Blind Faith: Our Misplaced Trust in the Stock Market--And Smarter, Safer Ways to Invest

Views: 1452
Ratings: (0)

The risk of investing in the stock market has increased remarkably over the last decade. In this period we've seen tremendous volatility in stock prices, a market bubble and its subsequent pop, a parade of corporate scandals, the demise of a leading accounting firm and proven deception by many so-called investment analysts employed by major brokerage firms. In addition, the realities of ever-increasing geopolitical risks contribute to an uncertain economic future. Blind Faith offers a cleverly simple yet revolutionary approach for managing investments in this perpetual high-risk environment. Corporate America and the investment industry have little to gain and lots to lose when investors decide to stop playing the traditional game that can -and has - destroyed trillions of dollars of individual wealth overnight. Readers will be equipped with both the strategy and the tools for success in virtually any economic environment while ending their participation in a system that has taken full advantage of their blind faith and misplaced trust.

List price: $17.95

Your Price: $13.46

You Save: 25%

 

13 Slices

Format Buy Remix

CHAPTER ONE: THE STOCK MARKET CAN WE WIN AT THIS GAME?

ePub

The investor’s chief problem—and even his worst enemy— is likely to be himself.

BENJAMIN GRAHAM, FATHER OF VALUE INVESTING,
SECURITY ANALYSIS, 1934

MANY MODERN-DAY investors have become like crazed gamblers, risking their nest eggs and retirement money on visions of a chance at 20 percent-plus returns on their investment portfolios. Most of them don’t even take the time to read a financial statement, yet they scamper to brokerage firms and mutual funds, surrendering every spare cent they can on a stock market system few of them understand. Greed, advertising, and peer pressure have lured them into a terrifying real-life game with sky-high stakes of fortune or poverty.

That’s gambling.

Have investors forgotten that stocks do not exist just to give us a lottery ticket to future riches? Stocks finance the agendas of business and their corporate executives. It’s a system run by professionals who spend a lifetime mining riches, at times contrary to the letter of the law. In the end, when the vein is dry, the gold is in their account; the fool’s gold is what’s left in our portfolios.

 

CHAPTER TWO: FAITH IN OURSELVES THE IRRATIONAL BEHAVIOR OF INVESTORS

ePub

Man is not to be comprehended in terms of sophisticated economic laws in which his innate ferocity and creativity are smothered under a cloak of rationalization. He is better dealt with in the less flattering but more fundamental vocabulary of the anthropologist or the psychologist: a creature of strong and irrational drives, credulous, untutored, and ritualistic. Economists should leave aside flattering fictions and find out why man actually behaves as he does.

THORSTEIN VEBLEN, AMERICAN ECONOMIST (1857–1929)

DO PEOPLE ACT rationally when making decisions about their investments? The connection between money and motive can leave us wide open and vulnerable to some very questionable investment strategies. Most economic and financial theory is based on the premise that people do act logically and consider all available information in the decision-making process. However, a surprising amount of evidence exists indicating that human beings show repeated patterns of inconsistency, irrationality, and incompetence when faced with decisions or choices that deal with uncertainty.

 

CHAPTER THREE: FAITH IN CORPORATIONS TRICKS OF THE TRADE

ePub

The greatest management sin today is not to report a loss, but to report a loss not expected by Wall Street.

DAN BERNHARDT, ECONOMIST,

UNIVERSITY OF ILLINOIS

STOCK PICKERS love to compare companies by analyzing easily obtainable financial statistics. One of the most popular measures is a simple ratio. It is calculated by dividing the current price of a stock by its last twelve months’ earnings per share, and is commonly referred to as the price to earnings (P/E) ratio.

Corporations with similar growth prospects usually have similar P/E ratios. The organizations that show the best earnings within the group are going to have the highest stock price.

The market price for a share of a growth company is rarely based on assets such as cash, land, and equipment but rather on current earnings and expectations of future earnings. Management fully realizes this and sees it as their mission to maximize earnings. Unfortunately there is a lot of leeway in determining how earnings are calculated. Some companies maintain strict and conservative accounting policies, while others stretch the rules to the limit and beyond.

 

CHAPTER FOUR: FAITH IN PROFESSIONAL ADVICE CONFLICTS OF INTEREST

ePub

Well, the broker made money and the firm made money— and two out of three ain’t bad.

ANONYMOUS

IT’S A DIFFICULT JOB, at best, to evaluate the merits of a corporation as a potential investment. Interpreting the accounting, understanding how the business operates, and factoring in a host of other issues, including current investor psychology, can make the task pretty intimidating for even the most seasoned professional. But the decision as to whether a stock should be bought, held, or sold is made easier for most employees of the brokerage and investment banking industry because as a group they think it’s always a great time to jump in and buy.

Investment analysts are researchers whose responsibilities include reporting on a particular company, following that company, and making recommendations on whether to buy, hold, or sell stock. With the emergence of CNBC and other investment-related media, analysts are continually in demand for interviews and their “educated” comments and recommendations. Their comments and stock ratings have become like gospel for certain investors. A new report on a company by these media analysts can have a dramatic effect on the stock price. In other words, they are influential figures in the investment world.

