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.

My Mistake!

Everyone makes mistakes once in a while...I'm no exception. Before I started this blog, about 3 months ago, I decided to buy a leveraged index ETF (exchange traded fund). It was the Daily Large Cap Bull 3X Fund from Direxion, ticker BGU. Now, let me remind all of you who are beginner investors: be very wary when buying leveraged funds, because leveraged funds are meant to increase volatility, or risk, as defined by the investment industry (I disagree with this definition, but that will be the topic of another post).

Anyway, what was my motivation for buying this fund? Let me give you some background: I re-started my investing career some time in 2007. I had previously invested from 2000 - 2003 and you guessed it, I lost my shirt! So, after taking a fairly extended break (I was rediscovering the Lord, courting my then girlfriend, and preparing for my wedding), I decided that I should start investing again. This time, however, I'm actually going to learn about investing before doing it. So, I read a few books on technical analysis and then fundamental analysis. Thinking I was ready to take on the world, I put a majority of my retire funds into stocks. That was before the market meltdown in 2008. So, fast forward a year or so to June of 2009. The S&P 500 had shed about 60% from its peak just a few months prior, but the market seemed to have bottomed. I studied the Dow Jones Industrial Average and S&P 500 Index over and over again to see if I can discover any characteristics of bear markets. This was what I found:

1. Almost all bear markets last less than 2 years (from previous peak to trough).
2. If you had invested in an index fund when the market first dropped to the midpoint ([peak+trough]/2), you would be back to where you were in less than 2 years.

Below is a figure of the Dow Jones Industrial Average, showing the 2000-2002 bear market. (I actually prefer the S&P 500 Index, but that's ok...) The peak occurred in January 2000 at 11723 pts., and the trough occurred a little less than 3 years later in October of 2002 at 7286 pts. Yes, this was actually a very long bear market relatively speaking (more than 2 years). The market hit the mid point in March 2001 at 9500 pts. So, according to my finding #2 above, we should be back at 9500 pts. by March 2003. Well, I was wrong...but not by much. By October 2003, 7 months after that, the index was back at 9500 pts. So, my theory wasn't off by too much.

Figure 1: 2000-2002 Bear Market - Dow Jones Industrial Average

If we apply this theory to the bear market of 2007-2009, the midpoint occurred around 1100 pts. in the S&P 500 index (assuming March 2009 was the real trough) in the September 2008. We should see S&P 500 rise back to 1100 pts. before September 2010. We're already at 1026 pts today (August 21, 2009). So, I think my theory will work again this time around.

Whew! That was a long background to the story, and probably will be longer than than the story itself. Anyway, this little theory that I came up with led me to buy BGU. By March of this year, S&P 500 had already hit 680 pts and was on its way back up. I thought that 680 was probably going to be the bottom of the bear market. After all, the index did lose about 60%. How much lower could it go? Even if the index went down to 0 pts (hypothethically speaking, of course), the midpoint would be 790 pts ([1580 pts + 0 pts]/2), and the market had already dropped past that. So, I thought buying when S&P 500 was at 900 pts. would give me a gain of 22% (1100/900) in less than 2 years, except with BGU, it is 3X leveraged. So, the gain could be around 66% (probably less than that because it is 3X daily and not over the long term). Not too shabby!

As I watched the market rise from 900 pts to 1000 pts in a mere 3 months, I was so proud of myself for making this great call! After all, I did lose a good chunk of my portfolio just a year prior. Then I started this blog...and the more I wrote about ethical investing, the more I introspected. There I was, saying how investing in mutual funds could potentially be unethical because these funds could have invested in questionable companies, but I knew for a fact that within the Russell 1000 index, which the BGU was trying to mimic, there were companies like Merck (makes vaccines from aborted human fetus tissue), Philip Morris (makes cigarettes), and probably a whole bunch of companies that tinker with human embryonic stem cells, manufacture/sell artificial contraceptives, promote abortion, etc. etc.

I am kind of shocked at how heedlessly I had acted when I decided to buy BGU. The only thought in my mind at that time was "66% returns...66% returns..." So, yesterday, I decided to sell all of my shares. I did make a decent profit, but at the expense of investing in some companies that had questionable practices. Now I'm wondering if this calls for a visit to the confessional...LOL!

In conclusion, don't follow what I did! The rule of thumb should be not to invest in any funds at all without doing some extensive research. However, since most of us have lives to live, my suggestion is not to invest in funds at all. Pick good companies with good practices and you'll sleep better at night!

