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Biggest Debt Bomb in History

Investors Guard Yourself Against Wall Street Deception

InvestorEducation / Learning to Invest Mar 19, 2009 - 08:17 AM GMT

By: Money_Morning

InvestorEducation

Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: If you're like many investors, you are probably sitting on the sidelines right now, unsure of what to do. If you want to buy, you may be thinking “let's wait a little longer.” If you want to sell, you might be concerned about “missing out.”

Either way (and even if you don't plan on making either move anytime soon), having a sense of what got us here can keep you from repeating the same mistakes and even help you make smarter financial decisions - particularly when it comes to repairing your portfolio and even growing it in the years ahead.


When it comes to understanding exactly “what got us here,” I find it helpful to review some of the key bits of advice that Wall Street kept pitching to retail investors, a series of widely accepted investment adages that somehow became gospel and that I refer to as “Wall Street's Biggest Whoppers.”

Let's take a couple of minutes to look at the Big Five - the five worst offenders from a list that I assure you is actually quite a bit longer:

Wall Street Whopper No. 1 : Buy and Hold - It was supposed be a simple proposition. Consistently put money to work in the markets, let it ride - and laugh all the way to the bank. The thinking was that you couldn't go wrong because the markets would go up 10% to 12% a year - each and every year (It's actually more like 4% to 6% - on average - but that's another story for another time.

What's important to understand is that “Buy and Hope” is the greatest myth foisted upon the American public in the last 200 years - the need for American International Group Inc.'s ( AIG ) retention bonuses , notwithstanding. As millions of investors have found out the hard way, the markets can - and do - frequently go through tremendous periods of readjustment.

This means that timing, as they say, really is everything. And “they” - the brokerage firms, hedge funds, ratings agencies and others that together make up “Wall Street” - don't want you to know that. Wall Street wants you all the way into the game all the time. It doesn't care whether you win or lose, just as long as you keep playing. So the collective “they” work together to pitch you whatever's hot, and then move on when that investment has run its course.

And don't even get me started about the conflicts of interest. The supposedly independent ratings agencies that rubber stamped everything from derivatives to high-grade debt have been in bed with the companies they're supposed to be regulating for years. Consequently, millions of investors thought they had the “green light” to invest in supposedly safe institutions that have proven to be anything but during the past 24 months.

Where the rubber meets the road - especially during the down years like we're living through now - is that the risks of outliving your money go up dramatically if you have to get out. In fact, if you achieve annualized returns of zero or less for the first five years after you retire, your odds of running out of money in the next 30 years more than double from 26% to 57%, a study from T. Rowe Price Group Inc. ( TROW ) reported recently.

And that's proving to be a tough reality for millions of investors who thought they had this handled. Which is why I was not surprised to see data from the Employee Benefit Research Institute quoted in Money Magazine showing that more than 30% of near-retirees, or those in the early years of their retirement, had more than 80% of their money invested in stocks at the onset of this crisis.

Many of those investors have undoubtedly sold off assets to finance living expenses while waiting for the market to reverse. And that's created a “double whammy” of sorts: Not only did they lose money on the way down; but those losses and the subsequent forced sales could well mean that their portfolios won't be big enough to benefit from the next upturn when it does arrive.

What to Do Now : As I have long espoused, the notion of being able to take on more risk simply because you have more time isn't what it's cracked up to be. Instead, it is far more appropriate to make choices based on the certainty of returns, especially now.

And that should start with how you think about dividends and reinvestment. In short: Boring never looked so good. Data from Wharton's Jeremy Siegel and Yale's Robert J. Shiller - not to mention from my own research - shows that dividends and reinvestment can be far more stable contributors to overall wealth creation than capital appreciation.

Looking ahead in uncertain times, the best choices remain those businesses with solid management, plenty of free cash flow, and an increasing dividends that are backed up by unstoppable global trends. Not overpaid, arrogant Wall Street executives who engineer risk under the guise of safer returns.

There are still plenty of choices available if you do your homework. And it's not too late to begin buying them selectively right now. In fact, as I wrote recently, history suggests we're nearing a once in a lifetime buying opportunity so the odds of an upside move could arguably outweigh additional downside…even if you don't quite get the bottom right.

Wall Street Whopper No. 2 :  Some Debt is Good (aka: The Careful use of Debt is an Appropriate Wealth-Building Tool) - This is one of Wall Street's biggest and most dangerous whoppers, and yet I almost hesitate to include it because of the e-mail I know it's going to generate. But at the risk of sounding like a broken record, if you owe somebody money, you've still got to pay it off one day. That means any growth you attribute to debt until it's paid off in full exists only in fantasyland. Ask General Motors Corp. ( GM ), Lehman Brothers Holdings Inc. (OTC: LEHMQ ), or any one of the dozens of world banks that are now coping with the aftereffects of growth through the supposedly “intelligent” use of debt.

And this is just as true on a personal level as it is on a professional and governmental level. I wish our leaders understood this, although - in their defense - they finally seem to be getting the picture in recent weeks. Better late than never, although I would just as soon not have seen millions of investors taken on a white-knuckle ride to begin with.

Perhaps the saddest thing of all - and one of the most important lessons we can learn - is that the lessons we grew up with no longer seem to apply. We were taught that if we worked hard and acted responsibly, we would flourish. But now, even if we were responsible, we're finding out that we're now liable for the “other” guys' debts, too.