 

CHAPTER FIVE: THE REAL WINNERS OF THE STOCK MARKET GAME

ePub

An infectious greed seemed to grip much of our business community. It is not that humans have become any more greedy than in generations past. It is that the avenues to express greed had grown so enormously.

ALAN GREENSPAN, TESTIMONY TO THE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, U.S. SENATE, WASHINGTON, D.C., JULY 16, 2002

THE INVESTORS who put their hard-earned dollars into the market take on the majority of the risk but receive only the crumbs of a market advance. The real winners are the executives, the brokerage industry, and the corporations. The potential rewards are so great that the behavior of these beneficiaries of market advances can range from unethical transgressions to outright fraud.

The primary argument in favor of large stock option grants to executives is that they give incentive to focus on earnings growth since management benefits if the stock price increases. If the stock price goes up, current stockholders should be happy to reward management for a job well done. There are some major flaws with this line of reasoning due to the inherent conflicts of interest and shortsightedness created by stock option compensation.

 

CHAPTER SIX: REDEFINING RISK MANAGEMENT

ePub

Today we could with total truth be called a nation of speculators…

THE NEW MCCLURES, A POPULAR MAGAZINE OF THE 1920S

ONE OF THE first steps to developing a financial plan involves taking an accurate assessment of what you own and owe, along with your sources of income. The next step is to get a handle on your attitudes toward risk and a clear understanding of your goals and objectives. This might be determined from a series of questions that you ask yourself or from an interview with a financial planner. The answers to these questions are important components in determining an appropriate investment plan because your risk tolerance level determines your overall approach to investing.

Investors define risk as the probability or likelihood of losing money. Here is a listing of risks that are traditionally of concern to investors:

Market risk—the probability of losing money in the securities markets

Interest-rate risk—the chance of being tied to a low rate for a long period of time when interest rates go up

 

CHAPTER SEVEN: MAINTAINING CONTROL OF OUR FINANCIAL FUTURE

ePub

You can never plan the future by the past. EDMUND BURKE, POLITICAL PHILOSOPHER (1729–1797)

THE ARMADILLO protects itself from its predators with armor made of small plates of bone. When attacked, it rolls itself up and becomes practically invulnerable. Since there are so many predatory risks in the investment world, like the armadillo, we need a protective shield to keep us invulnerable to them. We need to examine our goals and objectives and have reasonable expectations for returns on our investments. But before looking at possible sources for a return on our investment, we need to assure that there will be a return of our investment. We have to be constantly aware of the worst possible outcomes and of new defenses that we can use to protect ourselves while thriving in this harsh environment.

The first step in constructing a Protected Plan is to take a current inventory of how you shape up financially. This is basic and entails constructing a personal statement of net worth (balance sheet). List everything you own (assets) and its value in one column. List everything you owe (liabilities) in another column. The difference is your personal net worth.

 

CHAPTER EIGHT: THE MATCHING GAME INVESTING IN THE INDEXES

ePub

There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know.

WILLIAM BERNSTEIN, THE INTELLIGENT ASSET

ALLOCATOR (NEW YORK: MCGRAW-HILL, 2001)

CONVENTIONAL investment managers have an interesting view of risk. They are more concerned with the variation between the actual return on the money they manage and the overall performance of the market than they are with preserving the client’s capital. Most use specific benchmarks, such as a particular stock index, to evaluate their performance. If the benchmark stock index is up 20 percent and the managed funds do better, the manager is deemed to have a successful period. If the market is down 20 percent, the fund is deemed a success if it is down anything less than 20 percent. Success is defined as beating the market, not preserving the capital.

Endless combinations of stocks have been grouped together to form unique indexes. An index is initially based on the total value of a group of stocks. It provides a convenient measure for 130evaluating the stock price movement of the particular group of companies.

 

CHAPTER NINE: THE PROTECTED INVESTOR SMARTER, SAFER WAYS TO INVEST

ePub

The best way to escape from a problem is to solve it.

ALAN SAPORTA, RECORDING ARTIST

WWW.THINKEXIST.COM

IF THE TRADITIONAL methods for dealing with risk are inadequate, and the investor has placed a higher priority on preservation of capital than on trying to beat the market, what is the solution? We know there is an inherent risk when investing in the market, but what about the lost opportunity of missing out on the sometimes spectacular gains that can occur? What is a prudent, conservative investor to do?

There are money management tools that can virtually eliminate the risk of being in the market while still allowing for participation in any upside. Many of these tools have been significantly enhanced over the last ten years, while some have been around for hundreds of years. Some of these tools can become overly complicated for the nonmathematically inclined, but fortunately you don’t have to understand all the intricacies of the ingredients to follow a recipe for dealing with risk.