Can a Good Catholic Be Wealthy? Part IV of IV - Stocks vs. Mutual Funds

This is the last post of the 4-part series of "Can a Good Catholic Be Wealthy?" I hope by this time, I have convinced you that it is morally acceptable for a Catholic to be wealthy. Although in theory, this is not difficult to accept, there seems to be an unwritten rule against anyone making lots of money in a short span of time without actually working for it. I believe this thinking, at least in part, has stemmed from our understanding of the original curse, "Cursed be the ground because of you! In toil shall you eat its yield all the days of your life...By the sweat of your face shall you get bread to eat" (Gen 3:17, 19).

The perfect example of such a way of earning income is, of course, gambling. No work is involved in gambling (unless you're counting cards in Blackjack!). Any earnings or losses result purely from chance. Especially in fundamentalist circles, gambling is considered a sin. What does the Catholic Church say about gambling? We don't need to look far...the Catechism of the Catholic Church (CCC) paragraph 2413 states:

Games of chance (card games, etc.) or wagers are not in themselves contrary to justice. They become morally unacceptable when they deprive someone of what is necessary to provide for his needs and those of others. The passion for gambling risks becoming an enslavement. Unfair wagers and cheating at games constitute grave matter, unless the damage inflicted is so slight that the one who suffers it cannot reasonably consider it significant.

Therefore, the Church has exonerated gambling! Next time you win a few bucks at the casino, you don't have to lie about it to your friends at church. The caveat is that the likelihood of gambling leading to sin cannot be underestimated. It can lure us into various sins including several of the 7 deadly sins: greed, wrath, envy, lust and even pride.

Using your imagination, you can visualize someone who has fallen or is on the verge of falling into sin because of gambling. He would have brought much of his family's savings to the casino and lost it all, getting involved with loan sharks, lying to his wife, etc. etc. Much of this type of visualization can be transferred to someone in the stock market. It's the year 1999 and our imaginary "investor" friend has witnessed his co-workers make a killing buying stocks like Cisco and Nortel Networks. He soon sells all of his bonds and mutual funds and buys the above mentioned stocks. At first, he sees his investment grow by 20% in a couple of months. Then, towards the end of the year 2000, his stocks begin to sink. Thinking that they would bounce back, he takes a line of credit and "averages down", buying more. A few months later, the stocks continue to drop. This time, he re-mortgages his house and averages down even more. By the time the summer of 2002 comes around, he has lost more than 80% of his original investment and is in a ton of debt. There is very little doubt that investing in stocks has led him to sin. He has put his own well being along with his family's into jeopardy.

This type of "investor" is among many who give true investors a bad rep. They are the ones who create a bad aura around stock investing. Thus, responsible investing, for many people (including Catholics), exclude buying individual stocks because the losses can be so great. Mutual funds have emerged to be the vehicle of choice for many. Because they invest in many stocks, chances of losing 80% of the original investment is very slim. To any responsible person, mutual funds are the way to go. It must be a way to go for Catholics as well, is it not? I will go to argue that it is not for several reasons.

Why Investing in Stocks is Superior to Investing in Mutual Funds in Every Way

1. Ethical Investing - If you own a mutual fund, can you tell me what are its top 10 holdings? No? What about its top 5 holdings? Still no? What about its top holding? Well, then you're in serious trouble, my friend! As this blog will explore more down the road, ethical investing is a big part of Catholic investing! We are morally obligated to invest in companies that do not act contrary to the laws of God. For example, did you know that Merck produces vaccines made in part from aborted fetal tissue? If the mutual fund that you bought owns Merck, you are indirectly putting your money in a company that may be acting contrary to your conscience. If you want to invest ethically in a mutual fund, you should keep up to date with the hundreds of companies that it owns and ensure that each and every company are acting in at least ethically neutral ways. On the other hand, it would be much easier to do research on just a few companies.
2. Mutual funds are not immune to market downturns - as most mutual fund investors just found out the hard way in 2008-2009, mutual funds can drop by as much as 50% in a bear market. If you think by buying mutual funds, you're reducing your risk, you may want to do some rethinking. Mutual funds simply own multiple stocks and if those stocks drop by 50%, there is nothing preventing the fund from dropping by that much as well. Your best bet against this drop is to spend some time doing your homework and buy rock solid stocks (or even liquidate in a bear market).
3. Mutual funds really don't do that great - it's simple math. By investing in many stocks, a mutual will achieve the average of the returns of all of the stocks. Even if the fund manager has a few awesome picks, those great returns will always be dampened by the underperforming stocks. Why would you want to get an average return anyway? If you look at the S&P 500 index, from August 1999 to August 2009, the return was -22%. Say what? Yes, you would have lost 22% if you bought a S&P 500 index fund 10 years ago. That is the reality of the market average. On the other hand, if you had bought and held Apple (Ticker: AAPL) for the same period, you would have made more than 800%. How difficult was that? Not very!

