FSO Editorials: The Tremendous Advantage of Do-It-Yourself Investing by Robert B. Gordon 04/09/2004

The Tremendous Advantage of
Do-It-Yourself Investing
by Robert B. Gordon, Sc. D.
April 9 2004

In my 64 years of investing, I have rarely purchased anything offered by a broker or a telephone salesman. I have always enjoyed doing my own research. In my first job out of graduate school, I went to a local brokerage office and bought $10 each of 4 stocks I had selected from different industries and regions. It represented a large percentage of my first pay check. I can only recall the names of two stocks, Curtis Wright and New Mexico Arizona Land, both of which were still here the last time I looked.

I was not aware of any mutual funds at the time even though a very few were in existence. Sometime in the early 1950s, I became interested in conservative income funds for my wife’s mother who lived with us. Gradually, the number of funds increased and I commenced a lifetime practice of studying new funds as they were issued. Since then I have been a shareholder in hundreds of no-load funds of all types. I have read all the fine print and made purchases only after serious performance comparisons.

In the 1970s, I started an educational program for my two sons, then in college. I used a systematic investment plan, sponsored by Merrill Lynch, to make quarterly purchases of high-dividend paying common stocks and was very successful in growing assets thru the bear market of that decade. One son continued the program and the other used the proceeds for his medical school expenses.

I retired in 1980 and was able to purchase one of the very first computers by paying $3,000 and waiting 8 months for delivery. I learned programming at a local community college and wrote several major programs to pick the best funds from a series of past performance measures. For a number of years, with limited software availability, I sold my software for use on three different types of computers. Later on I started a monthly report with current performance on the best growth funds. But none of these activities compares in importance or job satisfaction with my current activities on FSO. I am having a ball in this job because of the fine support I get from my readers.

I am writing this piece because of the large number of readers who fear buying their first fund or stock. My own background makes it very hard to understand their problem. I never did subscribe to the opinion of one mutual fund expert who preached "buy the stock of the company whose product you know best." It is not the package, but what is in the box that counts. I have always put a huge emphasis on management skill and fund performance.

I am not spending nearly full time at my computer to entertain my audience. I am a teacher again after an absence of about 62 years and am trying to pass on what I have learned in the school of "hard knocks." I am pleased that a number of veteran advisers have written to say they are in full agreement with my views, but probably most brokers and advisors think we are in a new bull market. A reader recently questioned why I am always so gloomy about the economy. My answer was that I have to compete with a majority who have a very bullish view. The shock effect on the public from the next big market drop will have a drastic effect on morale and I want my readers to act now before any panic.

We have two types of hesitant readers that I want to help in this essay. First, those who have yet to make their first purchase of a mutual fund on their own. Second, those who may be quite experienced with funds holding long positions, but fear the purchase of even a small amount of a short fund like the Prudent Bear fund. The only way I can help is to use very simple examples and explain the huge benefits of doing something now that will help for the rest of their life.

Before we get into the specifics, we have to make a very important point. Buying only one fund is perhaps better than buying none, but can create problems for a new investor. It is far better to start with any of my very small 2 or 3-fund portfolios, because you will learn much faster and probably will not be troubled if your single fund happens to drop in price right after you have bought it. Mutual funds of all types are priced daily at the market close and I do not know any fund that is guaranteed not to drop its price. Although rare, it has even happened to money market funds. If small price fluctuations are troubling, then you should put your money in the bank.

In today’s Daily Reckoning, Editor Bill Bonner brings us a sorry picture of an American investor. Do you recognize anyone?

"Why do you refer to the great mass of investors derisively - the lumpeninvestoriat, you call them?" Your editor is gaining a small, pathetic notoriety in France. His book, translated into French, tells the frogs what they want to hear: that America, courting calamity, is almost sure to get her into the sack soon. Here in France, the story is heartwarming, rather than alarming - a bedroom farce rather than a tragedy. Several magazines have asked for interviews. The question about lumpeninvestors came from a reporter from Boursier.com, a French financial publication.

