Saturday, August 29, 2009

Rule #1 - The Book That Energized Me

It was the winter of 2007 and my portfolio had gone nowhere for much of the year (actually, it went down a little bit). At that time, I had recently rediscovered investing in stocks. I got married the summer of the previous year and had amassed a great amount of debt. I thought that it would be a good idea to accelerate the growth of my investment portfolio by investing in stocks. So, I opened a self-directed RRSP account (similar to the 401(k) plans in the US) and slowly moved my existing mutual funds into stocks. At first, I bought "safe" stocks like Manulife (ticker: MFC) and United Health (ticker:UNH). These traded sideways for a little bit; so, I sold them. Then, I bought the "Technical Analysis for Dummies" book and thought it could improve my investing strategy by using a more quantitative approach (technical analysis is really more like black magic). I also started reading up on options after my co-worker, Steve, had told me how he had made a killing in the options market. I began buying call options and put options at first. Then, I got into fancy stuff like strangles and straddles. It's ok if you have no clue what I'm talking about, because I hardly touch these investment vehicles anymore. While I did make some huge returns (e.g. I once made >100% in one day buying a Lululemon option), I also saw some of my investments vaporize (e.g. some out-of-money options that I bought expired worthless). In short, I was going nowhere fast and spinning my wheels like a madman!

Then, one evening when I got home, I saw an audio book on the kitchen table. "Rule #1 by Phil Town", it read. "What's this?" I thought to myself. My wife, Renee, came over and said she saw this on the rack at the library and thought I might be interested in listening to it. "Sure," I said, but in my mind, I thought that I didn't need to listen to this audio book; I had all the knowledge that I needed, recalling how good I was when I made the Lululemon trade, but also forgetting how I also excelled at losing money at the same time.

Since I have a long commute to work everyday (about one and a half hour total), I decided to pop the CD in to keep myself entertained. The audio book was actually read by the author, Phil Town, himself. That gave me a good first impression. Then, he had my after chapter 1. He actually didn't talk much about his method of investing. First, he told his life story of how he turned from a broke Vietnam vet hippie to a successful investor. He then went on to debunk some of the myths that all seem logical, but are simply not true. Some of which include: it is difficult, if not impossible to beat the market, and the best way to invest is to diversify and to buy and hold. But most of all, he gave me a glimpse of hope. What he was saying was that we don't need to submit to mediocrity. He claims that with his method, it is possible to make 15% returns every year. However, I think he's just playing it safe...in fact, I think it is probably possible to make 20-30% consistently year-over-year. He himself is the best example. Although not verified, he claimed to have turned $1000 into $1 million in 5 years.

I'm not going to summarize the entire book in this post, but he basically teaches 2 things in the book. The first is how to identify good companies. He does so in a very quantitative way, by looking at data readily available on MSN money. In fact, I have built a spreadsheet to do that. It literally takes about 5 minutes to analyze a company. If you want a copy of the spreadsheet, contact me. However, read the book first. The second thing he teaches is when to sell a stock, which many will agree is probably the hardest thing. If a stock goes up, you hold onto it, thinking it will continue to go up, until you realize your gains have been erased. Or your stock goes down, and you hold on and hold on, hoping that it would come back up some day.

After reading the book, I felt like a new man. The world seemed like a better place. Why is that? This is a little out of context, but it was due to one of the 3 theological virtues: hope! I was so disappointed at my performance in the stock market that I was ready to return to mutual funds, but now, I have found a quantitative method which will help me build up my wealth.

I have to confess that I did not go unscathed in the 2008 bear market. My portfolio did drop about 40% at one point. Having said that, it did perform better than the overall market, which dropped more than 60% at its bottom. One of the reasons was that I did not follow Phil's advice in selling...I held on. I am on my way to recouping my losses, but what is most important is that I haven't lost hope.

I would recommend this book to any beginner investor, or even a seasoned investor. It is an easy read and you will not regret spending the $17 at Amazon. I've put a link on the right side of this blog. And as Phil says, "Now go play!"

Update (2010-05-14)
I have now made available my Rule #1 spreadsheet.