Stop Doing This and Boost Your Returns by 190%

Keith Fitz-Gerald Oct 14, 2015
22 

There’s nothing like a market swoon when it comes to unleashing the most damaging of all investor behaviors – emotional decision making.

We’ve talked a lot about how catastrophic this can be during our time together with good reason – investors who make knee-jerk decisions damn themselves to abysmal returns.

Today, we’ve going to revisit the subject because emotions are running high right now and millions of investors are at risk of doing something stupid. I don’t want you to be one of them.

What I am about to share with you may make you uncomfortable. I totally get that. In fact, I’m hesitant to bring it up because it could easily be taken out of context.

But I am going to do so anyway for one simple reason – if you understand why Wall Street doesn’t talk about what we’ve going to cover today, then you’ll be perfectly positioned to understand the implications associated with what I want you to do next – and the tactics you’ll need to succeed.

Here’s what you need to know about the tactic that may already be costing you 190% returns.

Brain-Damaged Investors Make Better Decisions

Nearly 10 years ago, I came across a study in Psychological Science that was as profound as it was politically incorrect, at least on the surface, anyway.

The implications are pretty striking so you’d think Wall Street would have been all over it but, sadly, they’re not and won’t ever be. In fact, the only time I’ve ever seen it mentioned in the years since was by another fiercely independent financial analyst like myself, Ric Edelman, CEO of Edelman Financial.

Here’s what it says.

Researchers at three major universities – Stanford, Carnegie Mellon and the University of Iowa – published findings showing that brain-damaged individuals made better investment decisions than the rest of us.

To be precise, what they studied was the impact of injuries that prevented the brains of the injured from processing emotional stimuli and, by implication, responses to those specific inputs.

Researchers found that when they compared the findings to folks with no brain damage, the “injured” individuals made significantly better investment decisions.

That’s because the human brain is wired to evaluate economic and investing information using connections and pathways that are closely linked to emotional inputs. You’d think this kind of decision-making would involve logical brain pathways, but that’s not true.

This is why making decisions with your money can be very challenging, especially when the markets are uncertain and the investing landscape emotionally charged like it is right now. Because you are taking what should be a logical decision and using emotional receptors to make it.

It’s also why Wall Street wants you to believe money is complicated and why their ads are so slick. Unlike the average individual investor, the Big Boys have spent billions understanding what makes your mind work and how specific inputs prompt specific actions on your part – chief among which is commission-generating buying and selling activity that’s worth $18 billion or more a year to the top 25 firms.

They know that if you’re happy, then you’re generally going to be a buyer, and that if you’re sad or fearful, you’ll be a seller. And usually at precisely the wrong time, I might add.

The result is tremendous underperformance that gets dramatically worse over time.

Case in point, the latest DALBAR data shows that equity fund investors averaged only 5.50% in 2014 versus the S&P 500 which turned in 13.69% over the same time frame – an 8.19% difference.

That may not sound like much, so let me put that in perspective.

Taken over 10 years, that difference means $10,000 socked away by the average investor would turn into $17,081.44, or a gain of 70.08%. But a $10,000 investment that matched the S&P 500’s return would amount to $36,076.35 in the same 10 years – a return of just over 260%. The difference is 190%, or nearly triple your money.

I don’t know anybody – rich or poor – who can afford to throw that kind of potential away.

Again, this is an uncomfortable subject for a lot of investors.

Many of my own subscribers, in fact, thought I’d lost my marbles when I told them in 2007 to batten down the hatches at a time when they wanted to chase performance. On the way down, those who followed along with my recommendations had the opportunity to enjoy returns like the 101.68% we captured in iShares MSCI Brazil Capped (NYSEArca:EWZ) and 83.33% from iShares China Large-Cap (NYSEArca:FXI) respectively.

The same thing happened in March 2009 when I told them that it was time to buy. On the way up, those same subscribers had the opportunity to capture a slew of double- and triple-digit winners like CNH Industrial NV (NYSE:CNHI), Navios Maritime Holdings Inc. (NYSE:NM), and ABB Ltd. (NYSE:ABB) which we closed out at 104.43%, 104.05%, and 103.12% in three trades, respectively.

So how do you do the same thing, especially now when the markets are acting up again?

