Investing Habits:

A Beginner’s Guide to Growing

Stock Market Wealth
By Steve Burns & Holly Burns
Contents
Foreword
Introduction
Get Started Now
A Different Way to Make Money
Be an Employee and an Investor
Pay Yourself Before You Pay Taxes
The Power of Compounding Returns
The 100% Return That Most People Miss
How the S&P 500 Index Beats Mutual Funds
Don’t Buy-and-Hold Through Bear Markets and Crashes
Investor’s Cash Flow
Dollar Cost Averaging
Appendix: Investing Habits Summary
Grow as a Trader

© Copyright 2016, Stolly Media, LLC.

All rights reserved. No part of this publication may be reproduced,
distributed, or transmitted in any form or by any means, without the prior
written permission of the publisher, except in the case of brief quotations
embodied in critical reviews and certain other noncommercial users permitted
by copyright law.
Disclaimer:
This book is meant to be informational and should not be used as trading or
investing advice. All readers should gather information from multiple sources,
and create their own investment strategies and trading systems. The authors
make no guarantees related to the claims contained herein. Please invest and
trade responsibly.
“A habit’s a routine of behavior that’s repeated regularly and tends to occur
unconsciously.”
– Wikipedia
Foreword
“Speculation = timing the movement of money. Investing = converting time
into money.”
– @Jesse_Livermore on Twitter
This is a different kind of stock market beginner’s guide. The purpose of this
book is not to study the history of Wall Street and waste time on facts that
very few care about. This book focuses on the ten key principles that you can
do right now to start building and fortifying your own investing accounts,
regardless of where you are on your own financial journey. I didn’t write this
book based on theories or opinions, rather I am sharing my personal
experiences and the strategies I used to build my own accounts.
If you combine discipline and effort with the right strategies over time, magic
can happen. It’s no small feat to open an account and take it to six figures in a
few years, and it requires dedication, self-awareness, and an understanding of
the system. This book is not about the details of the stock market as much as
it’s about you, and the habits that you can develop to be a successful investor
and make money.
I am an avid nonfiction reader. I love to read books that not only share
knowledge, but can also empower me to change my behaviors and my life. In
this book I hope to share some things that you can start doing right now that
you may not being doing, or may be unsure about. I it will give you more
confidence in your future and you will be able to grow your capital beyond
your wildest expectations.
Introduction

“Successful Investing takes time, discipline and patience. No matter how

great the talent or effort, some things just take time: You can’t produce a baby
in one month by getting nine women pregnant.”
– Warren Buffett
Here is a quick lesson on the stock market for those readers looking for the
basics before we dive into the action steps.
The stock market has a very low barrier of entry. Almost anyone can own a
publicly traded company’s stock and potentially grow their own investment
account. Actively trading and investing in a successful company’s stocks
helps to diversify your ability to create income instead of selling your time for
money at a job.
Companies raise money when they go public by selling their stock on the
stock market through an Initial Public Offering. If a company has an IPO for
1 million shares offered at $20 a share, then they will take in $20 million if
the market buys all their stock at the offering price. Once a company takes in
the money from their initial share of stock through the IPO, their shares trade
on the open market and the price is determined by what investors and traders
are willing to pay for the stock at any given time. The value of a company is
set by the price of the stock multiplied by the number of shares of the stock
that were issued. If a company has 1 million shares of stock and the price of
the stock is $100 per share, the company market capitalization is $100
million, meaning the company is worth $100 million.
The company doesn’t determine the value of its stock, the market does. The
price of a stock is set by the last traded share price, because the stock market
is essentially an auction where there is a ‘bid’ and an ‘ask’ price at any given
time. The ‘bid’ is what someone is willing to buy the stock for, and the ‘ask’ is
what someone is willing to sell the stock at. When the stock is physically
traded, that becomes the stock price.
The company is separated from the buying and selling of its own stock unless
it issues a stock buyback program. During a buyback, a company will go on
the open market and buy its own shares and lower the share float available for
trading and investing. Share float is the actual number of stocks available for
trading at any one time.
A company can also issue dividend payments to reward investors with a share
of company earnings. Dividends are usually paid four times a year (quarterly)
on stocks. A dividend stock’s yield is determined by the amount of their
annual dividend payments divided by their current stock price. If a company
pays four annual dividends a year at $1 each for $4 in total annual dividends,
and the stock price is $100, then the stock’s yield is 4%.
Additionally, the company could also have a secondary offering of stock to
raise additional capital, but this brings more supply into the market and
dilutes the existing shares. A secondary offering is looked at negatively
because it shows the company needs to raise more capital because it doesn’t
have adequate cash flow inside the business to operate.
As mentioned above, the company can also buy back its existing shares and
lower the amount of shares available in the market. A buyback program
provides support for a stock price and takes supply of shares out of the
market, helping to increase the demand for the stock. Stock buybacks are
looked at as a positive sign, because it shows the investors that the company
believes that its best use of extra capital is to buy back its own stock.
This is the basics of how companies are related to their stocks. The company
and the stock itself are two different things. The stock market can be both a
wealth building and wealth destroying machine. It goes through cycles of
long term uptrends (Secular Bull Markets) and long term downtrends (Secular
Bear Markets) that can last for years.
The stock market can also experience short term bubbles like the dot com era
of the late nineties into March of 2000, when earnings and sales expectations
for the next decade were already priced into stocks and reality hit investors
hard. Likewise, it can have short term corrections with prices dropping 10%,
short term bear markets when prices drop 20%, and even crashes when the
market as a whole can plunge 50%, like late 2008 and early 2009.
The stock market is not the Holy Grail of riches where all you do is buy
stocks and win. The stock market is a game of survivorship. Some post IPO
stocks go on to rise by 1,000% over the next decade and eventually end up in
the Dow Jones Industrial Average as leaders of an industry. Others stock
values may lose half their value in six months, eventually being delisted as
the underlying company goes bankrupt.
The stock market is a reflection of free market capitalism with both winners
and losers. The leaders in the U.S. stock market have reflected advances in
technology, and the stock market is the mechanism for participating in the
growth of the modern economy.
Your ability to use the stock market as a wealth building tool will be based on
how well you can consistently do things that expose your money to good
opportunities and uptrends in the stock market as a whole, and in individual
stocks that are going up in price as their sales and earnings rise. When you
have captured some nice trends, your next job is to know when to exit with
profits and not allow them to be taken back during the next bear market, or
when the company makes a misstep and loses its competitive advantage.
There is a time to be in the stock market and a time to be out. This book will
be help you maximize your chances of making money long term, while
minimizing your financial and emotional risk.
Get Started Now

“The best time to plant a tree was 20 years ago. The second best time is
now.”
– Chinese Proverb
The main reason that the average person doesn’t build wealth through
participating in the stock market is that they never get started in the first
place. Most people know that they need to open a brokerage account, an
Individual Retirement Account, or contribute to their 401K, but they
generally fail to do so. Most people’s favorite day to plan is tomorrow. For
many, tomorrow turns into never as the days, months, and years go by.
Too often we wait for the perfect time to start learning what we need to do,
and many never do that much. After doing the homework necessary, the hard
part begins; you must start saving money, contributing consistently to an
account, and actively investing. The best time to start an investment plan is
always today and the second best time is tomorrow. It’s not always time to
buy stocks, but it’s always time to have a plan on how and when you will buy
them when the opportunity arises.
Investing is a lot like losing weight. There is a lot to learn and you can study
nutrition and exercise for the rest of your life in the pursuit of good health.
But it’s not rocket science, and we know that we can lose weight and be
healthier by lowering our food intake and increasing our activity level. The
stock market is the same way.
We know that we need to save money, put it in the stock market, and follow
trends for long term capital growth. Most long term buy-and-hold investors
have done well over the last ten or twenty years with little knowledge or in
depth research. They participated in the stock market and got rewarded in the
long term. I am not saying that buy-and-hold is the way to go, but that their
ability to take action rewarded them greatly in the 1980’s and 1990’s.
Investing and dieting success are more based on behavior than knowledge. I
have seen overweight nutritionists and I have also seen very intelligent hedge
fund managers lose all their money. Success in weight loss and investing both
come down to having the ability to consistently take the right actions and
impulse control.
You have to start the diet or the investment account for a chance of success at
losing weight or building capital. The magic is in the first step, and you can
only do that by getting started. Taking action and moving from the learning
phase to the action phase opens up new possibilities for the future. Your first
step is to get into the habit of taking action. Without it, nothing else matters.
The most important thing you can do as you read this book is take action and
start implementing the things you will learn. Action proceeds success. Don’t
wait for the perfect time to start, because there isn’t one. There will always be
something that comes up, giving you a reason to delay. It’s better to start now
with any amount of money than to wait for a magic time when your
circumstances are perfect. The principles in this book made the difference
between me having multiple six figures of capital in my investment and
trading accounts in my forties instead of having zero.
There is never a bad time to grow capital, and when you make the conscious
decision to take action, the results can be life changing. The dedication of
your continual actions will become habits that you no longer have to force
yourself to do, because they will become a way of life.
This book will give you action steps that you can agree with or disagree with.
If you disagree with one or just decide that it’s not the right time or thing for
you, then move on to the next one. However, if you do agree with the action
step, it’s time to do something about it. Take action, open the account, set up
the automatic transfer to your 401K, or buy your first stock.
While taking action and creating good investing habits doesn’t guarantee your
success every time you make an investment, it will make the odds of your
long term success an almost certainty.
Investing Habit #1
Take action: when you know what you need to do, don’t wait, do it today. The
most important part of investing is to start and then develop the habits of
consistent actions that will build your capital and net worth.
Is there anything you already know you have needed to do in your investment
life?
Is there anything you already know you need to do in your personal finances?
Are there any investment accounts that you already know you need to open?
Getting things done will feel good, clear up the past, and help you move
forward building good habits.
A Different Way to Make Money

