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CHAPTER EIGHT: THE MATCHING GAME INVESTING IN THE INDEXES

Winslow, Edward Berrett-Koehler Publishers 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.

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CHAPTER ELEVEN: REFORMING THE SYSTEM

Winslow, Edward Berrett-Koehler Publishers 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

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CHAPTER SEVEN: MAINTAINING CONTROL OF OUR FINANCIAL FUTURE

Winslow, Edward Berrett-Koehler Publishers 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.

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CHAPTER FIVE: THE REAL WINNERS OF THE STOCK MARKET GAME

Winslow, Edward Berrett-Koehler Publishers 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.

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CHAPTER TEN: INVESTING FOR RETIREMENT

Winslow, Edward Berrett-Koehler Publishers 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.

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