Risk management tools are commonly referred to as derivatives in financial literature. They come in two flavors: futures (contracts for future delivery at specified prices) and options 140(contracts that give one side the opportunity to buy from or sell to the other side at a prearranged price). Futures are only used in the commodities market. Options contracts, on the other hand, are commonly used to hedge stock market-related risks.

 

CHAPTER TEN: INVESTING FOR RETIREMENT

ePub

Go confidently in the direction of your dreams.

Live the life you have imagined.

HENRY DAVID THOREAU, WALDEN, 1854

IN 1900, 4 percent of Americans were age 65 or older. In 2000, 13 percent were 65 or above. By 2030 the Census Bureau projects that the figure will increase to 20 percent. This demographic trend will have well-documented negative effects on our social security system as the baby boomers begin to reach retirement age in 2010. Many argue that this trend will also create a volatile environment for the stock market as funds are spent or shifted to safer investments as people get older.1

Corporate stocks are the investment of choice for retirement plans. As a matter of fact, over 50 percent of the value of traded U.S. equities is now held in retirement accounts, and this number is growing. We trust and count on the market to help us accumulate a sufficient sum to allow us to retire comfortably.

We used to depend heavily on traditional pensions for our retirement income. The employer would provide a guaranteed retirement benefit based on a formula that factored in the number of years of service and salary. After twenty-five or thirty years of service, the employee would receive a reasonable retirement income to help supplement social security.174 Most employers set aside money for this liability and took on all of the investment risk. However, there were a few bad apples.

 

CHAPTER ELEVEN: REFORMING THE SYSTEM

ePub

Creative thinking may simply mean the realization that there is no particular virtue in doing things the way they have always been done.

RUDOLPH FLESCH, PHILOSOPHER AND EDUCATOR,

WWW.LINEZINE.COM

WE HAVE SEEN the tremendous conflicts of interest that plague corporations and their CEOs, the accounting industry, the brokerage industry, and even our federal government. These conflicts contributed to the shocking evaporation of wealth that investors endured in the early 2000s when the market bubble finally burst.

The solution to these problems isn’t easy. It will take a concerted effort by all concerned to re-create a fair and equitable capital system in which the investor gets a reasonable return that is proportionate to the risk assumed when purchasing equities. The markets will eventually provide such a solution, either through decreased share prices or meaningful change at all levels. If reformation doesn’t occur, further harm to stock portfolios is inevitable.

Investors who employ strategies for protecting principal are prepared for any scenario. The major overhaul required to win back investor faith and confidence is a huge and complex undertaking. Conflicts of interest still exist, which make the task a strenuous challenge. 190

 

APPENDIX A: USING OPTIONS TO REDUCE RISK

ePub

Options are derivative contracts that have no value on their own. They derive their worth from the value of some other asset. They are used to reduce risk and are the most sophisticated, intricate, and arcane of the financial instruments.

If used improperly, options can be among the riskiest of investments. In the early 1990s some institutions that obviously lacked a full understanding of the risks and consequences of the inappropriate application of derivatives became high-profile casualties of improper usage. An electric saw can be a valuable tool in skilled hands or a dangerous one in the hands of a careless individual. Orange County lost an estimated $2 billion and Long Term Capital, $4 billion from the bungled use of derivatives. The accompanying negative publicity gave these tools of risk management a tainted reputation.1

The call option is an agreement that gives the investor the right but not the obligation to purchase a security at a specified price within a specified period of time. Conversely, a put option gives the investor the right to sell a security at a specified price for a specified time.

 

APPENDIX B: CREDIT RATINGS

ePub

Credit ratings assist in evaluating the level of credit risk involved when investing in equity-linked notes, annuities, and insurance. Each rating organization uses a slightly different system. The highest four ratings encompass what is referred to as “investment grade bonds.” All ratings below the four highest are in the “junk” category. Moody’s and Standard & Poor’s publicize ratings on corporations and each has its own unique grading system.

See Table

As of the date of this writing, the more frequent issuers of equity-linked notes had investment grade ratings as follows:

See Table

Additional modifiers indicate whether the rating is at the top, middle, or bottom for each category. S&P uses plusses and minuses, and Moody’s uses 1, 2, 3, with 1 being the highest. Source: Moodys.com and Bloomberg Financial.

Ratings are fluid and can be changed at any time by the rating companies. Insurance companies have their own unique ratings. A. M. Best ratings are as follows:

See Table

Anything below a B+ should not even be considered. A. M. Best rates the leading companies that offer equity-index annuities as Superior. Weiss Ratings uses a different methodology for measuring the financial strength of insurance companies. The ratings are as follows:

 

Details

Print Book
E-Books
Slices

Format name
ePub (DRM)
Encrypted
true
Sku
9781609943202
Isbn
9781609943202
File size
0 Bytes
Printing
10 times
Copying
Disabled
Read aloud
Yes
Format name
ePub
Encrypted
No
Printing
Allowed
Copying
Allowed
Read aloud
Allowed
Sku
In metadata
Isbn
In metadata
File size
In metadata