“It’s not how much money you make, but how much money you keep, how
hard it works for you and how many generations you keep it for.”
– Robert Kiyosaki
Too many people spend their lives as employees and consumers. They sell
their time and skills for money, the money is taxed, they pay their bills, and
whatever is leftover is usually discretionary. The discretionary amount is
typically used for a vacation, on leisure activities, or buying more
depreciating consumer goods like furniture, electronics, or automobiles. With
only one source of income, this can be an exhausting treadmill.
Too many people have a negative net worth after a decade or more of hard
work. Most people work hard at earning and spending money, but put little
effort into saving or investing it. Buying products from Amazon is spending
money, buying shares of Amazon stock is investing money. Paying for a
movie rental on Netflix is being a consumer, while buying shares of Netflix
stock is being an investor in the company’s future.
Most people stay on the consumer side of companies and never move over to
the investor side. You can profit by being an investor in a company that
consistently grows sales and earnings and beats Wall Street’s expectations. If
you invest in a company that’s growing, the odds are that as it grows the share
prices will also grow and you will make money in uptrends.
Customers spend money to consume goods and services that depreciate in
value, while investors spend money to accumulate assets that could appreciate
in value over time. The best performing stocks of all-time are not obscure
penny stocks, biotech names, or secret, insider stocks. They are generally
household names like Wal*Mart, Apple, Home Depot, Priceline, Google,
Crox, Intel, Cisco, Microsoft, Amazon, and Netflix to name just a few.
For a company stock to go up significantly in price, it needs to experience
growth in stores, customers, subscribers, web traffic, and fans, based on their
business model. Growth ultimately comes from customers and, you will likely
find your best investing ideas while shopping at a store, going online, dining
out, or watching a movie.
You can buy stock in a company that has the potential to grow dramatically
over coming months or years and profit from the rise in the stock. This is
where large returns can be made when the timing of the buy is right, the stock
is in a long term uptrend, and the company goes on to innovate and grow its
earnings and market share. There are several things to consider when
investing; you have to buy the right company, you have to buy at the right
price, and the stock needs to be in a stable price range or uptrend.
These two aspects are critical when you’re considering a stock:
There are the fundamentals of the company- earnings, profit margins,
competitive advantage, industry, and growth prospects.
There are also the technical aspects of the price of the stock- Is it a good price
for entry? Is it a value at this price? Is high future growth already priced in? Is
the chart pattern of the stock bullish or bearish? Is price in an uptrend or
downtrend? Is there much of a safety margin at this price? How much lower
could it go?
One way to be an investor is to buy stock in the best companies in the world.
To be an investor, you have to add paying yourself money to invest in the
stock market at the top of your list of bills. Why should your investing
account not be up there with your car payment and Internet bill? Many people
have tight budgets but most the time it’s possible to make adjustments to free
up money to begin investing.
Even $100 a month will get you to $1200 in one year and $200 a month will
get you to $2400 a year. This is a good start, and your success will become
addictive as you see your capital grow. It’s rewarding over the years to see
your account go from $1000, then $5000, $10,000, $25,000, $50,000 and then
$100,000.
This money can be placed in a brokerage account, Individual Retirement
Account, 401K, or 403B. When starting out, it’s better to go into a tax
differed account if you don’t plan on touching the money for a decade or
more, because it can be deposited with no income tax and it can grow tax free.
If you’re doing short term speculating, then a brokerage account is needed.
Brokerage accounts are quick and easy to open online, and you will want a
discount broker that has small trading fees that are under $10.
This first account can be one that you speculate with money that you’re
willing to lose in the pursuit of big returns, or an account you plan to use long
term to build enough money for retirement. Or you can have both as many
people do.
Investing Habit #2
Create and follow a plan. Invest in the stock market on a consistent basis by
buying stock investments that meet your personal investing criteria, time
frame, and goals.
Ask yourself:
What are your specific investing goals?
Are you investing for retirement? Then you need to open a retirement account
or sign up for your employer’s retirement account.
Do you want to speculate in stocks? Then you will need to open a brokerage
account. Your priority should be commission price, because almost all
discount brokers are about the same when it comes to execution and customer
service. I would suggest going with a broker with a name you know and trust
so your money remains as safe as possible.
How much money do you want to put into your accounts? You can set up
automatic payroll withdrawals into a 401K account with your employer. You
can also set up automatic deposits into an IRA. You can also plan on putting
aside a set amount of your income from salary and bonuses into your trading
account at regular periods.
You do need to make it a habit of depositing money into your investment
accounts each and every month. This is how you will initially build your
investment account. You will be paying your investment account like it’s any
other bill, but instead of paying for a depreciating asset or making someone
else money, you will be paying yourself.
Your investment account is the one bill that will pay you back. If you nurture
it, it will continue to grow until one day it’s a source of income that can pay
you in capital gains on your holding, dividends from stocks, or interest if you
move it into bonds. Following this method will create a second source of
income for you, but it can only happen if you start paying yourself.
Be an Employee and an Investor

“People think that working hard for money and then buying things that make
them look rich will make them rich. In most cases it doesn’t. It only makes
them more tired. They call it ‘Keeping up with the Joneses.’ And if you notice,
the Joneses are exhausted.”
― Robert T. Kiyosaki
If you go to work every day at a publicly traded company, then your market
research may be better than many professional money managers on Wall
Street. It’s legal to invest in and trade the stock of your employer as long as
you’re acting on information that’s available to the general public. The CEO
and executives are regularly rewarded with stock options which are a large
part of their compensation packages. They may invest in the company
themselves if they see a bright future of increasing earnings.
Why not you? If you wonder why your company makes a big push to
maximize sales, cut expenses, and make their numbers at the end of every
quarter and at year’s end, it’s probably because they are trying to give Wall
Street positive numbers so the stock price can rise or at the very least, not go
down. The executives are almost always incentivized to meet expectations
because most times their stock options rise with increased value.
Executives and managers can be incentivized to make their individual
department budgets and meet their operational numbers so they receive
bonuses. The grumbling around the watercooler is true, the hard work and
sacrifice in the fourth quarter by hourly workers and middle managers in the
majority of publicly traded corporations are going for large bonuses for upper
management and executives. These are usually delivered through a payout in
cash, stock grants, or stock option appreciation.
These incentives are the carrot offered by companies to get the financial
numbers that they need. The purpose of publicly traded companies is to
increase earnings and decrease yearly expenses to increase valuation of their
stock.
Big cap companies purpose is to become more efficient, not create more jobs.
Wages are the number one controllable expense for most companies, so it’s
frequently one of the first places companies look to cut expense and increase
earnings. Job growth only happens when companies are growing.
As an employee, the more productive you are, the more you are safeguarded
against being laid off or downsized. As an investor who owns a stock you
want to see the company expanding and creating jobs due to growth. Hiring is
a great sign of a company growing. A company going through layoffs is a
sign of that it has moved through the growth stage and is not trying to
appreciate the stock price by becoming more efficient and increasing
earnings.
Mergers are done to increase buying power, share standard practices, and
become more efficient by streamlined. When a company merges it doesn’t
need two Loss Prevention departments, two CEOs, two Human Resource
Departments, two sets of executive officers, or two Boards of Directors. A
merger usually shows a company is done with its growth stage and now must
grow through acquisitions and mergers.
So what is an employee to do? Grumble about corporate greed to and go back
to work? Many do just that. Why not instead participate in capitalism? What
drives a company’s stock upwards is their ability to create great products for
consumers, paying people to be productive, and making money. Why not
align yourself with upper management’s incentives and start becoming an
investor in the company you work for?
Many companies have programs where you can buy company stock
commission free if you set it up automatically. Others will allow you to buy
company stock in your 401K retirement program. You can also set up an
account with a discount broker and start slowly building up shares in your
company each month by dollar cost averaging.
These strategies will transform you from employee, getting paid for adding
value, to investor in the company getting rewarded financially when the
company increases its earnings, grows it sales, and beats Wall Street’s
expectations. It’s like getting paid twice. You will be a capitalist benefitting
from your company’s financial success while you work towards your
financial success.
This works best if you work for a company that’s in a strong industry,
innovative, and sees growing sales and earnings. If its’s retail, it should be
adding stores, for example. Not only do you want to see efficiency of
resources, but it needs to be an industry leader with a trusted brand. Loyal
customers and employees can make the difference between big earnings and
mediocre results.
The stock should be in an uptrend, making higher highs and lower lows in
price over the past few months. It’s good to see your company close to its 52
week high in price. Ideally the best company stocks are within 10% to 15% of
their all-time high. If your company’s all time high is $100 and your stock is
at $85 to $90 that’s a good sign that it’s still in its growth stage and the stock
market itself is likely bullish. If your company’s stock is at $20 and its all-
time high is $50, then its best years may be behind it.
Join the happy stock investors who have made money and are looking for
higher highs in the future. Growth investing has a higher probability of short
term success than value investing. A stock that’s a great ‘value’ may take
years to be profitable, but a growth stock can double or triple in a manner of
months or years.
Your company may be a strong big cap stock that already pays a dividend and
is in the Dow Jones Industrial Average, or a smaller company that has the
potential to double or triple in size in coming years and is in the Russell 2000.
The company does need to trade on a major exchange like the New York
Stock Exchange or the NASDAQ, and not be an over-the-counter stock or
trade on the ‘pink sheets’. The odds are that you’re not working for a
company that’s a penny stock because most are not real companies.
Many financial advisers think that investing in the company you work for is
too much risk because your job and your investments will be tied up in one
place. Bill Gates and Warren Buffett did very well keeping their job and their
investments in one place for decades; their investments consistently making
them some of the richest men in the world. If you’re working for and
investing in a winner, then you can do very well. The key is that your
company needs to be a winner. It has to grow, be innovative, stay efficient,
have a brand that stands for quality, and the stock price needs to be near all-
time highs.
Investing Habit #3
If you’re working for a great company whose earnings are growing, then
don’t just be an employee, become an investor and profit from your
company’s financial success.
Here’s what you’re looking for:
Did your company grow earnings by 5% or more over last year? 10% or
more is excellent.
Are sales growing over 5% versus last year? 10% is excellent.
Does your company have new products, new technology, or new business
processes that give them an edge over the competition?
Is your company a leader in its industry, with name recognition and market
share?
Caution: Even if your company has all these things it can still go down in
value if equities as an asset class are under distribution. If your stock goes
under the 200-day simple moving average, then you should sell your holdings
and wait for that line to be retaken. The 200-day simple moving average is the
average price over the past 200 trading days and is represented as a line on a
price chart. Investors should be cautious when there are no buyers above this
line. This is a sign of a downtrend, and I don’t invest in stocks under this line.
(I will at times trade them, but that’s a different process than investing.)
The following chart shows one of the greatest companies of all-time. It has
one of the greatest balance sheets, some of the best profit margins in its
industry, a strong brand name, and has been an innovator in the sector.
Fundamentally, it’s one of the best companies in the world. However,
investors buy things to make money, not to lose money. Even though it may
be a great company fundamentally, the price action going lower than the 200-
day average of prices is a signal that investors are selling the stock.
From a financial perspective, what other investors are doing with their stock
holdings is just as important as how the company is doing fundamentally. The
trend in a stock’s price will turn into a downtrend long before the company’s
fundamentals change. This was demonstrated with Apple stock in 2008, 2012,
and 2015. You only want to invest in your company if the financials and the
stock price are both in uptrends.

