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Meet The Average Small Investor
 Let's
be frank. The average small investor doesn't have a clue how to make money in
the stock market. Take the case of a typical investor named Phil.
Phil is a 40-year-old network administrator who earns about $90,000 a year
before taxes. His wife, Phyllis, earns $40,000 a year as a nurse. Together, they
take home $91,000 after taxes. They have 3 children, 2 cars, two 401(k) plans,
an 1,800 square foot home with $120,000 left on their mortgage, $30,000 in
combined credit card debt, another $50,000 left on 25-year-old student loans,
and a Fidelity investment account with $15,000 they managed to scrape together.
This $15,000 investment 'stake' was going to be Phil's 'road out of the
corporate jungle' —his retirement 'nest egg' —and Phil wanted to make sure that
he understood the stock market completely before putting a penny of that money
at risk.
Of course, it never occurred to Phil that both his and his wife's 401(k) plans
were being administered by an accountant down the hall at work — a gal in her
mid-30's with no previous investing experience (other than a Masters Degree in
Economics) who hangs on to her financial planner's every word for her personal
investment decisions, and then mirrors those decisions at work when
administering the company retirement portfolio.
Starting in 1998, Phil got the idea that he could 'get ahead' faster in life by
'playing the market.' As a bright 'computer guy' with college degrees to prove
it, Phil figured he had the 'wetware' (that's computer talk for brains) to make
money in the stock market.
He considered options, commodities and bonds but worried that they were all too
complex for a rookie, so he decided to begin with stocks which he saw as easier
to get 'under his belt.'
So Phil began by reading every investment book he could get his hands on. He
would spend all day Sundays at the local Barnes & Noble store, sipping coffee
and reading the most popular current releases on the Investment and Finance
shelves.
He used his spreadsheet software to create a $15,000 virtual portfolio and began
paper trading it, meaning that he would track his ideas on paper, before putting
any real money at risk.
Phil began faithfully watching one of the more popular financial shows on
television, hosted by a fellow named 'Lou.' He tracked every stock mentioned by
every guru interviewed on Lou's show.
When he failed to make any real money over the next six months by following the
guru’s recommendations, Phil switched to another 'talking head' by the name of
'Louis.' When this expert's annualized returns over the following six months
just barely kept pace with inflation, Phil turned off the TV financial shows and
decided to return to the 'true and tested' methods that had worked for his Dad,
which was to read the major daily financial newspapers.
He began by scouring The Wall Street Journal each day for stock tips from
prominent columnists. When he failed to make enough money (or actually lost
money) with the Journal, he switched his subscription to Investors Business
Daily.
When that didn't work out too well, he began devouring monthly issues of Money,
Forbes and Inc. 500 'magazines. When a hot stock appeared as a featured company
on the cover, Phil would buy it, only to often watch it decline in the weeks and
months to follow. He realized that he was continuously 'getting in too late.'
To counteract this 'timing problem,' Phil signed up with a stock broker
recommended by his brother-in-law. He figured that a good broker who was 'in the
trenches' would be 'in the know' and thereby able to provide him with a steady
stream of 'hot stocks.'
When his paper portfolio lost even more money, Phil switched to a new broker.
And then a third. Then when he read an Internet web site that reminded readers
that most (but not all) stock brokers are just glorified salespeople who are
instructed by their supervisors to push certain favored stocks and that if they
were truly financially independent, they wouldn't be working from a cubicle all
day, punching a clock for a large financial firm and 'pulling down' at most
$100,000 a year. Phil fired his third broker in frustration.
Phil then decided to hire a local financial planner whom we'll call 'Bob'. Bob
is a member of Rotary. He attends church each Sunday, helps to organize the
local Boy Scouts paper drives, coaches Little League, and is an upstanding
citizen. Some call him ‘a pillar of the community’.
Bob holds free evening seminars once a month where he explains to locals how to
make money in the markets. Many of these attendees are senior citizens who can't
afford a penny's worth of risk.