What follows is our answer: "The idea that the average person somehow becomes an 'investor' simply by buying a mutual fund or a share of Yahoo is a myth and a fraud. He is not an investor anymore than a man who tries to make money at a slot machine in Las Vegas is a businessman. He may wear a suit and tie. He may carry a brief case. He may even tally up his expenses and net them against his income, but he's really just entertaining himself. "Warren Buffett is an investor. Carl Icahn is an investor. These are guys who study businesses - in detail - and decide which businesses they want to own. "The little 'investor' doesn't do that. He merely reads an article in the paper. People are getting older, he discovers. 'Oh,' he says to himself, 'I'll put my money in nursing homes.' But this knowledge - that people are getting older - is the kind of knowledge that Nietszche called 'wissen.' It is public knowledge... abstract, vague, misleading, and for an investor, worse than no knowledge at all.

Just because the average age is increasing doesn't mean you're any more likely to make money in a nursing home stock than in a nursery stock. If you buy on the basis of the news, or what your neighbors suggest, or a tip from your broker... you are just gambling. "In order to invest, you would have to know a lot more; you would have to do actual research, like Buffett does. You have to have what Nietszche called 'erfahrung' - practical, experienced-based, direct, often personal knowledge. "The average guy who buys a mutual fund is not an investor at all; he's a chump, a patsy, a schmuck. We say that affectionately, of course.

Were it not for this guy, most of Wall Street would be out of business. Because what this guy really does is not invest, but consume. He's a consumer of Wall Street products... he's the source of financial firms' revenues and profits. He's the reason people on Wall Street drive around in big Mercedes and have mansions in the Hamptons. "The trouble is, you can't get rich by giving other people your money. And you can't get rich by spending it, either. The whole U.S. economy only gets bigger by, say, 3% per year on average. So, if you really did 'invest in America,' maybe you could expect your investments to rise at a 3% rate. But if you consume the financial industry's products, you have to realize that the sellers/packagers/brokers/ financiers and so on have to get a cut. And those fellows don't work cheap. Nobody wants to buy 'investment' products from a poor man. So, like Vegas casinos, Wall Street institutions need to spend a lot of money to keep the rubes coming in the door. Warren Buffett once estimated that the financial industry gobbled up nearly a third of all investment gains. Plus, the average lumpeninvestor has to provide higher returns to the 'smart money,' the people who actually know what they are doing"

My comments on the above are that the author speaks the real truth. He is an astute viewer of Wall Street and a superb writer. Tens of millions of American investors will lose most of their money in the years ahead - unwitting victims of Wall Street avarice. To escape their clutches, you have to learn to use your native abilities and become a do-it-yourself investor. Our goal has been and will continue to be to assist you to the best of our ability. We can only show you the way to beat Wall Street at its own game. You, dear reader, must teach yourself to outsmart them by doing it yourself. We can give you examples and bring you to the moment of decision, but you have to do all the rest.

The average price of three different funds will always be much more stable than any single fund. It also helps if all 3 funds are created or managed with the ability to own several asset classes. Here we will suggest 3 well-managed funds with excellent performance records that make a great portfolio for beginners. They are relatively stable and their average price variation should not trouble most new investors. Owning this trio, even for only a year, would be quite educational and provide confidence to continue, which should be the goal of any investor. We classify all three of these funds as stable, but all 3 will vary differently in their day to day prices:

The Permanent Portfolio Fund, PRPFX, has a great 33-year record of price stability and owns six different U.S. and Swiss asset classes. It permanently owns 25% gold and silver bullion.

The Hussman Total Return fund, HSTRX, is managed by a brilliant Ph.D. manager and adds several quite different asset classes than PRPFX and can use hedging to protect its profits from any loss.

The Prudent Global Income fund, PSAFX, owns short-term foreign government bonds and gold and adds greater breadth to the portfolio.

A portfolio containing equal amounts of these three funds can be assembled for just $6,000 in a taxable account and $3,000 in a tax-free account.