Chart courtesy of StockCharts.com

If you’re working for a great company don’t just be an employee, be an
investor.
Pay Yourself Before You Pay Taxes

“In this world nothing can be said to be certain, except death and taxes.”
- Benjamin Franklin
There are two truths, at some point we all die, and we all have to pay taxes.
We can postpone death with a healthy lifestyle and avoiding physical danger
when possible. We can also avoid short term income taxes by contributing to
a tax deferred retirement account. In the United States at the time of this
publication, people can contribute $5,500 ($6,500 if you’re age 50 or older) to
an Individual Retirement Account. This is useful if you don’t have access to
an employee sponsored retirement account like a 401k, 403b, or 457b.
Deferral limits for contributing to a traditional 401k plan, 403b, and 457b at
the time of this publication is $18,000. There are allowances for playing
catch-up for those over 50 years old, and they are allowed to contribute an
additional $6,000 to their tax deferred accounts.
The power of contributing to a tax deferred account is threefold.
You’re lowering your tax liability right now. Your taxable income is now less.
If you make $68,000 a year and contribute $18,000 to your 401K, then your
taxable income is only $50,000. In countries with more progressive income
tax regulations, a tax deferred account could end up saving a large amount,
because it goes directly into your account and doesn’t see the tax man until
you withdraw it.
As an added bonus you don’t pay capital gains tax on the returns of your tax
deferred account until you withdraw the money. Your capital grows tax free!
If you make a 20% returns on your account of $100,000, that $20,000 doesn’t
go on your taxable income report as capital gains for the year you earn it. It
stays whole and ready to compound next year. This is a huge win because
taxes don’t eat up your capital gains and it can grow and compound in peace.
If you’re like the majority of people, you will be contributing to your tax
deferred retirement account in your peak earnings years between 25 and 65
years old. If you end up leaving your tax deferred account alone to grow until
you’re ready to retire, then you should be in a lower tax bracket in your
retirement.
When you do begin to take out money from your tax deferred account to live
off of, you will have a lower income than your working years. When you
have a job, you’re paying for your commute to work, wardrobe, eating outside
the home, childcare, just to name a few. Hopefully you will not need the same
level of income in retirement that you did in your working years. If you draw
out less from your account in your retirement years than you earned in your
working years, then your taxable income will be much lower.
So the goal would be to contribute to your tax deferred account when your
income is its highest and then withdraw the money from your retirement
account when your need for capital is much lower. You will pay taxes on a
much lower percentage in retirement than you would have in your working
years. This is why I don’t like Roth IRAs and Roth 401Ks. Why would you
want to be taxed in your working years and lose out on compounding tax free
over your lifetime?
Why would you want to use a Roth to divert paying taxes now instead of at
retirement? Roth accounts have you pay taxes now and not pay them when
you withdraw the funds in the future; to me this is backwards unless you plan
to be in a higher tax bracket at retirement than you’re in now. It’s very
uncommon for retirees to have a huge tax liability in retirement, but it is a
common problem for high income earners to need a break from being taxed
heavily in their peak working years.
The normal process of earned income is:
Income -> taxes -> paycheck
We are changing it to:
Income-> investing-> taxes -> paycheck
If you’re an employee and contribute a percentage of your income directly
into a tax deferred retirement account, then the money goes into your
investment account before you pay taxes on it. You bypass the tax man in the
present and will pay him way down the road. Hopefully, the future will be at a
lower income rate and you can pay at your own pace through withdrawing
capital only when you need it for living expenses at a much lower rate than
you had in your peak earnings years.
Depending on your income tax rate, you could be getting a 10%-39.6% return
at the start of your tax deferred deposit by not having to pay income taxes on
the money right now. If you take home $1,000 of income and are taxed at a
25% tax rate, your $1,000 becomes $750 in take home pay. If you deposit the
$1,000 into a tax deferred account, it will stay $1,000 and then be able to
compound tax free until the day you withdraw the money. The $250 that
would have become taxes lives on in your 401K account to grow for many
years to come.
This is a powerful concept that enables you to keep your money now and put
it to work compounding instead of giving it to the government. The
government created this tax loophole process because employees need of a
way to build their own wealth to live off of in retirement, because defined
pension plans have vanished and the viability of the social security system is a
big concern to the majority of people.
Investing Habit #4
Pay yourself before you pay taxes. Contribute into an available tax deferred
retirement plan. You can avoid paying taxes short term and allow your money
to grow tax free long term. This can be an IRA, 401k, 403b, or 457b plan in
the United States, but other countries have their own systems. Here are some
of your options in the United States. Check with your company’s
administrator or Human Resource department for what is available
specifically to you.
A 401k plan is primarily for the employees of businesses.
A 403b plan is primarily for non-profit workers in charities, hospitals, and
ministries.
A 457b plan is primarily for government workers.
An IRA can be opened through most brokerages accounts and the
contributions can be taken off your taxable income.
Contributing to your own tax deferred retirement account decreases your tax
liability and allows you to compound the money that would be spent on taxes
right now. By diverting it during a period when you would be paying at a
higher rate to a lower rate, after you’re retired and need to start withdrawing
the money for living expenses, you should be in a good place.
The Power of Compounding Returns

“Compound interest is the eighth wonder of the world. He who understands

it, earns it … he who doesn’t … pays it.”
– Unknown
When I was 16 years old I was a sales clerk in a shoe store. We had a lot of
downtime on slow days after dusting and straightening in between customers.
I studied compound interest and return tables during this downtime. It was
amazing to me how money could grow, all on its own.
If started to understand that if I had $10,000 and returned 12% a year for 6
years, my money would double! In year seven my $10,000 would have grown
to almost $20,000, and I would be earning $2,400 with a 12% return on my
money.