Three Ways to Remove Emotion from the Equation

Success comes down to removing emotion from the equation… actually, in much the same way injuries removed the emotional processing from individuals in the research I just told you about.

First, use a “risk-parity” portfolio model like the 50-40-10. Wall Street will try to convince you that diversification is the way to go, because not all assets go down at once if things blow up. But there’s a flaw in that model. Spreading your money out to get the lowest mean gains is not a recipe for wealth – in fact, it leaves you at the mercy of unseen risks. Ask anybody who got “halved” twice in the last decade how diversification worked out! Long story short, it didn’t. The best professional investors of our time DO NOT blindly distribute their money across a slew of asset classes, and you should not do it either.

The better way to go is a “risk-parity” model, like the 50-40-10 portfolio I advocate in the Money Map Report. (I’ll show you exactly how this in an upcoming column.) By concentrating assets and periodically rebalancing between core assets, growth/income, and speculative positions, you are effectively “forcing” yourself to buy low and sell high using proven logic – not emotion. Plus, this keeps performance-robbing fees low, which Wall Street hates but you’ll love because it can add a lot to your returns over time.

Second, capitalize on chaos. If you’re like me, you grew up with “buy low, sell high” being pounded into your head. It’s absolutely true – but emotion makes it hard to apply. Knowing that everybody else is panicking should be an open invitation to put new capital to work when prices are low. The key is buying companies that have solid business models and long-term growth potential at a time when they’ve been temporarily put on sale by short-term events.

Third, use simple trailing stops to protect your capital and control risk. The goal here is, again, to remove emotion from the equation. Having a trailing stop percent that’s pre-selected the moment you buy helps you do just that. I typically recommend setting a 25% trailing stop on most investments. As an added benefit, trailing stops help you maintain a calm, reasoned perspective at times when everybody else is seemingly losing their minds (and making tremendously costly decisions that are not in their best interest).

Most online platforms have stops built in. So there’s no excuse for not using them.

To be fair, the common complaint I get on trailing stops is that they force you to sell when you may not want to. I hear ya, which is why I’d like to point out that you can use options or inverse funds to accomplish the same thing.

For now, just remember, the more “sophisticated” you get, the higher the risk of emotional decision-making. And that’s not the goal.

Simplicity, security, and the tactics needed to harvest big profits – that’s the goal.

Best regards for great investing,

Keith

22 Responses to Stop Doing This and Boost Your Returns by 190%

  1. Robert Johnson says:

    Keith,
    Your 50-40-10 stock allocation is the basis of your Money Map Report advisory service. However, you also constantly remind us that we should never put more than 2% of investable assets into any one position. How do you reconcile that given you only have about 5 stocks recommended under core assets where you want 50% of our investments. Does this imply that we should be 80% in cash?

    Thanks for your work. I enjoy it very much.

    Rob

    • Keith says:

      Hello Rob.

      That’s an excellent question. The 2% Rule is best applied to trading capital so that would be the 10% categorized as Rocket Riders in the 50-40-10. It’s for discretionary capital rather than core holdings that do not change much.

      Best regards and thanks for being member of the Total Wealth Family, Keith πŸ™‚

  2. Enrique says:

    Excellent cautionary note…for all of us with our eye on the markets.

    Thanks Keith!

    • Keith says:

      You bet Enrique.

      These days one can never be too careful.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  3. JP MAGUIRE Jr says:

    WHAT ABOUT REIT’S AND MLP’S ARE THERE ANY THAT ARE RIPE FOR THE PICKING???

    • Keith says:

      Hello JP.

      You bet there are. The trick is to concentrate on REITs that are driven by businesses other than real estate and which have clients with consistent contract based revenue or otherwise solid funding that guarantees the rent roll. MLP’s are one of my favorites at the moment because they remain largely isolated from the price of oil and gas yet still produce solid cash flow. I’ll have ideas for both in upcoming columns.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  4. Jean says:

    I can’t afford to be emotional. I
    I sold a bunch of non producing stocks and put it all into Apple stock. I’m loosing money in one of those Index Funds and think I need to dump that too and load up on more Apple Your thoughts, please????
    Thanks for your thoughtful newsletters.