Portfolio Gain from 9/18/2002 to 4/05/2004
Fund	Allocation	% Gain
PRPFX	33%	17.9%
HSTRX	34%	13.2%
PSAFX	33%	15.6%
Average	100%	15.6%

These are excellent returns for 3 conservative stable funds. No one should expect these great returns to continue in view of the serious problems ahead for the economy and stock and bond market. It is not even possible to say this portfolio will not drop in value at some time but it is much, much safer than any portfolio consisting chiefly of common stocks.

We are suggesting using equal percentages of the 3 funds, but using 40% or more of HSTRX would be even more stable because Dr. Hussman is authorized to use up to a 30% hedge to safeguard any gains. It is the only income fund I know with this great safety feature.

This is one of the very best ideas that has come to me recently. I hope that all readers will think seriously of giving it a try before this bear starts down hill again. When this great idea came of out the blue, I mentally said a very big "wow." I believe that it will have a great learning potential for all investors:

Three Year Gain
Fund	Allocation	% Gain
HSGFX	75%	15.8%
BEARX	25%	8.4%
Average	100%	15.6%

My guess is that in the next three years the gains shown above may well be reversed with BEARX out-gaining the growth fund. But, please note that except for short periods, I do not expect any losses. These two funds, in some optimum combination, are very unlikely to encounter net losses. Consider this guess of what will happen. On every major market drop, BEARX will make large gains and HSGFX will be fully hedged to prevent any loss. On every major market rally, HSGFX will be lightly hedged and make gains that may counter any losses in BEARX. The very best ratio of these two great funds will have to be determined by you, the investor. The 3 to 1 ratio above is just my best guess right now.

I have never been so impressed by a fund manager as I am of Dr. John Hussman who manages the two funds bearing his name. It is unheard of for a manager to assess the market status for his shareholders early each Monday morning and then give his plans for the coming week. His remarks are not for everyone as much of them are couched in a scholarly Ph.D. language, but the general trend can usually be understood.

I can recommend this portfolio idea to experienced investors who are free to choose or experiment with the fund weighting. It could prove to be a good money maker with the best ratio. I can recommend the above portfolio to relatively any investor provided that a minimum amount of money be involved which is:

Portfolio with Fund Weighting
Allocation/Fund	Taxable Account	Tax-Free Account
75% HSGFX	$6,000	$3,000
25% BEARX	$2,000	$1,000
Total	$8,000	$4,000

It is entirely up to my readers to act as they wish. I am suggesting an extremely low risk way to experiment with a fully managed short fund that also holds about 20% gold. We do not know at this stage where the optimum ratio falls for these two funds but, once found, it could be a big winner in the bear market ahead. I solicit reader feedback on this issue.

Most people would probably think this 2-fund portfolio is riskier than the previous 3-fund mix, but in my mind I think this two-fund combination will prove to be quite stable and may actually bring a better return over the next few years. Time will give us the answer.

Now, of course, there is no reason why anyone cannot build both portfolios and obtain a greater probability of overall success. Let’s consider them in the form of a 5-fund portfolio.

I have been troubled by e-mails that indicate readers are picking just a few funds from my portfolio suggestions. I do not advise this and also I have no way to prevent it. My goal from the start was to build a complete answer to the problem at hand. I realize that some cannot afford a larger portfolio. In that case, I suggest they pick a small portfolio, which we always aim to be as stable as possible.

Although at this time we only have a candidate list of about 30 funds, both stable and volatile to work with, we rather like the following proposal which uses only 5 funds to great advantage. Experienced investors can play a bit with the percentage allocation, but we suggest building the following portfolio which we expect to do well in both up and down cycles.