After I reached almost $20,000 in six years, I would be making back my

original capital every four years.
I was fascinated by these tables and the idea of money making money. I didn’t
know at the time that this was what it’s like to operate as an investor.
Investors seek to obtain and build financial capital by putting it to work in
growing investments. In the above example, once the money grew to over
$100,000, then the annual return would exceed the original investment.
The early stages of getting the capital together is hard because you’re
converting your working hours to money, but the later stages of compounding
capital are easier. You gain momentum as your money grows faster through
good returns than you can earn it by selling your time. While 12% annual
returns will seem very high to readers experienced in the financial markets,
this number is a worthy long term goal for everyone.
The key to successful compounding is to grow it consistently and not let it be
destroyed through excessive risk taking or by not having an exit strategy for
your investments. Even buy-and-hold investing from 1930-2013 in the S&P
500 index returned about 9.7% annually when including dividends. The 12%
annual return we are looking for has happened historically in small caps; they
have returned 12.7% annually from 1930-2013. So it’s possible to have these
returns on average over the long term. I have had over +20% annual returns in
my accounts half the time in the past twenty plus years of being in the stock
market. I have achieved an average of 12% long term returns through
investing, trading, and avoiding bear markets and market crashes. That’s
where the real danger exists- having negative returns. The best thing you can
do to maintain good, long term returns is to not lose money. Play it safe with
stable investments. Be an investor and not a gambler.
If you lose 10% of your money you have to gain 11% to get back to even.
If you lose 20% of your money you have to gain 25% to get back to even.
If you lose 50% of your money you have to gain 100% to get back to even.
The most important aspect of compounding your money over the long term is
not to lose a lot of money in the pursuit of your gains. If you have $10,000
and lose 50%, it takes you down to $5,000. A 50% return on your now $5,000
only takes you back to $7,500. You would need a 100% return on your $5,000
just to get back to your original $10,000. You would need to double your
money just to get back to even.
When you suffer the loss of capital, it is much more difficult to get back to
where you started. It’s easier to keep what you have and grow it slowly. When
compounding your money, it’s crucial to invest it in solid companies with
long term track records or bonds from financially strong companies. Avoid
chasing investments that have a lot of risk like penny stocks or suspicious
business ventures. Don’t use financial derivatives like options or futures until
you have a full understanding of exactly what you’re doing and how much
you’re risking.
Derivatives are not investments; they are bets on a specific movement in a
specific time frame. Options and futures are for trading and not investing.
They can build wealth if you trade them systematically with a winning
methodology. For the majority of readers of this book, being invested in the
stock market during its uptrends will be the smart way to go in pursuit of
steady long term returns. The key is to grow it consistently and not let it be
destroyed through excessive risk taking or not having an exit strategy for your
investments.
The compound return tables seemed like magic to me. I knew that at some
point in the future I could build up my capital to the point where it made more
than I did. If I invested my capital wisely and could return 12% a year, it
would double at the end of the sixth year. If I could really knock it out of park
and return 20% a year, I was looking at doubling at the end of four years. The
key would be to figure out how to get these returns through the stock market,
and how to get the capital in the first place. I decided I would sell my time for
money by working, and then put that money to work in order to save time in
the future. I wanted to be an investor, putting my money to work for me more
than I worked for money.
When I was in my early twenties, one of my friends had about the same in his
retirement accounts as I did; we both had about $15,000. He was eager to
cash out his account and pay off some bills and have some fun. I counseled
him against it because I was looking at the long term potential of the growth
of our money with compounding starting at such a young age. I told him at
the time that whatever he spent it on would ultimately cost him six figures
over the long term.
Ignoring my advice, his $15,000 turned quickly into $13,500 after he got a
10% early withdrawal fee because this was a tax sheltered retirement account.
Withdrawing from a 401K before the age of 59 ½ creates a 10% early
withdrawal fee. It’s better to leave it alone and let it grow tax free. The money
should have then turned into $10,500 as he should have held back another
20% to pay his income taxes on this money at the end of the year. Once he
withdrew the money it became taxable income that he was supposed to claim
it on his income taxes, which he didn’t.
He ended up owing the Internal Revenue Service $3,000 after he spent all of
the money. What a terrible way to waste his seed money. My $15,000 account
ended up being over $60,000 a few years later by March of 2000, thanks to
the dot com bubble and my aggressive investments in tech mutual funds. This
same account over the years ended up being multiple six figures after adding
to it and having great returns during bull markets and going to cash during the
2008 financial meltdown.
This should be one of the biggest priorities for readers of this book. Start,
build, add to, and compound a retirement account so you have a nice nest egg
to retire with one day.
When we start out, almost all of us spend money to become educated. We
invest in ourselves to acquire the knowledge and skills to produce a high
enough income to support ourselves. Then we sell our time to receive pay that
we can live off of month to month. The next step in this process is to put
away money in a retirement account that will someday pay us for the time we
allowed our capital to stay in investments, or actively trading our capital in a
systematic way to create consistent returns over a long period of time.
We can be paid for the time our capital spends in the right assets just like we
can be paid for the time we spend working. The amazing thing is that our
capital will grow and we will even begin to get returns on our returns. If we
start with $10,000 and make a 10% annual return, then we have $11,000 after
the first year. The magic begins to happen when that $1,000 in returns makes
$100 in returns on year two so we go to $12,100 after two years. Your money
starts to make money on its own!
I have been fortunate enough to make my teenage dreams come true, and over
the past 25 years I have created this compounding in my accounts. For me,
capital preservation is the key. Grinding out 15%-20% returns a year can
work magic in a few years, and if you throw in a few 40% and 50% return
years, you can build capital quickly. The best place to find these levels of
returns is in the stock market, primarily during bull markets. It’s possible to
achieve 8%-20% returns in the stock market over long periods of time based
on the levels of risk you’re comfortable with. These returns have been
accomplished by trend followers, index mutual funds, and even buy-and-hold
investors over most 10-year time periods.

If you have never pondered the power of compounding an investment

account’s returns for capital appreciation, please give this chart your attention.
It’s possible to be a millionaire in a reasonable amount of time if you leave
your capital alone and let it grow. This is a program that anyone can use with
simple trend following methods, discipline, and adding capital. Using an
index and moving averages is not rocket science. Implementing this inside a
tax deferred account like a 401K, 403B, or IRA eliminates the capital gain
taxes and helps it compound tax free.
The easiest way to accomplish this is to start building capital at a young age
and get a head start on the compounding. But remember, it’s never too late to
start. If you have 10-20 working years left and the benefit of a higher income,
then you can contribute more money and build capital even faster than a
younger person without your earning prowess. Once you get into the six
figures, the acceleration of the growth is amazing.
The opposite of compound growth of returns on capital is the trap of paying
interest on debt. If you owe $100,000 on your house with a 30-year mortgage
at a 5% interest rate, then you’re paying $5,000 a year in interest as you try to
pay off the mortgage. An amortization table is set up to keep you paying
interest on the remaining mortgage balance for the life of the loan. You have
paid interest on the loan, year after year, making the cost of the house versus
the list price unbalanced.
It’s the same way with credit card debt. If you’re charged 12% annual interest
on a credit card, the interest and debt work against you growing at 1% a
month in most cases. A $10,000 credit card balance is costing you $100 in
interest every month, and ends up being closer to an annual rate of 12.68% a
year when compounded monthly. You end up paying over $1,200 in interest a
year on your credit card balance.
The bigger your debt, the higher the interest payments and the more the
compounding will work against you. If debt is carried over multiple years,
then you could end up paying the interest on the interest of your debt. This is
how people get on the wrong side of compounding interest and have it work
against them.
The rule of 72 is a shortcut to estimate the number of years required to double
your money at a given annual rate of return. The rule states that you divide
the rate, expressed as a percentage, into 72:
Years required to double investment = 72 ÷ compound annual interest rate
72÷6=12: This formula shows it takes 12 years to double your capital with a
6% annual rate of return.
72÷7=10.29: This formula shows it takes 10.29 years to double your capital
with a 7% annual rate of return.
72÷8=9: This formula shows it takes 9 years to double your capital with an
8% annual rate of return.
72÷9=8: This formula shows it takes 8 years to double your capital with a 9%
annual rate of return.
72÷10=7.2: This formula shows it takes 7.2 years to double your capital with
a 10% annual rate of return.
72÷12=6: This formula shows it takes 6 years to double your capital with a
12% annual rate of return.
72÷15=4.8: This formula shows it takes 4.8 years to double your capital with
a 15% annual rate of return.
72÷20=3.6: This formula shows it takes 3.6 years to double your capital with
a 20% annual rate of return.
72÷25=2.88: This formula shows it takes 2.88 years to double your capital
with a 25% annual rate of return.
Very few people are able to compound capital because they end up cashing
out their 401K, 403B, IRA, profit sharing account, or trading account when
Life Happens. The math is not the hardest part of compounding capital over a
long period of time, rather it’s the behavioral aspect of compounding money
that requires the most commitment. Outside the spreadsheet and theory is
where automobiles break down, medical emergencies happen, and what can
go wrong will eventually go wrong.
An emergency may have people running to cash out their investment account
when they feel like they have no other option due to a surprise medical bill or
their central heat and air goes out. Others will take the money and just use it
for a vacation, home improvement, or the car they always wanted. The thing
that they don’t understand is that the purchase and short term gratification
could cost them six figures or more in the long run.
It takes planning, but setting up an emergency fund and always maintaining
the right insurance to protect your long term capital from being pillaged when
life happens, is one of the most important things you can do for your financial
future.
Focus on your future financial goals and make them your top priority. Your
investment account and long term returns are an offensive play to score
financial points, but you also need the defensive play of an emergency fund or
short term credit to handle any big financial problems that occur. You need to
leave the financial seeds you have planted alone so they can grow. The goal of
compounding money is not to harvest your financial crop until you have
planned to. This should be for retirement as well as financial independence. If
you follow this advice, your compounded capital should one day be giving
you a paycheck.
Investing Habit #5
The habit that you must master is to not touch the money you have set aside
for long term compounded returns. Leave this money alone to grow for an
extended period of time.
Compounding works best if you start young and get strong returns early. It
will take a lot of discipline to get in the habit of having plans in place to avoid
taking out this money and spending it.
I have used mutual fund returns, indexes, and individual stocks to get returns
of 10%-20% a year on average, so it’s possible and worthwhile. The stock
market is the best path for most readers. However, someone who makes over
$200,000 in income or has more than 1 million dollars to invest can have
money managers handle their money.
More conservative readers will prefer the more consistent returns of bonds,
and others will lean toward high dividend paying stocks. The specifics are not
as important as the general principles of investing in what is comfortable for
you that will keep your capital safe. You will need to have an entry and exit
strategy for your investments to avoid holding through a financial crisis or
bear market. More importantly you will need a re-entry strategy to get back in
when the trend finally reverses.
Compounding can either work for you or against you. Put the power of
compounding in your favor by building your own capital and letting it grow
over the long term.
The 100% Return That Most People Miss