According to local reputation, Bob had been 'hot' in recent years. Of course,
anyone who could throw a dart at the stock pages of the New York Times could
have made money during the raging bull market of the 90's, but most locals
weren't astute or experienced enough to realize this.
In early 1999, Bob got many of his clients (including dozens of seniors living
on fixed incomes) into the Nasdaq, just before the Nasdaq tumbled by 75% in
early 2000 (the so-called 'Tech Wreck') when the 'dot.com' bubble burst.
Some of Bob's senior clients, believing that they had actually retired only to
witness the wholesale decimation of three-quarter's of their retirement nest
egg, returned to the work force, some passing out carriages at Wal-Mart while
others passing out burgers at local fast food drive-thru's.
Was Bob censured by the agencies, organizations and bureaus that license him to
provide expert financial advice? (give financial advice without a license and
you can go to jail) Nope, not a one. Did Bob's reputation get dented in any way?
Not in the least. Sure, some of the locals grumbled and sought greener pastures
elsewhere, but most stayed with Bob. Why?
Because they believed that Bob did 'the best he could under the circumstances.'
After all, 'no one can predict the market,' and 'Bob is a good man.' Bob is
still holding free seminars where he tells attendees, 'Hang in there. We'll do
better next year.'
Frustrated once again and now 48 years old and not feeling any younger, Phil
began subscribing to a half dozen of the top-rated financial newsletters
published by prominent investing gurus. He got their names from the Hulbert
Financial Digest which tracks the performance of investment newsletters.
When the 'picks' and 'recommendations' from these newsletter gurus caused Phil's
paper portfolio to bounce up and down like a bungee cord over the following six
months, he turned to 'hot stock tips' from co-workers at the water cooler. Some
of this 'picks' made money, and some were ‘real stinkers’.
After two years into Phil's new investment career it slowly began to appear to
Phil as if the 'random walk theory' of stock market investing was actually
correct; that there was no way to predict where the market, or even any single
stock, was going to go next.
Maybe the best thing for Phil and Phyllis was to find the best conservative
mutual funds they could, forget altogether about stock investing and get back to
planning their next vacations.
Then, one day, a really sensational junk mail marketing piece arrived in Phil's
mailbox. This was a truly lavish piece, printed in three-color raised print, and
containing a gold foil-lined RSVP card for a 'FREE!', one-day 'Wall Street
Workshop' to be held a week later at a local hotel.
Phil knew this hotel was a posh property and figured that the 'Wall Street
Workshop' people must be a really 'top outfit' if they could afford the
conference room rates (to Phil's consternation, his daughter Britney was
considering this pricey property for her upcoming wedding reception).
So Phil signed up immediately for the free, one-day workshop. He even called the
toll-free number to guarantee himself admission. The day of the event, Phil got
there extra early to assure himself a good spot, right up front. As he sat there
all day, on the edge of his seat, he learned about things like 'rolling stocks,'
'covered calls' and 'stock splits.'
These were ideas that Phil had read about in the many investment books he had
perused, but here they were, being put to practical application in the stock
market, based on real companies. The presenter even listed these companies right
on the white board, and showed how beautifully each had performed over the
previous year.
A week or so later the dinnertime phone calls began to arrive from the free
seminar company who now described themselves as Phil's new 'investment
partners.' They were calling to invite him to dig into his investment capital
and fork over ‘just $3,995’ (a $1,000 discount from the regular $4,995 price
because he Phil already attended the one-day, free workshop) for a three-day
'Super Seminar' where attendees like Phil would be able to 'trade live along
with our staff.'
They were told to 'open a live brokerage account before you come ... and be sure
to bring your cell phone so you can call your broker right from the seminar room
and place your trades, live in the market, along with your presenter.'
The seminar was to run all day Monday, Tuesday and Wednesday, three days that
Phil's company agreed to deduct from his scheduled vacation time. Phil couldn't
sleep the night before the event.