What To Do Now : From an investing standpoint, confine your choices to those companies with little or no debt. Steer clear of the ones that are on the U.S. Federal Reserve's IV drip. Yes, those companies probably have upside, but the real test will be what happens when they are forced to wean themselves off their Fed-administered drugs and operate without the crutch of government financing. History suggests that many will fail - despite the government's unprecedented efforts to save them.

On a personal note, borrow conservatively and only if you have to. Pay off your credit cards each month or shift to a cash-only, “pay-as-you-go” spending plan if you can't keep that spending under control. Refinance your house before interest rates begin rising dramatically to cope with the almost-certain after-effects of current stimulus spending . And by all means make sure that whatever debt you take on is debt you can afford to pay off.

Wall Street Whopper No. 3 : It Pays to Diversify - The conventional wisdom used to be that if you spread your money around, you'd somehow be safer. This is no more effective than rearranging the deck chairs on the Titanic. It's better to get off the boat.

In uncertain times, it's how you concentrate your money that matters. This is an important adjunct to “investing with certainty in uncertain times,” and I've long advocated the benefits of stability and consistency as a means of getting ahead of the game - and staying there.

The proprietary 50/40/10 (Base Builders/Global Growth & Income/Rocket Riders) portfolio structure we utilize in our monthly newsletter, The Money Map Report , is a terrific example of what I mean. Not only does this portfolio strategy instill a discipline that forces investors to adhere to a “safety-first” philosophy, it has also proved itself to be far more stable than the broader markets since the credit crisis began. It kicks off higher-than-average income, demonstrates lower-than-average volatility - and still generates all the upside you can handle.

This safety-first discipline, with its dual emphasis on high current income and long-term appreciation, has generated some truly impressive returns.

And t his brings me to a key point: Far too many investors don't understand how the game must be played right now. They think that investing in rocky times is an all-or-nothing equation.

It's not.

Instead, it's about the continual adjustment of positions to reflect changing assumptions related to risk - especially now that the risks of stock ownership have changed.

What To Do Now : In an era of simultaneous collapse, when then stock, bond, housing and credit markets have cratered at the same time, there's simply no excuse for not hedging your portfolio at all times, not just when it's popular to do so. Nor is there any reason why you shouldn't be thinking safety first. That way you have the freedom to screw up on speculative bets instead of being dependent upon them to regain what you lost on foolish moves made during the downturn.

And by all means, learn how to use any of half a dozen specialized tools - like inverse funds, or options - to make low-risk, but-often-spectacularly-profitable choices, even under current market conditions. That way you can plan for the worst , yet still obtain the best of what's out there.

Wall Street Whopper No. 4 : Your Home is an Investment - No, it's not. At best, it's a roof over your head that keeps you from being priced out of the local rental markets. At worst, it's a money pit that provides you with the illusion that you're doing something sensible with your hard-earned money - despite the fact that an entire industry would have you believe otherwise.

Research from Shiller, the Yale economist, shows that, since 1900, home prices have run sideways or even declined for long periods of time. That means that - except for two steep run-ups - one after WWII and the other as part of the late 1990s lending binge - real estate hasn't been the winning investment everyone claims it to be. And millions of people are learning the hard way that real estate can, and does, lose value. Seems they've conveniently forgotten the lessons Texans in the oil patch learned in the early 1980s or that Japan experienced in the 1990s.

Wall Street Whopper No. 5 : Shop 'till You Drop and Save the Economy - The U.S. government wants you to spend money. And Wall Street, together with the credit card companies, want you to save their sorry hides by helping you do just that. That's why so much of the stimulus planning - if you can call it that - revolves around tax cuts and handouts. It's all window dressing.

Nothing - and I mean nothing - will matter until the banks start lending again.

Period.

What To Do Now : Keep your powder dry. History shows that the ebb and flow of money has never been smooth. Ever.

So to talk as if what's happening now is an enigma is to ignore the past. We've been here before. There was the Panic of 1873 (sometimes called the “real” Great Depression ), the Great Financial Crisis of 1914 , and the B anking C risis of 1931 , for example. The reason what we're living through now feels different now is that those events are simply beyond the living memory all but a precious few people.

But take heart, for there are some bright spots to look to.

America's safe-haven mantra - misguided though our policies may be - is an important indicator that savvy investors should plan for an eventual rebound - even if we're destined to test new lows in the months ahead, and even if we have to look outside our own borders as a part of that process.

[ Editor's Note : The ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will quickly and painfully determine the winners and losers out in the global financial markets. Investors who ignore this " New Reality " will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

In fact , Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as " The Golden Age of Wealth Creation ." His key discovery: Despite the gloom brought about by the ongoing financial crisis, we may actually be standing on the precipice of the greatest investing opportunities we'll see in our lifetimes. To capitalize, today more than ever, investors need to employ the correct tool.

In his newly launched Geiger Index investing service, Fitz-Gerald feels that he's found that needed device. Geiger Index , developed after more than a decade of work, is a new, computerized trading model that's based on a mathematical concept known as "fractals." This system allows Fitz-Gerald to predict price movements of broad indexes, or of individual stocks, with a high degree of certainty. And it's particularly well suited to the "trendless" markets that are the norm today. Check out our latest insights on these new rules, this new market environment , and this new service , Geiger Index .

And look for Fitz-Gerald's next Geiger Index " Webinar ," which will be held Tuesday (March 24) at 4 p.m. For more information on Fitz-Gerald's Web summit, please click here .].

Money Morning/The Money Map Report

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