“If you receive a 401(k), 403(b) or TSP match from your employer, invest up
to the match.”
– Dave Ramsey
Some of the best stock traders that I know have had 100% annual returns.
That usually happens in unique environments perfectly suited for a trader’s
specific trading method. My best return year in active trading was 52% in
2012. Most of the best money managers in the world like Warren Buffett,
George Soros, Paul Tudor Jones, and Peter Lynch have about 20% annual
returns on average over long periods of time.
What if I told you there was a way for most employees to get an instant 100%
return on their money? Does this sound interesting? Would you turn down a
100% return on your money? Where else are you going to find a 100% return
outside of penny stock newsletters or Las Vegas? This type of return on your
money can be found as near as your own employee sponsored 401K program.

Amazingly, many people don’t know about this, it’s part of most companies
benefit packages, and it replaces the pension plan program of the last century.
This is the benefit the company created so that they could define their
retirement expenses and cap their potential exposure of costs for the
retirement of their employees. In some companies this is what replaced an
older profit sharing program, where the company would contribute all the
money to an employee’s defined retirement.
If the company contributed the whole 10% of an employee’s income to a
profit sharing account each year, they could cut that expense in half by
changing to a 401K match program where they match up to 5% of the income
of the employee. The employee can still get 10% of their income into a
retirement account, but the employee has to chip in the first 5%. The biggest
way the employer wins is that most employees don’t ever contribute their half
of the 5%, so the employer doesn’t have to match anything. The employer
only has to match what is contributed. No contribution equals no expense.
How does the 100% return work if you contribute to a 401k that matches? In
the United States, most major corporations, and even some private businesses,
have 401K match programs. These are tax deferred retirement programs
where the employer will match what the employee puts in to their account.
Each company is different, some will match your income up to 5%, while
others will do more and some will contribute less.
If you make $50,000 a year and put in 5% of your income each week, by the
end of the year you will have contributed $2,500. Your company will have
matched with an additional $2,500. Each week around $50 goes into your
401K account automatically and the company also puts in $50. Your $50
becomes $100, and so a 100% return at the start. In addition, this is pretax
money in a standard 401K, so you’re deferring income taxes until you take
the money out and use it in retirement.
You get your tax free 100% return at the start, and the capital gains and
dividends from investments also grow tax free until you redeem it. Throw in
some good stock market trend following strategies and compounding returns
over many years and you can build up your account to something very
sizable. The key is starting with a 100% right off the bat so you give your
capital a long term ripple effect in your returns. The $50 that was already a
gain can start producing returns in your account from day one. Your instant
100% return can go directly into your investments and begin to grow.
Some companies will only match buying the stock in their company. That’s
fine because you’re buying the stock for half price! If the stock drops by 50%
you’re still at even from your entry point. That’s an incredible safety margin
from the entry price; most investors can only dream about such a deal. If the
stock does end up in a downtrend, you can sell it when your program allows
it.
If you’re working for a great company that’s growing earnings and sales
consistently, then the stock that you have to buy could go on to rise and turn
into a great investment over time. If a stock you bought that was matched at
100% doubles, then you’re up 300% from your buy point.
For example:
You buy your company’s stock for $40, but they match your contribution so
your cost basis is $20. If the stock price goes up to $80, you made a 300%
return from your $20 cost basis. You put $200 into your 401K to buy 5 shares
of stock at $40.
Your company matches the $200 and you get an additional 5 shares, so you
got 10 shares for a $200 investment. Your actual cost basis is $20 a share and
if the stock doubles from $40 to $80 or from $400 to $800 for the 10 shares,
your $20 cost netted you a $60 gain per share for a 300% return.
However, the plan will probably have parameters for how long you have to
hold the shares after the match. It would be good risk management to sell the
stock when you can so you don’t have as much risk exposure to just one
company, unless you work for one of the greatest companies in the world like
we talked about previously. If you decide to hold stock in your company, then
at least have an exit strategy to lock in profits or cut losses. A long term
moving average system or short term profit target is the simplest way to
approach this.
The important thing is that you have to get in the habit of automatically
having your full match deducted from your paycheck and put directly into
your 401K account. The hard part is having the discipline in your personal
finances to allow for enough room in your budget to make this happen. A few
hundred dollars a month is a lot to most people. However, if a decision like a
new car payment or dining out too much is costing you a full 401K
contribution to get a 100% match, then you’re paying double for whatever
consumer good you’re buying.
If that $400 new car payment is stopping you from contributing that $400 for
a full match each month, then the car really costs you $800 a month from the
missed opportunity. This is called opportunity cost, and isn’t your financial
future worth driving your car for a few extra years or cooking more at home?
You will have only one opportunity to get a 100% return at the beginning of
an investment entry with zero risk. Don’t miss this opportunity if you have
the ability to participate in your company’s 401K program. You can set your
allocations in your 401K so that after the direct deposit, the money goes
directly into stock funds, bond funds, or even money market funds depending
on your personal investment plan and the current market trend. However, it
does have to go directly into your tax deferred 401K plan to qualify for a
match.
Investing Habit #6
Find out what percentage of your contribution to your retirement account that
your employer will partially or fully match.
Contribute the full, matched amount and set up an automatic payroll
deduction for each pay period. You may have to make adjustments in your
household budget so you can afford this new expense, but this is an
investment in your future with a 100% return. This is the best return you will
find in the investment world without risk, so don’t miss this opportunity.
There is very little free money in this world. If your employer offers it, take
it!
How the S&P 500 Index Beats Mutual Funds
“[The S&P 500 index] is the most historically reliable single metric of the US
market over the past 140 years for both price and dividends. The early Dow
12 was too small and volatile to be a proxy for the broader US market, and
the Dow of the past few decades also lacks sufficient diversification to be the
best single gauge of the US equities market.”
– Doug Short
According to the New York Times, of the 2862 US stock mutual funds that
existed in March 2009, not a single one beat the market. How many mutual
funds routinely rout the market? The answer is zero. When you buy a
managed mutual fund, the odds are that you will get someone who charges
you a management fee for underperforming their benchmark. Their fees will
also eat into your capital over the long run.
Losing 1% to 2% of your capital to fees each year hurts your ability to
compound and grow. It’s like a leak in your financial boat. Mutual fund
managers have a great business model, at least from their perspective. The
investor (that would be you) takes all the risk and they get paid set fees
regardless of their performance. Mutual fund managers collect big fees for the
expectation of doing one thing: beating their benchmark. Managers of mutual
funds that invest in big cap stocks should beat the S&P 500, while small cap
mutual funds should beat the Russell 2000. That’s their job. If they can’t do
that what is their purpose for existing?
Over the long term, 80% of mutual funds don’t beat their benchmarks. What
that means is that the SPY ETF beats 80% of active managed mutual funds.
The SPY ETF beats 80% of mutual fund managers for three primary reasons:
It has a very small management fee of .09%.
It follows the S&P 500 index rule based system. It’s managed in a mechanical
way and not based on a manager’s opinion or emotions. This is an edge.
It can’t underperform the market because it’s the market.
Mutual funds also have a built in disadvantage to their benchmark due to
expenses for management, administrative fees, and brokerage expenses.
These expenses can range from 0.2% for an index mutual fund up to 2% for
some managed funds. The 80% of mutual fund managers that don’t beat the
S&P 500 still get paid, which in turn reduces their overall returns.
The mutual fund manager gets paid before the investors and receives a
paycheck whether they create a return or not. If they are managing a $100
million mutual fund, they could be making $1 million a year if their pay is
just 1% of the fund. If their administrative fee is 2% of assets under
management, then they would have to beat the S&P 500 by 2% just to be
even. One of the main reasons that mutual fund managers can’t beat their
index is that they have to beat the index by the amount of their administrative
fees so they start in the hole.
Another reason that mutual fund managers have difficulty beating their
benchmark index is that an index is a mechanical system. The S&P 500 is
weighted by market cap, and stocks enter and leave their index based on their
size. Companies that do well and grow in market capitalization enter the S&P
500 and the companies that drop in size fall out of the index. The biggest and
most successful companies in the world that are in a price uptrend get the
most weighting in the S&P 500, while less successful companies that have
prices in downtrends have less influence.
The S&P 500 index system is designed to let winners run and drop losers out
of its holdings. This is a trend following system due to the way it’s built. The
S&P 500 index also has a survivor bias built in. The companies that are going
bankrupt leave the index early because their price drops out of the market cap
threshold and emerging companies enter the index when they grow to a
certain market cap size.
The S&P 500 index is managed based on a system and that gives you an edge
over mutual fund managers that could make emotional, opinionated, and ego
based decisions that are less than ideal. The committee that selects the
components are largely free from the pressure of quarterly returns and
performance so they can choose the S&P 500 in a more academic rule-based
way than mutual fund managers can choose their fund’s holdings. Indexes are
adaptive and designed to reflect the American economy. They are also
diversified across different sectors.
“When considering the eligibility of a new addition to the S&P 500 index, the
committee assesses the company’s merit using eight primary criteria: market
capitalization, liquidity, domicile, public float, sector classification, financial
viability, length of time publicly traded and listing exchange.
The committee selects the companies in the S&P 500 so they are
representative of the industries in the United States economy. In order to be
added to the index, a company must satisfy these liquidity-based size
requirements.”
Market capitalization is greater than or equal to US$5.3 billion.
Annual dollar value traded to float-adjusted market capitalization is greater
than 1.0.
Minimum monthly trading volume of 250,000 shares in each of the six months
leading up to the evaluation date.
– Wikipedia
Indexes are dynamic and evolve with the economy and advancing technology.
They don’t rely on the skill of a money manager, instead they follow the
largest current trends. Let’s take a look at the long term evolution of an index.
Since the S&P 500 has so many components, let’s look at the more
manageable Dow Jones Industrial Index.
Here are the original 12 Dow Jones Industrial Components of 1896:
American Cotton Oil
