Fate of the "Average" Investor
Van K. Tharp, Ph.D.
Joe Smith retired in 2003. He had done well during his working years and had a retirement income of $6,500 per month, including his social security. He had saved about $623,000 as a nest egg for emergencies in his retirement. He still owed about $350,000 on his house. Joe and his wife debated a lot about whether or not they should pay off the mortgage with their cash. The house payment was nearly $2,000 per month and if they paid it off, they’d have plenty of money to spend each month and little to worry about.
Joe had lost about 30% of his retirement nest egg during the market crash from 2000 to 2003. However, in 2003 the market was going up. Joe figured the
worst was over, and he could probably make 10% per year on his money. That would give them an additional $5,000 per month for spending, which more than covered his mortgage payment. Joe had an advanced degree in civil engineering and as far as he was concerned, investing wasn’t rocket science. He’d do well in the market because he was a smart guy. Chances are, he thought, he could be better than average and get his account back up to a million dollars
(like it was before the 2000 crash).
Joe made the mistake that many people make. He’d spent nearly eight years learning his profession and much of his life staying on top of it. He thought he was smart enough to
out perform the market professionals and make 10% or more each year as an investor in retirement. After all, it just amounted to picking the right stocks and he could do that.
Joe was now 68 years old. His total education in the market consisted of reading three or four books on how to pick the right stocks plus a book about Warren Buffett, written by someone other than Warren Buffett. He also watched the financial news regularly, so he was sure he could make his fortune. And he read several financial newspapers each day, so he felt informed.
For a while, Joe was right. He made about $120,000 with his investment from 2003 through 2005, and they
spent about half of that. Thus, Joe’s account at the beginning of 2008 was worth about $683,000. However, Joe was not ready for the second leg of the secular bear market. On September 30th, the stock market was down over 20% for the year, and Joe’s account was down 29%—it was now worth about $478,000. If he paid off his house now, it would take most of his assets. And when the bailout bill passed, he watched the market fall by triple-digit declines each day. Joe was really worried as his account balance approached $400,000.
The CNBC gurus, Suzie Orman and Jim Cramer, say stocks will soon be a bargain.
"Don’t sell unless you need the money." Didn't they realize that by that standard of just invest and hold, he was down nearly 60% from his equity high in 2000? In fact, Joe now needs to make 70% on his money just to break even on the year, and he was struggling to make 10% per year.
What’s the bottom line here? Joe spent 8 years getting his education to become a good engineer. Yet, he treats the investing process like anyone can do it. It’s similar to walking into a hospital and asking to operate on someone’s brain without any training. You can’t do that in the hospital, but it’s easy to do in the market. In the hospital, it would mean someone’s life. But when you do it in the market, it means the death of your account.
What does it take to trade successfully—especially in this market? Remember, we’re in a secular bear market that could last another 10 years. The U.S. as a country is bankrupt and no one seems to realize
it because we spend money like crazy. The 700 billion to bail out the troubled debt is just a drop in the bucket. It could get much, much worse. And what happens when the baby boomers really need cash for retirement and there is a net
flow out of the stock market? There will be a giant sucking sound coming out of the
Ask yourself the following questions:
1. Do I treat my trading/investing like a business? Have
I prepared for it like a business?
2. Do I have a business plan—a working document to guide my trading business?
3. Do I make mistakes regularly where a mistake means not following my rules?
4. Am I following the ten tasks of trading to prevent mistakes?
5. Do I have a tested system? Do I know how that system will perform in different kinds of
6. We’re currently in a volatile bear market. Do I even know what to expect from my system in such a market?
7. If I don’t, am I still trading it?
8. Do I have exit points preplanned for every position I currently have in the market?
9. Have I developed specific objectives for my trading?
10. Do I understand that I achieve my objectives through position
sizingSM? Have I developed a specific position
sizingSM algorithm to meet my objectives?
11. Do I understand the importance of the first ten points?
12. Do I understand that I create my own investment results through my thinking? Do I accept responsibility for that creation?
13. Do I regularly work on myself to make sure that I follow the above 12 points?
Circle all of the responses that are true for you. If you have not circled at least ten of the thirteen, then you are not taking your trading seriously. Your financial health is in danger.
Here is what you need to do: don’t accept the notion that you are just an average investor and there is nothing you can do. You create your own results, and your results right now come from playing a game with no trading.
