FSO Editorials: Becoming an Expert Investor... by Robert B. Gordon 07/06/2004

Becoming An Expert Investor
May Be Easier Than You Think
by Robert B. Gordon, Sc. D.
July 6, 2004

The dictionary defines an expert as a person who has special knowledge in a particular field. Sixty five years ago I was an expert in the specialized field of Physical Metallurgy in which I had spent 3 years in the laboratory doing something that had never been done before. That expertise won me a doctor’s degree but I started to lose it 4 years later when I was promoted to a supervisory position in a different field of metallurgy. Unless a particular form of expertise is carefully preserved by further work in the same field it can be lost and quite readily.

When I retired from my professional work in 1980, I started to develop my skills in investing that had been an avocation for 41 years. In 1981, I purchased my first computer and started to write software to aid my investing. Then I sold software for several years and finally started a monthly mutual fund data service that survived for quite a few years. I then was a qualified expert in another limited area. Finally, at the ripe old age of 86, I started to write on the internet, at first in general topics on the economy and gradually developing into writing primarily about mutual fund investing because of the obvious great need among my readers.

I continued to write about the economy, synthesizing the expert words of others for the benefit of my readers. I also continued to write about the Elliott Wave theory of which I had become, not an expert, but an enthusiast and teacher. It is my hope that many of my readers will eventually subscribe to one of the available EW publications. The current June monthly report, just issued, shows an amazing variety of charts from stocks and bonds to social items that have formed beautiful Elliott waves ready to plunge.

My earlier expert abilities have certainly faded with the years, but I think my ability to synthesize information to achieve practical investment goals may have actually improved. I am certainly more capable than ever before to meet my own investing goals. And I know from reader letters that many of them have been helped. So, my present goal is to continue writing and answering your questions to the best of my ability.

How do you define investment success? I do not believe it is measured by percentage return on your assets. I think it has more to do with having the ability to make changes when needed and keeping your nerves steady in stormy markets. I think it comes from trying different things in different kinds of markets. Early on, a new investor would be well advised to have several small different portfolios to be able to compare their reaction to various types of market conditions. I am currently running four rather large portfolios to gain experience I can pass on to my readers.

Many young investors (in experience only) mistake others for experts. For instance, 99 of 100 brokers are not experts, just salesmen. Perhaps, 9 of 10 mutual fund managers do no original thinking but just copy what other funds of the same type are doing. They buy the same stocks and are paid by how they do in comparison to other fund managers. These sad facts emphasize the need for individuals to decide to teach themselves in their own way at their own pace. That is why, in difficult markets like this, it is extremely important for every intelligent adult to become their own investment expert. And as I’ve been trying to explain in past essays, the learning process is really much simpler than most people expect. We will go into this subject later, but first I want you to have the thrill of discovering a very unusual fund managed by an exceptional manager.

When you find a really top-rated fund of its class, you can be sure the manager’s experience and skill is the reason. In this special fund, the original manager is still at the helm, ready to put his expertise to work in the investor’s behalf. This special fund does not employ anything unusual like the Hussman hedging so I decided to put it in the "stable for the long term" category and have already made my first purchase of this great fund. This category means that the price may dip somewhat but the long term is quite favorable. In other words, it will do well in rebalancing and should provide good profits over the long-term.

I’ll tell you how I found it so you can find it too. This fund is a Moderate Allocation fund as Morningstar defines it. They usually hold both stocks and bonds and normally more stocks than bonds. Go to Morningstar and click on Tools, then on Screening mutual funds. Select Moderate Allocation funds, no load, 5 star and you will get a list of about 25 funds. Choose the one with FP as the first two letters. Click on the fund name and go back to the first Morningstar page and read the information about this fund. Read every bit of information and see if you can determine what greatly impressed me.

I like the fund size and stability of the manager. I like the chart showing great superiority in the bear market over the class average and the S&P500. Then I moved down as always to see the summary of its current holdings. There it was: 47% cash, 43% stocks and 8% bonds. The fund manager must be reading the EW reports. I have never ever known of a fund to own 47% cash unless it was being liquidated. The other bullish funds are 95% invested now, right at the market top as usual. And the manager of some funds might be fired for holding too much cash. Then, I went to the upper left corner of the page and clicked on Risk. The values were all highly favorable. I then went to my FastTrack(tm) screen and viewed the full 11 years history of this great fund. It has gained 12.6% per year over its lifetime and had its worst period from Spring 1998 to Fall of 2000, probably another period when it was heavily in cash and couldn’t find anything to buy. And from the end of this flat period, the fund chart shows it gaining at over 21% a year!