American Sugar
American Tobacco
Chicago Gas
Distilling & Cattle Feeding
General Electric
Laclede Gas
National Lead
North American
Tennessee Coal Iron and RR
U.S. Leather
United States Rubber
At the turn of the 20th century the United States was a primarily agrarian
economy, as is reflected in the index. Electricity was at the beginning of its
growth stage. Commodities were growing industries to keep up with the
industrial revolution and the growing American economy. This index
reflected the era and would have had investors in some of the healthiest
companies of that time.
But things change, and that’s why indexes change.
Dow Jones had to more than double its components to get a better
representation of the American economy. The S&P 500 has enough stocks so
it has plenty of components to get investors a piece of all sectors and
industries.
Here is a list of the current 30 Dow Jones Industrial Average Components in
2016:
Apple
American Express Company
The Boeing Company
Caterpillar Inc.
Cisco Systems, Inc.
Chevron Corporation
E. I. du Pont de Nemours and Company
The Walt Disney Company
General Electric Company
The Goldman Sachs Group, Inc.
The Home Depot, Inc.
International Business Machines Corporation
Intel Corporation
Johnson & Johnson
JPMorgan Chase & Co.
The Coca-Cola Company
McDonald’s Corp.
3M Company
Merck & Co. Inc.
Microsoft Corporation
NIKE, Inc.
Pfizer Inc.
The Procter & Gamble Company
The Travelers Companies, Inc.
UnitedHealth Group Incorporated
United Technologies Corporation
Visa Inc.
Verizon Communications Inc.
Wal-Mart Stores Inc.
Exxon Mobil Corporation
We see the 20th century technologies and industries represented in this index.
Credit cards, airplanes, industrial equipment, computers, software, chemical
companies, entertainment, retail, financial services, medical, fast food,
apparel, oil, and even General Electric from 1896.
The DJIA evolved with the times. Companies left as they were no longer
leaders in the economy and new leaders emerged to enter the Average. An
index will do the work for passive investors. Indexes are systematic and rule
based in their selection of components. They pick the strongest leading
stocks, they diversify across all industries, they let winners run and cut losers
short, and their holdings are liquid.
The simplest way to buy into an index is to purchase an index tracking
ETF:
SPY is the ticker for the S&P 500 exchange traded fund.
DIA is the ticker for the DJIA exchange traded fund.
QQQ is the ticker for the NASDAQ 100 exchange traded fund.
IWM is the ticker for the Russell 2000 exchange traded fund.
These ETFs can be bought and sold just like stocks intra-day and in the after
hour’s market. They provide liquidity and easy entries and exits with your
investments. These are available in most Individual retirement accounts.
401Ks will likely only offer index mutual funds. They are great choices that
provide the same benefits as index ETFs.
Mutual funds only give quotes at the end of the day and only trade at the end
of the day, so there is a disadvantage. However, investors should be using
entries and exits at the end of the day so this should work with few issues.
Look for the word ‘index’ in your mutual fund options inside your 401K, and
look into the prospectus to see which index the mutual fund tracks, along with
the management and expense of the fund.
Mutual fund products to avoid:
Never purchase a mutual fund with a load charge. There are front-end load
mutual funds and back-end load mutual funds. This means if the mutual fund
pays the broker that sold you the fund a 5% commission and you put $10,000
into the fund on a front-load fund, $500 goes to the broker, $9,500 goes into
the fund, and you start with a 5% loss.
If it’s a back-end load fund you pay the load fee when you withdraw the
funds. Also be aware of any redemption fees that you will be charged when
you withdraw your funds. In the age of no-load mutual funds, ETFs, IRAs
and 401Ks, there is no reason to ever buy a mutual fund that charges you for
your purchase. Find low management fee no-load mutual funds.
Investing Habit #7
Stop investing in managed mutual funds and start investing in index mutual
funds or index exchange traded Funds.
Contribute into an index fund in your IRA, 401K, or 403B.
If you want to buy-and-hold, then buy-and-hold and index.
Use index ETFs for easy entries and exits when needed, even intra-day.
Never buy a mutual fund with a load fee.
Stop subsidizing mutual fund manager’s lifestyles with managed funds and
focus on investing in your own lifestyle.
Don’t Buy-and-Hold Through Bear Markets and
Crashes
“There are only two things you can really do when a new bear market
begins: sell and get out or go short. When you get out, you should stay out
until the bear market is over. […] Selling short can be profitable, but it’s a
very difficult and highly specialized skill that should only be attempted during
bear markets. But be forewarned: Few people make money shorting.”
- William J. O’Neil
The buy-and-hold investing strategy is a bet on the stock market going up
over the long term. During the 20th century, the stock market returned an
average of about 10% a year, so there were plenty of reasons to party when it
was 1999. Buy-and-hold was considered the Holy Grail and all pullbacks
were just buying opportunities. This was even more pronounced in the 1990’s
because that decade returned about 18% a year on average, and the 1980’s
returned over 17% a year on average.
Buy-and-hold investing looks great in hindsight. Long term, the stock market
always bounces back and all stock market sins are forgiven if you hold a
diversified basket of growth stocks, value stocks, income producing, and
international stocks. The idea is that you buy them at any time and hold them
until you retire. Is it really that easy? The problem is timing and investor
emotions.
Buy-and-hold is a trend following trading system for stocks. Your entry signal
is anytime and all the time. Your exit signal is when you approach retirement
and start to diversify into bonds, or pull out your money from stocks for living
expenses. This is a system that buys and sells based on the premise that stocks
will always go up over long periods of time because of the growth in the
market based on new companies that create new technology, and continued
population expansion.
The sample price data is not looked at closely enough, and relies too much on
the latest secular bull cycle from 1982 to 1999, ignoring the time periods that
would have been a waste of time and a large risk. One quick example is the
first decade of the 21st century from 2000-2009.
The Dow Jones Industrial Average closed at 11,497 points on December 31st,
1999 and it closed at 10,428 points on December 31st, 2009. For a decade,
buy-and-hold investors rode quite a roller coaster for no returns. You don’t
have to pay a mutual fund manager or financial advisor to not get a return,
you can do that in a savings account with virtually no risk. When I avoided
the 2008 meltdown, I had a great decade of returns by holding on to my 2003-
2007 gains from the bull market years.
Buy-and-hold investing is not the Holy Grail, and it doesn’t always work in a
timely manner. The 1905 Dow Jones Industrial Average close of 96 points
was not permanently eclipsed until 28 years later in 1933. The DJIA spent 15
years trying to break over 100 points permanently before the roaring twenties
finally saw an amazing run up of 500%. It reached 381 points from 1921 -
1929 before a crash back to 41 points in 1932. Yes, that’s a crash from 381 to
41 points in the DJIA.
Buy-and-hold advice would have been just to hold on, it will work out in the
long run, and stocks always go back up. That would have been a ride that few
professional money managers could withstand, much less the average
investor. The problem with buy-and-hold is that we have a limited amount of
time to make our returns. When we are fortunate enough to participate in a
bull market, we have to have a process for locking in those gains in the short
term and wait for the next bull run.
Another example is that the 1965 Dow Jones Industrial Average close of 969
that was not permanently broken until 17 years later in 1982. The DJIA spent
17 years fighting to break over the 1,000-point resistance level.
Another element for consideration is the destruction of buying power of your
money while you’re waiting a decade or two to get your investments back to
even. As the government continues to print dollars, it creates inflation because
more dollars keep chasing the same amount of goods. Currencies lose their
buying power over the long term when the amount circulating continuously
increases.
The inflation-adjusted high set on December 31, 1965 would not be surpassed
for nearly 30 years, until the Dow’s first close above 4,700 on July 7, 1995.
The 2003–2007 bull market was a cyclical bull closing peak of 14,164.53 and
didn’t surpass the inflation-adjusted high set on December 31, 1999.
The stock market does tend to go up over the long term. It does eventually
break above previous all-time highs. This is driven by the new, innovative
companies whose growth of sales and earnings trend long term with the
world’s economies. The majority of the profits in the stock market are made
by the market leaders during bull markets because capital is flowing into
equities and pushing up prices.
The stock market doesn’t always go up in the short term. There are
corrections of 10%, there are bear markets where prices pull back 20%, and
there are also crashes of 50% or more during financial panics. These
downtrends happen in both individual stocks and in stock indexes.
The biggest challenge for investors is the psychological and emotional stress
that comes with trading real money in real-time. It’s difficult for a buy-and-
hold investor to say they are investing for the long term, and then see their
money evaporate. On paper a 10% correction sounds like a pretty small thing.
But when a 40-year-old investor gets his 401k retirement statement from his
administrator and his $250,000 account is $225,000, that’s real money and it
hurts. One losing month he can probably handle, but when the next month’s
statement balance is $200,000, the market is in bear territory with a 20%
downtrend.
This is how bad decisions happen. $50,000 is just too much to lose in two
months, so our investor moves his stock investments to cash the next
morning. Finally, the pain and fear of loss is gone, what a relief. But in reality,
that was the full downside move and short term, 20% bear market bottom is in
and the market rallies back. The next month the market has rallied 10%, but
our investor missed it because he is still in cash, figuring it’s is a fake move
and will wait to get in when it pulls back to where he got out. The following
month, the market is back to even and he missed the move. Frustrated, he
jumps back in right at the short term resistance and loses money on the next
retracement in a range bound year.
Most investors lose money when they start making decisions based on how
they are feeling and not investing in a systematic way. Exiting your
investments when you’re afraid and entering them again when you’re greedy
is the quickest way to lose money. The easiest way to make money is to hold
stocks in bull market uptrends. The easiest way to lose money is to hold
stocks through bear markets. While the stock market as a whole does tend to
bounce back in the long term, the same is not true for individual stocks.
Stocks can go to zero. Companies can go bankrupt and be delisted.
To avoid corrections, bear markets, and crashes, we need a price filter that
gets us out before the market is down 10%, 20%, or 50%. Getting out after
these things have happened is what causes under performance against the
stock market averages. Another common problem is when investors get out
near or at market top, or at the beginning of a downtrend, they don’t know
when to get back in and miss the next uptrend entirely. We need a simple
signal that gets us out early enough to avoid big losses and gets us back in fast
enough to capture the next big gains. The answer to this is to use the 200-day
simple moving average of price.
Chart courtesy of StockCharts.com
The blue line on the chart is the 200-day simple moving average. The clearest
signal that an index is going to correct is when price loses this line. It will
start to go under and over this line a few times before the downtrend begins.
You will have a few false entries and exits before you will be glad you’re out.
The whipsaws in price and reversals you will experience will be offset by the
money you save by being out at the right time.
When do you get back in?

