%—yet Glacial is still worth more from Year 3 onward. Why? X-Cite’s 7% jump is based on the previous year’s low.

But I promised to keep this note math-free, so imagine a person walking a dog instead. The shorter the leash, the less space the dog has to run around. The longer the leash, the more erratic the dog’s path will be. Standard deviation measures how much data tend to scatter around its mean—the path. As we just saw, low standard deviation also pays you money.

I could stop right here and hope that you take this lesson to heart, but I won’t. As much as I love describing finance concepts using clever company names and dogs, I want you to start making money right now.

I said this advice could make you instantly richer, and “instantly” doesn’t mean “maybe sometime in the future.” In the latest issue of Money Forever, we shared an opportunity to invest into a vehicle built to outperform the market by managing volatility. I was extremely excited to present it to our paid subscribers because I knew they’d love to earn more by risking less. Who wouldn’t?

So please pardon my blatant self-promotion. I work in an industry where 80% of the time the market is obsessed with the wrong stock, and the noise drowns out the right idea. I can silence the cacophony for you, though, and show you where to find the right ideas. And that goes beyond our most recent pick, although you do need it in your portfolio. Money Forever’s mission is to make your money last—plain and simple.

We think this pick will go a long way toward doing just that.

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The article A Math-Free Guide to Higher and Safer Returns was originally published at millersmoney.com.

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The world’s greatest stock picker? Bet you sold Apple and Google a long time ago

By John Mauldin

My good friend Barry Ritholtz, famous for launching The Big Picture blog (and since graduating to being a regular Bloomberg columnist as well as writing a weekly column for the Washington Post), is well-known for being a contrarian. Barry is a regular dinner partner when I get to New York, and he also participates in the annual Maine fishing trip. We frequently trade information … and barbs. The word colorful affectionately comes to mind when I think of Barry (and maybe opinionated would work).

I can usually count on him to find at least a few things to disagree with me on at our dinners. No matter what devastating arguments I produce to demonstrate the errors in his thinking, he conjures up new facts to support his flawed positions. We have had a few of these episodes as members of a panel in front of a large public audience, much to the amusement of the spectators (and watching Barry can be an entertaining spectacle). My only real frustration with Barry is that he is mentally faster than I am and he seemingly remembers every obscure data point from the last thousand years. I consider it a triumph if I merely hold my ground.

But one thing we do agree on and are both passionate about is that we human beings were not designed for these modern times. As I so often say, we evolved on the African savanna dodging lions and chasing antelopes. We have converted those survival instincts into an unwieldy approach to dealing with financial markets, which is not the optimal way to approach investing. Both of us write a great deal about behavioral investing and the foibles of human nature.

I was struck by the insights of Barry’s latest Washington Post column. How difficult it is for us humans to hold on in the middle of dramatic volatility. Don’t you wish you had held Apple for the last 10 years? A 1000-bagger is not to be sneezed at. But dear gods, the volatility! And what about the stocks that once looked like a better bet than Apple that went to zero? How do you decide when to hold and when to fold? (Cue Kenny Rogers.)

This is a short Outside the Box, but it’s one that should make you think, which is the purpose of this letter.
And in a departure from my usual close, I want to offer two links. The first is to a fascinating web post at something called distractify.com of 52 colorized historical photos. You  have seen most of these photos in black and white (or at least you have if you have reached my advanced age). Seeing them in color is quite another story.

Second, and not for the faint of heart, is a link to a rather heated exchange between Ben Affleck and Bill Maher over radical Islam and Islamaphobia. I generally find Maher annoying, sometimes in the extreme. But this “conversation” is instructive. It illustrates the tensions in the Western world around dealing with Islamic beliefs and the religion in general. The other guests chime in with fascinating anecdotes. You can decide for yourself who wins this argument, but it is one that is increasingly important in our world. And I am not sure anyone will be comfortable with the answers. This is courtesy of my friends over at Real Clear Politics.

I am still luxuriating in the aftermath of my birthday party on Saturday night. Friends flew in from all over the country (and from around the world) and surprised me. Too many to mention, but I was deeply honored and humbled. My staff and friends and family put the whole thing together (huge thanks to Shannon and Mary and Shane and my kids). My daughter Melissa put together a playlist on Spotify of all the songs she has heard me listening to over the years. Three and a half hours of one hit after another. We are working on making it available to those of you who are already on Spotify.

And just for the record, that morning I did 66 consecutive push-ups on my 65^th birthday. I then went on to do a total of 360 push-ups (50×5+44) in less than two hours, with the help of an Avacor machine to cool me down between sets, in a workout that included a similar number of abs, lat pulldowns, arm exercises, etc. Knock on wood, I do not plan to go gently into that good night. As a geek, I am coming late in life to loving the gym. But better late…..