As the seminar unfolded, he sat and watched in fascination as a seminar
presenter dove in and out of the market over and over again, in real-time,
winning an average of 3 out of 4 trades, each lasting anywhere from a few
minutes to a few hours, and 'bagging' short-term gains in the range of 5%-15% on
each trade.
Phil's eyes practically came out of his head. In short, he went ballistic, in
part because he had sworn to Phyillis that he wouldn't trade real money at the
event and couldn't believe how many 'hot deals' he had left 'on the table.'
During the weeks following the Super Seminar, all Phil could think about was
quitting his job and 'day trading' the market for a living. Because he couldn't
afford to quit with a mortgage, two car payments, credit card bills, student
loans and a daughter about to get married, Phil began staying up until midnight
— sometimes until 2:00 in the morning — playing with the $1,995 trading software
Phil had bought at the Super Seminar, discounted $1,000 'that day only' for
Super Seminar attendees.
Somehow Phil couldn’t get things to turn out quite the way the seminar presenter
had done. Some trades worked and some didn't. A stock that had been rolling in a
channel for over a year began trading outside of that channel and Phil's paper
portfolio lost some more money.
Some of the covered calls worked well on paper, but Phil didn't have enough
investment capital both to buy 100 shares or more of several different stocks,
and to 'write covered calls' against them at the same time.
As for stock splits, Phil was taught five different ways to 'play' them, but as
it turned out, he wasn't able to time them very well and neither lost nor made
money on them over a six-month period in his 'portfolio.' Basically, his
investment account balance went 'sideways' as Phil would later confess to his
wife.
As the weeks followed, Phil watched his paper portfolio get chopped to pieces
even further as commissions ate up most of his profits. He'd get three wins in a
row only to give his profits back in a string of four subsequent losses.
Meanwhile, he was getting increasingly tired and irritable, spending less and
less time with his family, and seeing the quality of the work he performed at
his 'day job' begin to suffer.
All in all, after three years of diligent effort, Phil had managed to 'blow big
holes' through three separate $15,000 'paper trading' accounts. Since Phil and
Phyllis had only $10,000 left in their Fidelity account after spending over
$5,000 on seminars (including airfare and hotels), software (including hardware
upgrades), newsletter subscriptions (sorry, no refunds), financial planner
management fees and commissions (also non refundable), they didn't feel very
confident about their prospects for long-term wealth building in the stock
market, especially considering that it was now 2001 and the entire market was
taking a long nose dive.
Little did Phil know that this downward trending market was a gift from the
markets to those who knew how to safely sell short, because you can almost
always make money a lot faster when things go down than when they go up.
Unfortunately, both Phil's first and second brokers, as well as both of his
financial planners had warned him that 'only gamblers sell short,' so Phil was
mentally conditioned to only ever buy stocks and hope (pray) for them to go up.
Is Phil's story typical? It would appear so. In fact, there are thousands of 'Phils'
out there who have followed comparable investment 'career paths.' Each does his
or her best to muddle through.
If they are lucky enough and happen to be investing in a long-term bull market
such as occurred during the latter part of the 20th Century, one in which every
investor was automatically an overnight genius, they will probably be OK. They
may see gains of up to 12% per year, with real inflation carving 8% or so out of
the middle. But basically, they will spend most of their time bobbing in the
stock stream, drifting along with the Wall Street tide, and hoping that there
are no financial tsunamis just over the horizon.
Ask them if it’s reasonable to expect 3% per month from the markets and they
will look at you as if you have two heads. ‘No way’, they will say. ‘And even if
you could get returns like that, you’d have to keep climbing way out on risky
limbs, and that’s not for me.’
Yet there definitely are safe, tested and easily understood methods of obtaining
consistent annual returns that leave inflation in your rear view mirror, with
risk well controlled, and perform well, regardless of whether the market is
going up, down, sideways or doing loop-the-loops.
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