Chart courtesy of StockCharts.com

As in this example, when price moves back over the 200-day simple moving
average, you can re-enter not based on an opinion, but based on the fact that
price began to move back in an uptrend. You enter based off the price being
over the 200-day moving average on the daily chart and enter the same day at
the close. While this price filter doesn’t substantially increase your returns, it
does decrease the emotional, financial, and mental pain of drawdowns in your
retirement account.
You can watch from the sidelines during bear markets and know when you
will get back in. Your losses will be small if the moving average doesn’t hold
and you have to get back out. Your wins will be big if price does hold above
the 200-day and a new uptrend begins. This can be used as an exit filter for all
of your stock holdings.
It looks a little different during the decade of 2000-2009 with an exit and
entry strategy:
For $SPY, using the 200-day SMA as an end of day sell/buy indicator from
January 2000 to December 2009, the 200-day SMA returns were 20.3% with
a 27.3% drawdown. The $SPY buy-and-hold returned a negative -8.7 return
with a 55.2% drawdown for the decade. The 200-day cut your drawdown in
half and leads to a small return. For a $200,000 account an almost 30%
additional drawdown equals $60,000 less in drawdowns.
For $SPY using the 200-day SMA as an end of day sell/buy indicator from
January 2000 to March 2009, the 200-day SMA returns were -1.7% with a
27.3% drawdown. The $SPY buy-and-hold returned a negative -35.9% return
with a 55.2% drawdown for the decade. The 200-day cut your drawdown in
half and leads to a flat return after 9 years instead of being down a whopping
-35.9% loss, even at the market bottom in March of 2009.
From January 2000 to October 2015 The S&P 500 tracking ETF SPY using
buy-and-hold returned 91% with a 55.2% drawdown.
Here is what happened when we introduced some simple moving average and
exited the investment during downtrends in price. These were long only
systems so we never sold short.
For $SPY using the 200-day SMA as an end of day sell/buy indicator from
January 2000 to October 2015, the 200-day SMA total SPY returns were
96.1% with a 27.3% drawdown. We cut the drawdown in half versus buy-and-
hold by introducing one long term moving average.
For $SPY using the 250 day SMA as an end of day sell/buy indicator from
January 2000 to October 2015, the 250 day SMA total returns were 120.5%
with a 23.1% drawdown. We cut the drawdown in half versus buy-and-hold
and also increased the return. This was a longer moving average than even the
200-day, avoiding exiting too quickly and helped us avoid some of the
premature false exits.
Investing Habit #8
Have an exit strategy for your investments before you enter. Don’t hold your
investments when the reason you got in is no longer valid. If the storyline
changes, so should your investment holdings. The simplest way to exit is to
sell if your investment’s price drops below its 200-day simple moving average
of price.
Always have a valid reason to get into an investment and a valid reason to get
out.
Have an exit strategy to take your profits off the table while they are still
there.
Even if you don’t use the 200-day moving average, find a process with the
same principles that works for you.
It will save you a lot of financial pain to get out of the stock market before a
correction, downtrend, or bear market and not after it has happened.
Even when you avoid a downtrend you don’t add any value to your long term
returns if you don’t have a process for getting back in at the beginning of the
next uptrend.
Investor’s Cash Flow