    • Keith says:

      Hello Jean.

      Thanks for asking. That’s an important question and you’re not alone in wondering. I’ve tackled this in the Weekender so that all members of the Total Wealth Family can benefit.

      Best regards and thanks for asking, Keith πŸ™‚

  5. dean says:

    excellent and very logical

  6. Cathy Michalak says:

    Hi Keith, I’ve been following your column for a long time. My portfolio includes stocks, gold, Mutual Funds. It’s not very large, you see, I am example of a TBI who invests. Plus, my account has been robbed by those who have “helped” me πŸ™
    I enjoy following your column!!

    Thank you,
    Cathy

    • Keith says:

      Hello Cathy and thanks for the kind words but also for sharing. I am glad you’re here.

      Investing is a funny thing…rich or poor, large portfolio or small, the same principles apply. More importantly, so does the concept of success. I will do my very best to make sure the trust you place in me is well founded.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  7. Ruta Ruth Rootenberg says:

    Hi Keith, Thanks for your great encouragement and support.
    I may have missed one of your instructions: Do you mean that when we take our gains
    from certain funds that it;s the time to sell them? I am referring to DRI, FCAU and FPX.
    I have not sold them and do not know what was actually meant by your comment about
    these stocks.
    Wishing you enjoyable travels!

    • Keith says:

      Hello Ruth.

      You are very welcome!

      As for the instructions, you are correct. When it’s time to go, it’s time to sell. Usually, there are a corresponding set of “Actions to Take” in the paid services so that’s where you’ll find the precise language you need. Please call customer service if you any questions whatsoever.

      In the meantime, I’ll work on being more clear when I’m writing more conversationally.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  8. Charles Mazza says:

    Great article, please keep them coming!

    • Keith says:

      Thanks Charles.

      I will do my best. There’s certainly no lack of material to address at the moment.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  9. Henning says:

    Great article, and yes agrre that emotion is a tradekiller. Enjoy your writing even though I am only into currency and commodities. But the same trading phsycology is valid also here.

  10. Keith says:

    Hi Keith,

    I have two questions.

    Not panic selling is so important, but that begs the following question – when people were actually panicking in 2008 – when the markets last took a major dive.
    1. What was your annual performance of the 50-40-10 model in 2008 when the S&P dropped 37%?

    The second is more personal and takes a little more background to ask. I’ve recently changed tactics and invested using your 50-40-10 model rather than wide diversification in index funds across all markets using a 60% stock/40% bond split I’ve been doing since 1999. I am using money in a non-taxable account – my traditional IRA . Since I am using non-taxable funds , there are no tax implications until I actually start withdrawing the money after I am 59.5 and then it’s taxed as ordinary income. So here comes my question.

    Would you change any of the base building – that 50%. My specific question in regards to the Nuveen (NQX) and US Global Investors Near Tax Free Fund (NEARX) which I believe are tax free. Why invest in tax free funds when the account is already tax free? Are there other funds you would put in the 50% rather than these two that don’t have the tax implications being that my money is already in a tax free vehicle – a traditional IRA?

    Thanks for all your advice and feel free to chop off the second question if you like (to hopefully answer personally).

    Sincerely,

    Keith (great name!)

  11. Houyhnhnm says:

    Keith,

    In light of flash crashes, what do you think of using stop limit orders to limit downside risk instead of stop orders, especially on ETFs, which can apparently be mispriced with impunity any time volatility is unusually high?

    Thanks,
    Houyhnhnm

  12. Don Klinger says:

    On trading stops I’m using 15% as opposed to your 25%. Please give more information to use to change to the higher figure.

  13. Peter says:

    Frankly, it’s quite difficult those days to disregard the emotional side to reorganize our stock allocations, and when biotech stocks are in our portfolio is even worse to make logical decitions…

  14. Mike says:

    I read, in a report , that there are tens of thousands of people retiring everyday. The baby boomers are getting old, (me one of them) :(. Now, they are tapping into their pension funds and retirement accounts. These huge stock market players are selling shares to come up with money to pay these people, who have been investing in them for decades. Is 2016 a year in which an exorbitant amount of people got to retire? Are these pension funds pulling the market down? How can we profit from this? Just a thought

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