Going back to Genesis...in the beginning, God did not intend for us to have to toil to make a living. So, why would it be contrary to His will to invest in stocks to earn good returns, as long as we invest in ethical companies and in responsible ways? In future posts, we shall explore together these various aspects of investing. Of course, we'll learn how to make some good money in the market as well!

Can a Good Catholic Be Wealthy? Part III of IV - The Rich Young Man

I venture to make a hunch that 99.9% of Christians worldwide is familiar with the story of the Rich Young Man in the gospels. You know, the story about the man who goes up to Jesus and asks what he must do to gain eternal life, and then goes home disappointed because he was very rich and didn't want to give up all his belongings? See, wasn't I right? You do know the story! This story used to bother me, not a lot, but enough. And I bet it bothers some of you, too. Let's take a look at the story as Matthew narrates it in 19:16-22.

Now someone approached him and said, "Teacher, what good must I do to gain eternal life?" He answered him, "Why do you ask me about the good? There is only One who is good. If you wish to enter into life, keep the commandments." He asked him, "Which ones?" And Jesus replied, " 'You shall not kill; you shall not commit adultery; you shall not steal; you shall not bear false witness; honor your father and your mother'; and 'you shall love your neighbor as yourself.'"The young man said to him, "All of these I have observed. What do I still lack?" Jesus said to him, "If you wish to be perfect, go, sell what you have and give to (the) poor, and you will have treasure in heaven. Then come, follow me." When the young man heard this statement, he went away sad, for he had many possessions. Then Jesus said to his disciples, "Amen, I say to you, it will be hard for one who is rich to enter the kingdom of heaven. Again I say to you, it is easier for a camel to pass through the eye of a needle than for one who is rich to enter the kingdom of God."

Why does this story bother me? It's quite obvious! Jesus says, "it will be hard for one who is rich to enter the kingdom of heaven." Uh oh! I guess I shouldn't really be rich then. Actually, that wasn't really the scary part. The scariest part was that it appeared that in order to enter into the kingdom of heaven, we need to sell all of our belongings and give them to the poor.

Let's hold our horses a little bit. One thing that I learned in my biblical courses is that in order to perform exegesis on a passage, meticulous analysis of each and every sentence is required. Let's backtrack a little and see what actually happened. First, the young man approaches Jesus and asks him how he could gain eternal life. Jesus replies by telling him to follow the commandments. That's it! There's no mention of giving up all of one's belongings or anything to that effect. If giving up one's belongings were a prerequisite for entrance into the kingdom of heaven, just think about how many people would be left out!

So, what is the real message of this story? Let's continue with the passage. After the first exchange, the young man continues to probe Jesus. His motive is unclear, but he does seem to be genuine. Jesus then tells him that if he wanted to be perfect, then he should give up his belongings and follow Him. It is true that we should all aim to be perfect, but it is also true that not many of us will ever attain that lofty level.

Let's continue this thought along the lines of vocation. St. Paul tells us in 1 Corinthians 7:25-31 that it is better for one to remain single because one is spared of worldly worries. So, becoming a priest or a religious is a more direct route to God. However, we know that not everyone is called to become a priest or a sister. Nor is married life an unholy way of living. In fact, married life is really good (I can attest to that)! It's just that a married person has a lot more to worry about aside from his faith. I, for example, need to worry about my job, the economy, what kind of flowers to get my wife for our anniversary, whether to buy pampers or huggies, etc., etc. The same goes for wealth. Once a person attains a certain amount of wealth, he needs to figure out how to make use of it for the good of his family, friends, and society. One thing that is important to note is that these worries are not necessarily bad. If you have these worldly worries, it shows that you are being a responsible person. However, they do detract us from the ultimate good, that is God. That is why St. Paul tells us that it is better to remain single and also why Matthew recounts this story to us.

Therefore, the message of this gospel story is the same as that of Part I and II of this series: it is alright to be wealthy, but God must ultimately come first. The young man, wishing to be perfect, was not able to leave everything behind, and therefore, chose a more indirect and imperfect route to the kingdom of heaven. But it is possible for him to get there, just like the rest of us sinners, because "for God all things are possible" (Matt 19:26).