Dividend payments are how a company pays investors part of their earnings.
How important were dividend returns for investors in the stock market over
the long term? From 1930-2012, dividends have been about 42% of the stock
market’s returns, or about 3.9% of the annual return on stocks each year.
Almost half of the gains in stocks as an asset class have come from investors
getting paid dividends for owning stocks. This is how companies return some
corporate earnings to their shareholders. Companies only pay dividends when
they are through the majority of their growth stage.
An income investor can be paid by owning a stock that pays a dividend or by
owning a bond that pays interest. A stock investor can make money when
they sell an appreciated asset to earn capital gains, or by owning a stock or a
bond that pays a quarterly dividend. In stocks, this is called income investing.
If you see the word income on a mutual fund in your income, the fund is
trying to hold companies that pay a dividend.
Bonds pay interest at set times per year. The lower the risk to your capital
while holding the bond, the lower the interest rate. Likewise, the higher the
risk to your capital, the higher the interest rate you will be paid to hold the
bond. High yield bonds come from higher risk companies, and the safest
bonds come from the biggest governments. An extremely high interest rate
over 15% starts showing danger signs of possible default or bankruptcy. An
extremely low rate of return like 2% shows there is almost no risk.
When investing for income, your #1 priority has to be the safety of your
capital and not the pursuit of the highest possible yield on your money. It’s
also crucial to sell bonds or stocks that are being held for income if their
prices fall below the 200-day simple moving average of its price. This is a
danger sign that something could go sideways. You shouldn’t enter any
dividend stock or bond unless its price is trading over the 200-day simple
moving average. There must be an exit strategy to keep your capital safe and
avoid any defaults or bankruptcy on your income investments.
A company can do four things with its profits:
Reinvest in the company through capital expenditures. New stores, new
headquarters, upgrade computer systems and technology, and employee profit
sharing programs.
Acquire other companies. Buy smaller companies to integrate with their own
and share standard practices to expand their business size and operating
area.
Repurchase shares. They can buy back the shares of the company and reduce
the share float available on the open market. This increases shareholder value
by reducing supply of shares and creating demand.
Pay dividends. This is when a share of company profits is paid to investors
who are holding shares of the stock on its ‘must own’ date. The company
usually says when it announces a dividend that it will be “Payable to
shareholders of record as of” and the dividend will only be paid to people
that are already holding the stock on that date.
Dividends are paid once a quarter, or four times a year. If a $100 stock has a
4% yield and pays a $4 annual dividend, then investors will receive $1 in their
account every quarter. Some income and dividend ETFs will pay a dividend
each month as an average of the dividends that the ETFs components earn and
the ETF is collecting. After a dividend is paid, the stock will usually drop in
price by the amount of the dividend gain is taken out of the price. If you’re
short the stock when it pays a dividend, then you must pay the dividend. You
will not receive a dividend on a stock unless you buy it at least three days
before the “must own” date because it takes three days for stock purchases to
clear. There is no way to game the system.
Income investing can be a part of your investing portfolio, but the risk to your
capital has to be worth the interest or dividends you’re receiving. You want
your dividend paying stocks to have a record of consistent and growing
dividend payouts. Decreasing dividends are a sign of trouble and you should
exit any stock that decreases or suspends its dividend payment.
Bonds should be invested in with bond ETFs or bond mutual funds to
diversify your risk of having bonds in only one company or one sector.
Diversification in this area of investing helps you avoid the danger of one of
your investments being on the wrong side of a national default or a company
bankruptcy.
Investing Habit #9
Invest in strong companies that have a history of paying consistent and
growing dividends. This is called income investing and can add to your
overall annual returns. Hold some stocks or exchange traded funds that will
pay dividends for holding them. Diversify any bonds you hold by using bond
ETFs or bond mutual funds.
Only buy dividend stocks if the company has consistently paid and raised
dividends over years.
Diversify your bond holdings with ETFs or mutual funds.
The yield you receive has to be worth the risk you take.
The higher the dividend or bond interest, the higher the risk to your invested
capital.
Dollar Cost Averaging
“Don’t Buy All at Once. To maximize your profits, stage your buys, work your
orders and try to get the best price over time.”
– Jim Cramer
Dollar cost averaging is staggering buys in a long term investment so your
short term timing is not as important as being correct in the long run. In dollar
cost averaging, you can be wrong about your timing and still be right in the
long term and make money (this applies to investing where you’re buying a
long term holding for a fundamental reason. This doesn’t apply to trading
because traders are buying a short term holding for a technical reason. Traders
should never add to a losing position after being proven wrong from a
technical reason).
Investors should not dollar cost average in an investment once they are
proven fundamentally wrong. If Netflix is taking market share from
Blockbuster and you see Blockbuster’s earnings and sales dropping quarter
after quarter, you don’t keep dollar cost averaging down in Blockbuster- you
get out!
You also don’t keep dollar cost averaging into an asset in a downtrend making
lower lows and lower highs over weeks and months. Dollar cost averaging is
best used with index funds inside retirement accounts with a long term
holding strategy. If you’re just starting out, then the fluctuations of market
corrections and bear markets will likely have little effect on your long term
investment results.
It’s not a big deal to ride the market waves in the early years of dollar cost
averaging when your account is small. Even years later when you have built
up a large account and you have moved the bulk of your account into cash as
the 200-day simple moving average is lost, you could start dollar cost
averaging with weekly contributions after a 20% correction in the stock
market. The best scenario would be an automatic contribution into and S&P
500 index fund inside your retirement account where you also get a company
match.
You should dollar cost average into stocks during an uptrend when indexes
are trading over the 200-day simple moving average, and you should dollar
cost average into stocks that are trading within 15% of all-time highs if they
are also above their 200-day simple moving average.
You should not dollar cost average into the stock market until after a 20%
correction. Dollar cost averaging at the beginning of a downtrend takes a long
time to get back to even. After a market has corrected 20% and held its low
price for a week, then it could be time to start dollar cost averaging back in.
However, if the new low price after the correction has been lost, it’s time to
take your new contributions that were being dollar cost averaged in, and wait
for a new bottom to take shape or for prices to overtake the 200-day simple
moving average. Dollar cost averaging in during an uptrend or after a market
correction can be profitable and psychologically comfortable. Dollar cost
averaging into a downtrend could take years to get back to even and be very
stressful.
Dollar cost averaging into an investment is a great way to spread out the risk
of capital on your initial entry price levels. If you’re putting $10,000 into the
stock market and you put in $500 each week for 20 weeks, then your cost
basis will be the average of your weekly entries over a 20-week period. You
won’t be trying to pick the exact place to enter, instead you will be averaging
out your money and your time frame, trying to be right more about the long
term exit than the short term entry.
You increase your chance for profitability when the price increases over your
average entry price rather than your first entry price because it lowers the
need to be exactly right about your entry and gives you more flexibility on the
exit.
Some investors set up their retirement accounts on a ‘set it and forget it’
system where they plan to allocate the new money that goes into their account
straight into the stock market over the next 10 years. Their plan is never to
touch it. I don’t support this plan. I don’t believe in dollar cost averaging into
a downtrend. I do believe that dollar cost averaging back in after a bear
market can provide a great risk/reward ratio, and you can build a position
before the next bull market uptrend by spreading out your risk.
Dollar cost averaging is one way to spread out your risk on entries and build a
position over time instead of making one big entry. Many investors will find it
less stressful than making one big move. This can also help with entries back
at the beginning of potential bull markets. On the first day of a break over the
200-day simple moving average, you may put a percentage of your money
back into the market and then add to it each day that the market stays above
the 200-day simple moving average.
The day that the market price closes over the 200-day simple moving average,
you may move 20% of your investment capital into the market and then add
an additional 20% each day if price remains over the 200-day simple moving
average. If price stays over the 200-day simple moving average for five
straight days, you will be fully invested after the fifth day. If it doesn’t hold
and the trend resumes back to the downside, you will lose less money as you
go back to cash. This is one way to spread out your risk of whipsaw reversals.
Investing Habit #10
When building a position in an investment, you can manage your risk by
spreading out your purchases over a long period of time. If you use a set
amount of money for purchases, you will buy less shares when it’s expensive
and more shares when the price is lower, and you will average out your cost
over the long term. You will spread out your risk by being able to buy
multiple times.
Dollar cost average into stock market positions during an uptrend and not a
downtrend.
Dollar cost average into stock market positions after a bear market
correction and not during a bear market correction. Wait for price support to
develop for a week before taking action.
It’s safer to move your money back into being fully invested in the stock
market in stages than all at one time.
Dollar cost averaging makes your entries less important and gives you more
time to be profitable.
Dollar cost averaging makes investing more psychologically comfortable by
taking some pressure off the importance of entries and exits.
Appendix: Investing Habits Summary
You can build a diversified investment portfolio by investing in the following
investment vehicles:
- A strong growth stock in a company that’s changing the world.
-Your company stock if it’s growing in sales and earnings.
-Stock index ETFs like SPY, DIA, IWM, and QQQ for diversification across
big caps, small caps, and tech.
-Diversified income funds for dividends.
-Diversified bonds through bond ETFs or bond mutual funds.
-You should only enter into investments that are in an uptrend and whose
price is over the 200-day simple moving average.
-You should exit any investments if its price drops under the 200-day simple
moving average or the reason you invested in it is no longer valid.
Investing Habit #1
Take action! When you know what you need to do, do it today. The most
important part of investing is to start. After you get started, you can develop
the habits of consistent action that will build your capital and net worth.
Investing Habit #2
Create and follow a plan. Invest in the stock market on a consistent basis by
buying stock investments that meet your personal investing criteria, time
frame, and goals.
Investing Habit #3
If you work for a great company that’s growing earnings and sales each year,
then don’t just be an employee, be an investor. Profit from your company’s
financial success.
Investing Habit #4
Pay yourself before you pay taxes. Contribute to a tax deferred retirement
plan. You can avoid paying taxes short term and allow your money to grow
tax free, long term. This can be an IRA, 401k, 403b, or 457b plan in the
United States. Other countries have their own account types.
Investing Habit #5
You must develop a habit to leave your money alone so it can grow over time.
Compounding works best if you start young and get strong returns early. It
takes planning, but setting up an emergency fund to protect your long term
capital from being pillaged when life happens, is one of the most important
things you can do for your financial future.
Investing Habit #6
Find out what percentage of your contribution your employer will match or
partially match in your retirement account. Set up an automatic payroll
deduction for the full match amount. You may have to make adjustments in
your household budget so you can afford this new deduction.
Investing Habit #7
Stop investing in managed mutual funds and start investing in Index Mutual
Funds or Index Exchange Traded Funds.
Investing Habit #8
Have an exit strategy for your investments before you enter. Don’t hold your
investments when the reason you got in to them is no longer valid. If the
storyline changes, so should your investment holdings. The simplest exit
strategy is to sell if your investment drops below its 200-day simple moving
average of price.
Investing Habit #9
Invest in strong companies that have a history of paying consistent and
growing dividends. This is called income investing and can add to your
overall annual returns. Hold some stocks or exchange traded funds that will
pay you for holding them. Diversify any bonds you hold by using bond ETFs
or bond mutual funds.
Investing Habit #10
When you want to build a position in an investment you can manage your risk
by spreading out your purchases over a longer period of time. If you use a set
amount of money for purchases, you will buy less shares when it’s expensive
and more shares when the price is cheaper. You will average out you cost
basis and only need to be right in the long term. You will spread out your risk
by being able to buy multiple times.
Sources:
Wikipedia
New York Times
CNN
StockPicksSystem
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