It is time to hit the send button. I am off to the Great Investors’ Best Ideas Symposium here in Dallas. It is a who’s who of famous investors, all of whom agreed to speak and to give one investment tip to aid a great charity. Bill Ackman, David Einhorn, Paul Isaac, Bill Miller, Ray Nixon, Richard Perry, T. Boone Pickens, Michael Price, Tom Russo, and moderated by Gretchen Morgenson. Have a great week while thinking about how to get your human nature under control.

Your more human that I want to admit analyst,

John Mauldin, 
Editor Outside the Box

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The world’s greatest stock picker? Bet you sold Apple and Google a long time ago.

By Barry Ritholtz
The Washington Post, Oct. 4, 2014

Let’s imagine for the moment that you are the World’s Greatest Stock Picker. You have an uncanny talent for ferreting out “the next Microsoft” – companies that are on the sharpest edge of what’s next, that are about to undergo tremendous growth. These firms will rule the world: They will be the most powerful, profitable and influential corporate entities known to man.

Even better, your superpower is that you can find these companies when they are tiny, before they have had their explosive growth, when hardly anyone has heard of them. You find and buy these stocks while their prices are still in the single digits. Companies like Apple, Google, Tesla, Netflix and Chipotle that will one day measure their growth in increments of thousands of a percent.

Can you imagine how much wealth you could create?

I have some bad news for you, kiddos: Even if you had that superpower, it would be worth surprisingly little to you. The odds are that it would not create much wealth, and it might even cost you money.

How could that be possible?

The short answer is your brain. The three-pound ball of gray matter sitting atop your spinal cord was never designed to make risk/reward decisions in capital markets. It took about 100,000 years to optimize for its intended purpose: Keeping you alive.

The occasional Darwin Award aside, it does an outstanding job of keeping you safe from all manner of predators on the savanna. That you now live in a condo and enjoy lattes is irrelevant to its functionality. Its job remains keeping you alive long enough for you to procreate, pass your genes along and perpetuate the species.

This dynamic, opportunistic, self-organizing system of systems occasionally runs into trouble when we try to force it to perform other, “off label” uses. That includes buying and selling pieces of paper that represent tiny slices of companies. As we shall see, that big, under utilized brain of yours is no help anytime it gets over-stimulated by your emotions.

Which is precisely why being the World’s Greatest Stock Picker is unlikely to be how any of you is going to get rich. Let’s use the shares of five companies as examples: Google, Tesla, Chipotle, Netflix and Apple.
The performance of each since its initial public stock offering has been nothing short of astounding. Since going public, each stock has generated returns of more than 1,000 percent. A $10,000 IPO allocation in any one is now worth at least $100,000.

To give you an idea of just how phenomenal these companies have done, Google is the laggard of the lot. Since its IPO in August 2004, it has gained a mere 1,282 percent. Tesla edged out the boys from Mountain View, Calif., with a gain of 1,352 percent. And they did it in less than four years – Tesla’s IPO was June 2010 – vs. the decade it took Google to gain 1,000 percent.

Those spectacular returns look downright paltry compared with the 2,865 percent gain Chipotle has had since going public in 2006. And Netflix beats that, rising 5,816 percent since 2002.

Then there is Apple. It is a beast unto itself, racking up a mind-boggling 22,288 percent in appreciation since its 1980 debut. It has become world’s biggest company by market capitalization.

Even if you bought large chunks of each of these firms at their IPOs, the odds are that nearly all of these giant gains would have eluded you. Why? As I shall show you, each of these companies would have sent you running for the exits – repeatedly – over the years, screaming as if your hair were on fire.

Don’t believe me? Consider the facts:

• Netflix has lost 25 percent of its value on four separate days. Not over four days; on separate occasions, it lost 25 percent in a single day. In one four-month stretch in 2011, it lost 80 percent of its value. On Netflix’s worst day, it fell 41 percent.

• Chipotle has lost 15 percent in a single day on four occasions. During the 2007-2009 crash, it lost 76 percent of its value – about 50 percent worse than the market overall.

• Tesla went up 400 percent in 6 months, then lost 40 percent over the next 10 weeks. In one month, it lost about 25 percent of its value.

• Google lost nearly 70 percent in the Great Recession. During its worst quarter, its stock price fell more than 36 percent.

• Apple has lost 25 percent or more six times in the past 10 years alone. That was after its meteoric rise. During its worst week, it was cut in half, falling 51 percent. It saw similar damage during its worst month and quarter as well – getting cut in half in each time   period.

How often have you invested in a stock, only to get scared out of it when things grew shaky? That’s fairly typical behavior for investors.

Now imagine how you would have behaved if you happened to have a significant part of your net worth tied up in that one holding.