Do you have a business plan to guide your trading? If you don’t, then you need to develop one. And a good starting point for that is our
Business Planning CD Series. An even better start is our Blueprint for Success
Workshop. The bottom line is that you need to develop a working document to guide you as a trader/investor. I personally think that the Blueprint workshop that we give is absolutely vital information. Since the current one is sold out, I’m willing to do another one
December 6-8, if there is enough interest. Show your interest by signing
up and paying a $500
deposit. If we have at least 10 within the next ten days, I’ll
hold the workshop. Otherwise I’ll immediately refund your money or apply it to one of the Blueprint workshops being held in 2009—your choice.
(Update: We had one cancellation today so we do have one seat open for
the October workshop).
Your business plan should have a worst-case contingency plan. You need to understand everything that could go wrong and how to respond to each contingency as it happens—not when it is over.
Do you really have a trading system? What is the expectancy of the system? What kind of markets does it work in? Right now we are in a volatile bear market. Does your system work in that kind of market? Probably not! If that’s the case, why are you still trading in a market that’s not right for your system and watching your account fall?
If you do not trade for yourself and have professionals trading
for you, do you realize they must be 95% invested even in a falling market? They get paid 1-2% of the value of the assets they have under management. They get paid even if you lose money.
And what about the trades you do have? Do you have a bailout point for those trades? That is, do you know what a 1R loss is for you? Or have you already hit a 3R loss and now you are starting to ignore the market, hoping that if you don’t see it, the fall will stop. So whose fault is it that you are ignoring the market?
When the market has clearly turned, you should get out. Let’s look at the stock market and see when that
Chart 1 shows the trend of the market, and at what point the market was no longer going up. This chart shows weekly figures of the S&P 500 since 2003. The 10 and 40 week moving averages are essentially equivalent to the 200 and 50 day moving averages that most professionals use. Notice that the 10 crossed below the 40 late last year and that was a clear signal that the market had changed. That occurred at about 1484 on the S&P 500 on December 17th, 2007. Today the S&P 500 stands at about 1000—that’s close to a 30% drop.
There were other signs that occurred then as well:
• A head and shoulders top formed, although that was not obvious until about 1400 on the S&P 500.
• If you had drawn a long-term trendline (since 2003), you could have gotten out at about 1400 as well.
• There was an even stepper trendline, which started in 2006, that was broken around 1450.
• My market type analysis has been saying that the U.S. stock market was basically in a bear mode since January 2008 and that the bull market ended and switched to volatile sideways in June 2007.
That’s plenty of evidence. If you had a plan to get you out of mutual funds when any of those signals occurred, you would be in good shape. But, if you are an average investor, you probably haven’t put much time into studying the market. You just think you know what you are doing. What would happen if you tried to build something and only put that amount of study into it?
Lastly, there is a well-known saying about how to make money in the market: buy what’s going up and when it stops going up, sell it. Unfortunately, most people listen to the opinions of others and cannot see for themselves what is happening. From April 28, 2003 through January of 2008, my market classification model did not have a single week that was classified as bearish—the market was either bullish or sideways. Those were the times to be in mutual
funds as you can see from Chart 1.
Furthermore, when the bear raised its
head in January 2008, you did not want to be in mutual funds or any sort of long-term investing situation involving the stock market. Look at
Chart 1, and you can see that there were no bullish periods—none. You just have to look at the chart.
If you are a little more sophisticated, then you can buy stocks that are going up and short stocks that are going down.
Chart 2 shows one stock, MYGN, that was going up throughout much of this bearish 2008. From March through July, there was plenty of evidence that it was bucking the trend and in July and August, it was very strong.
However, short candidates have been even better. Most of the darlings of the stock market, before the disaster started to hit in July, have plummeted. They include oil stocks, mining stocks, gold stocks, and even some tech stocks like Apple. All of them were good short candidates a long time ago and most of them are not on the prohibited list of 799 that you cannot short.
And by the way, the first part of learning to be a good trader/investor is to work on yourself. I’ve told many people these things over the years, but only those people who clear away the trash in their minds (i.e., non-useful beliefs and emotions that get in the way) are even capable
of seeing what’s going up and see when to sell when it stops going up. That’s why the Peak Performance Course and our Peak Performance Workshops are so important.
So how about you? Are you going to continue to be an average investor and suffer the same fate of other average investors? Are you going to say, “No, this is not for me” and leave it up to ‘professionals’ who will keep you invested even when the market is going down because they get paid as long as you keep your money with them? Or are you going to take the steps necessary to treat the handling of your money like a business?
Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely
recognized for his best-selling book Trade Your Way to Financial
Freedom and his outstanding Peak Performance Home Study program
- a highly regarded classic that is suitable for all levels of
traders and investors. You can learn more about Van Tharp at www.iitm.com.
here for information about the tentative December Blueprint for
Trading Success Workshop.