I hope that the quick readers who skipped over the Morningstar page will go back now and do it right now as it represents one of the greatest lessons any investor can every learn. There is absolutely no substitute for integrity and competence in a mutual fund manager. Other desirable features are moderate asset size and stability of the management staff. There are a few good large funds but they are exceptional.

These are just some suggestions that could be adopted or varied as each reader sees fit.

Three very important asset classes, each of which will make money in my opinion if rebalanced well. That is the purpose of this learning portfolio. At every top and bottom of BEARX, just sell everything and divvy up the dollars. Nothing could be simpler.

            HSTRX      1/3
            PSAFX      1/3
            RYJUX      1/3

Balanced U.S. and Foreign bonds with a short 30 year U.S. bond fund that should do well in a rising interest rate climate. This portfolio should be closed out if interest rates stabilize.

            HSGFX      1/4
            PRPFX       1/4
            WTR          1/4
            RYURX      1/4

A hedged growth fund, Permanent Portfolio with 6 asset classes, Aqua America, largest water stock in U.S. and reverse S&P500 short fund - a total of 9 funds and 14 different asset classes. Now, it might be easier to build a 9 fund portfolio but the interpretation of each asset class’s performance would be somewhat harder. It would probably be simpler to add a tenth asset class, perhaps a gold stock or fund, and give each a 10% allocation. That makes for very easy rebalancing. So let’s try it and see how it would have performed.

DIVERSIFIED PORTFOLIO Performance from 7/2/2001 to 7/2/2004
Allocation	Percent	% Gain	Weighted %
Stable Assets
HSGFX	10%	16.1%	1.6%
HSTRX	10%	7.5%	0.7%
PSTRX	10%	15.4%	1.5%
Total Stable	30%		3.8%
Long-Term Stable Assets
FPACX	10%	14.7%	1.5%
PRPFX	10%	10.1%	1.0%
WTR	10%	10.9%	1.1%
Total Long-Term Stable	30%		3.6%
Volatile Assets
CEF	10%	18.9%	1.9%
Short Funds
BEARZ	10%	15.0%	1.5%
RYJUX	10%	-7.8%	-0.8%
RYURX	10%	-0.7%	-0.1%
Total Short Funds	30%		0.6%
Portfolio Grand Total	100%	14.2%	11.4%

This portfolio holds 30% each of three groups, stable, long term stable and short and by our rules just misses being called conservative. 30+ 1/2 x 30 = 45 but the 3 long term stable funds are all of high caliber. So I would rate this portfolio as very good for anyone wishing an excellent learning experience. Each of the listed members of each group is completely different and will "march to its own drummer". I will be pleased to hear from anyone who starts this portfolio or any variation.

It is simply impossible to learn how to manage any portfolio in a severe bear market by reading about it in any book. Now fortunately we are discussing long term portfolios, not short term trading. But, by working with two or three of the small portfolios over the next two years, I am confident you will emerge as a seasoned investor. And, if I am still alive and you write me I will be very happy to congratulate you.

If you have been with me for more than a few weeks, I’m sure you know that you cannot survive what lies ahead by buying two or three funds chosen by throwing a dart into the weekend price page. But the average investor’s method may be much worse than that by stealing ideas from questionable sources. Investors who do not have a planned portfolio of the right asset classes are going to be in big trouble. And, as we know, there were huge losses during the first bear leg in 2000 and 2001 that will come again in 2004 and 2005.

The Wall Street ads for portfolio balancing and rebalancing cannot possibly do the job that we have been teaching now for many months. The reason is very simple, most fund families, even the large ones, do not have the necessary asset classes and the speakers are not even aware that they exist in most cases. Some of the funds we are now using in our portfolio examples do little or no advertising which is a very great benefit to all serious fund investors.

With a sound balanced portfolio, what else must a serious investor do to weather the storms ahead? It is really very simple, just watch the market ups and downs and keep looking for a good time to rebalance. The purpose is two fold: (1) to keep the portfolio reasonably close to the intended composition, say every two years, and (2) rebalance more often to take profits at market tops or bottoms. The latter objective does take experience but will surely come with two years of portfolio management.

I have to mention one more task that may arise. If one of your funds in any asset class is not doing as expected, it probably should be replaced if given a reasonable time to perform. But you better have another one ready to replace it. So it is always a good idea to keep looking for new and better funds. Follow my example above with FPACX. I am not always going to be here to help you. Get the habit of perusing the 5 star Morningstar funds. Our list of funds is currently only adequate in short funds and we need more in the important stable category. If Hussman Growth fund keeps growing it will eventually lose the ability to provide hedged growth.

The market seems to have started wave 3 down but it could still have one more bounce. The gold market is completing a bear market rally and appears ready for another drop that will surprise all the gold bugs.

I enjoy reading your e-mails, so keep them coming with both your successes and your problems. Ask your questions and I will try to answer them.