Let’s say a decade ago, you put $15,000 into Apple. You bought 1,000 shares at $15 (with $13 cash) because you thought that newfangled iPod had some potential. Since then, it split two for one and then earlier this year, it split seven for one. You now are holding 14,000 shares of Apple. At the current price of about $100, it is worth $1.4 million dollars. For most people, this is a very high percentage of their net worth. How well do you sleep when 90 percent of your total net worth goes through giant swings?

Apple was worth about the same amount in September 2012 – just before it gave back almost half its value, falling 44 percent. Would you have held on? What about all of those prior 50 percent corrections?
This is not an academic theory. Consider how you have reacted to much more modest drops in your holdings. How often were you shaken out of a stock, only to see it rocket higher after you sold? And somebody was dumping stocks in March 2009; after all, selling climaxes (also known as capitulation) are how bottoms are made.

Some years ago, I recommended to the brokers I worked with to do just that regarding Apple. They bought millions of shares at an average price of $15. At $20 dollars, they were selling it, whooping it up and high-fiving one another. When I asked why they were selling it when my price target was higher ($30!), I was told: “It’s a 33 percent winner – time to ring the bell, Ritholtz!” That was even before any trouble had hit.
How many of you, dear readers, could hold onto a giant winner like these five for the duration? How do you know that any of these are not about to turn into a classic disaster stock? Think about once-giant winners that collapsed: Lehman Brothers, WorldCom, Lucent, JDS Uniphase.

All of these were one-time market heroes; all went bust in spectacular fashion. Your superpower gives you the ability to find the giant winners, but it does not give you the ability to hold onto them, nor does it give you the ability to distinguish between the superstars and the washouts.

As we have discussed previously, this is a feature, not a bug. The good news is your brain has kept you alive long enough to read this column. The bad news, it also made you sell Apple 10,000 percent ago.
The reality is, when it comes to risk/reward decisions, you are just not built for it.

Barry Ritholtz is Chairman and Chief Investment Officer at Ritholtz Wealth Management. His columns on personal finance can be found at the Washington Post. His daily musings on all things finance- & Wall Street-related can be found on Bloomberg View. Be sure to check out Masters in Business, his weekly interview series on Bloomberg Radio. Follow him on Twitter @Ritholtz.

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The article Outside the Box: The world’s greatest stock picker? Bet you sold Apple and Google a long time ago. was originally published at mauldin economics

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How the Best Analyst In the World Nailed Netflix

Most every day we interact with the best market analyst in the world. The problem is most traders don’t even know it, or think about it.

I’m referring to....The market itself. Here we have a powerful, dynamic, up to the minute force, which is the sum total analysis by some of the smartest people in the world all coming together in one place. It is amazing!

When a market closes, you have the best indication of market trend and value, and what’s going on in that particular market. The markets really do decipher the complexities of the economy, the future prospects for a stock, or the supply and demand picture for a futures market.

For example, Netflix, which reported disastrous earnings last night was pummeled this morning, losing some 35% of its value. The best analyst in the world alerted smart traders that there was trouble ahead for this stock.

And our very own Trade Triangle technology nailed this one, just like it has done with so many other markets in the past. This move did not come as a complete surprise to MarketClub members, who have been short Netflix since August 9th at $225.30, with our original sell/exit/short signal. You can put the best analyst to work for you everyday when you use MarketClub.

Why are Tuesdays important? Quite often market reversals happen on Tuesdays. As an example, it’s Tuesday and the S&P500 and several other major indices are down from their recent rally highs. Tuesday is when traders decide to take profits based on the momentum from the weekend and Monday. This is the theory behind our 52 week high and 52 week low rule. You follow through with the momentum Friday to Monday and take profits on Tuesday.

Whether or not this is a major reversal in the market is too early to tell, but remember it could be. The S&P500 is coming from a 61.8% Fibonacci upward correction.

There’s going to be numerous opportunities in the markets in Q4, like the gold market. We alerted you yesterday with a +100 Chart Analysis Score and gold is up dramatically today, proving again that the market is the best analyst in the world.

Now, let’s go to todays video and the charts covering the six markets we publicly cover.

Netflix Is Killing Blockbuster, Check Out This Free Stock Analysis Video

That's right, Netflix is killing Blockbuster and there might still be some upside left in Netflix stock. If you love the movies, then you’ve got to love this stock.

This stock has been acting very well lately as it seems to be able to shrug off all the negative news that we have been bombarded with lately.

In this short five minute video we explain in detail and take you step-by-step in what we think is happening to this particular stock. All of our indicators, including our trade triangles are pointed on the upside for this one market.

We are putting the video online so you can watch it with our compliments. There is no need to register and you can watch it right away.

Click Here To Watch Video