Stable Bear Market 5-Fund Portfolio returns to April 6, 2004
Fund	Allocation	3 Year	2 Year	18 Month	Weighted 18 Month
Permanent Portfolio	28%	15.3%	17.7%	20.1%	5.6%
Hussman Strategic Growth	15%	15.8%	16.4%	15.6%	2.3%
Hussman Total Return	15%	N/A	N/A	9.5%	1.4%
Prudent Global Income	15%	15.5%	13.4%	17.3%	2.6%
Prudent Bear	27%	8.4%	11.7%	-11.0%	-3.0%
Total	100%			Grand Total	8.9%

The 18-month negative return for BEARX is about as bad as we expect to ever see since the market has been going up for most of the time in a major bear rally.

Although shown only in their prospectus and latest report, which you should be sure to read, all five of these funds have the right to own gold. PRPFX and BEARX have large holdings which some day will be big winners. The others may or not hold gold depending on the managers judgment.

I have been a student and follower of the Elliott Wave theory since 1995 and have surely learned that it should not be used or practiced lightly by rank amateurs like myself. It is a very complex and difficult art and best left to experts to read its message. But when the message of the waves reaches the end of a fifth wave, either up or down, I take it very seriously. According to Robert Prechter, who has been studying gold for several decades, gold is in the act of finishing a fifth wave up and will turn down from approximately its present price level. There is a huge battle going on in the gold futures market between the shorts and longs which will determine what finally happens.

Although he cannot determine the price of the ultimate top, Prechter is adamant in his opinion that the next big move will be down. So, I adopted a wait and see attitude. I retained my large gold bullion position which is part of my estate and I sold my gold stocks and funds until we have a final answer from the market itself.

I have received several fairly nasty letters from gold "bugs" who use blunt words to describe my insanity. But, at my advanced age, I stick to my "guns" and do not flinch. The gold situation will clear itself in due course as the present huge battle between the "longs" and the "shorts" is resolved.

I bring this subject up, to again remind all readers that the precious metals market is a wild and volatile place. Experienced investors can enter this market as they wish, but my more than 30 years experience requires me to suggest that average conservative investors should let others have the buy and sell responsibility. In the five-fund portfolio described above, all five funds have the authority to own gold. This is rather unusual and a plus for the investors.

Some people do not swim. Some do not drive a car. Some do not invest in stocks or funds. But when interest rates have been at rock bottom for quite some time, the willing non-investors are making a real sacrifice whether they know it or not. Then, there are a myriad of investors who have never held a short position. And when the market goes up for twenty five years, as it did from 1975 to 2000, there appears to be no need to trade on the short side unless you are a professional trader. But, when we are facing what may be the longest bear market in world history, say 50 or more years, active investors should at least investigate the merits of owning short positions as part of their portfolios.

The 5-fund portfolio presented above is capable of giving my readers a quite safe introduction to adding a short position to an already conservative portfolio. But they have to see a need and make their own decision. No one else can do that for them. I have now owned BEARX on and off over at least the past 5 years. I was experimenting before the end of the bull market and paid in losses for the experience. I now own about 5 short funds and consider it just another asset class to use when it is called for. The fund owner sees nothing different in owning a short fund except it goes up in price as the market goes down, which is not that bad a feeling for the investor.

Please go back and reread that Daily Reckoning story. I do not want you to be that kind of an investor. I am teaching you to think and act for yourself and be ever free of the greedy clutches of Wall Street. So please think very carefully about what action you will take in response to this essay.

It’s your life and your money and your responsibility. You can lead a horse to water, but you cannot make it drink. I am here today to help you and answer your questions, but that may not be true tomorrow. Here is all that you need to do to buy directly from the fund, just two steps.

1. Phone the mutual fund administrator and request a prospectus and application form.
2. Return the form with your check. You will receive a record of purchase, not a certificate.

Permanent Portfolio - 1-800 531-5142
Hussman Funds - 1-800 487-7626
Prudent Funds -1-800 -711-1848

All the funds in my portfolios can also be purchased from many on-line discount brokers.

I will do my best to answer any question to help you get started. Please know that I normally give the details of funds only when they are one of a kind as is true with these five. Eventually every serious investor has to develop the ability to select funds for themselves.