Introduction to Buy and Hedge: The 5 Iron Rules for Investing Over the Long Term
Join the authors on a brief but instructional journey back in time—but not too far back. Think about the year 2008. More specifically, think about your investment portfolio in 2008. Warning: This journey might be upsetting and/or emotionally painful. If you are like most investors, your portfolio suffered losses that were historic in size and scope. Believe me, we are reluctant to take you on this journey. After all, this is the first paragraph of the first chapter of the first book we have ever written. Putting you in a bad mood in the first paragraph is a little risky. But we hope this exercise will prove enlightening.
Next, think about the investment destruction that continued through early 2009. Unbelievably, the markets sank to even lower lows. Along with these new market lows came historically high market volatility. Respected financial institutions were on the brink of failure. Every day was a new adventure in the market. Finally, mercifully, the markets recovered sharply in mid-2009, and they have been on a steady rise in the two years since.
Consider for a moment the investment climate back in the fall of 2008. The market crash was precipitous and calamitous. Think about the investment decisions you faced with your portfolio. If you are like most American investors, you thought about doing one or two of the following:
- Curling into the fetal position and hoping it would all go away
- Calling your investment adviser and screaming at him to do something
- Selling everything
- Looking for ways to find any tax advantages from your investment losses
For 90% of investor households in this country, one or several of these decisions were an implicit or explicit outcome of the 2008–2009 market collapse. But of these four actions, the only one that was even modestly productive was the last one. At least the investor who looked for tax efficiency from the losses might have saved himself a bit of money. But it's hard to save on taxes when you don't have any gains to offset the losses. You can at least admire the person who tried to find tax efficiency for his "glass half-full" attitude.
The other investment options would have been counterproductive. An investor who runs and hides from his portfolio might as well dismiss any chance he has for achieving his investment goals. Screaming at your adviser won't help, especially because he owns some of the responsibility for your portfolio's poor performance. Maybe yelling at him made you feel better. But did it make your portfolio perform better?
Last, selling everything in your portfolio is not a long-term solution. Pulling your money out of the market might have made you feel better in the short term. In fact, you might even have missed the continued market declines through early 2009 if you liquidated your portfolio right after the crash in September/October 2008. But did you get your portfolio reinvested in 2009 in time to enjoy the sharp reversal in the market? You probably didn't. Timing the market is a difficult proposition. The best traders in the world time the market—and the data says that fewer than half of them succeed. Is that the portfolio strategy you want to rely on? Always being right about timing the market?
The authors promise this painful journey is almost over. We have one last question for you to consider in light of the recent stock market performance. Do you think the recent activity, volatility, and turmoil in the market are the new normal? Or do you think we just survived the equivalent of the market's 100-year flood? Or do you think the answer lies somewhere in between?
If you think we just survived the 100-year flood, this book isn't for you. You can invest your money in the broad markets and sit back and wait for it to appreciate. You can put this book down. And, by the way, good luck!
If you think the market has the potential for significant turmoil and volatility, this book fits you like a glove. Even if you just think that the markets are uncertain, and you worry that it is possible that this is the new normal, this book will work for you. If you are just uncertain about the markets in general, the lessons you will learn in this book will work for you in any market.
The Buy and Hedge strategy is a new way to invest. It is an all-weather portfolio approach to help you beat the markets. Our Five Iron Rules of Buy and Hedge, when implemented effectively, will provide you with a portfolio that you can feel secure owning. And by "secure," we mean you will sleep well at night knowing that you have limited the potential destruction that market volatility can create in your portfolio.
Buy and Hedge the book is for the investor with a long-term outlook who wants to take control of his or her portfolio. It will teach you to build and manage a balanced, diversified, and hedged portfolio. By hedged, we mean a portfolio that limits its downside losses in a violent and volatile market. Hedge fund managers and professional money managers use these techniques. And we teach them in this book using straightforward and easy-to-understand language. Most important, the book shares techniques that can be implemented quickly and efficiently. In other words, you don't need to be a full-time money manager to make this portfolio work for you. It does help to have a basic understanding of financial markets and to already be a do-it-yourself investor.
The authors worked together at TD Ameritrade (TDA), where we were employed for over a decade. TDA is the largest online brokerage in terms of total investor transactions executed. We spent our time at TDA building the trading and investment platform that is used by millions of clients today. In fact, collectively we launched over 100 tools and enhancements while at TDA. And we led the initiatives that spent nearly 750 million acquiring several companies. Each of these companies was acquired so that we could unleash their new investment tools for our clients. We estimate that together we met more than 10,000 individual clients at client functions and events. Simply put, we were intimately involved in the expansion and growth of the fantastic online brokerage industry.
The main competitors in this space have really democratized the investing industry. The little guy can now manage his money in a way that only institutional investors could have achieved 10 to 15 years ago. The main players—TD Ameritrade, E*TRADE, Charles Schwab, and Fidelity—all deserve kudos for tearing down the barriers and reducing the friction for the individual investor to take control of his or her financial future.
In our combined 22-plus years in this new industry, we have learned an important series of lessons, which you will benefit from. The first lesson is that it is very difficult to beat the market. Even professional money managers have a hard time picking stocks that beat the market. We have tried—and we can attest to our scars and bruises. The second lesson is that it is supremely difficult to stay disciplined within an investment strategy. Discipline is the key to being a successful investor. And the third lesson is that we have never met an investor who consistently beat the market without following a disciplined investment strategy. We have met disciplined investors who did not beat the market. But we have never met an undisciplined investor who consistently beat the market over the long term.
We have experimented with many investment strategies over the years. In fact, our jobs at TDA encouraged us to use the tools and products. And being product developers at heart, experimenting with different trading systems and investment strategies came naturally at a company like TDA. Both of us will even tell you that we had a lot of fun being two of the more active users of the tools and products within the industry. After our testing and experimenting with different investment strategies, we developed the Buy and Hedge strategy and now endorse it for the do-it-yourself investor. We have successfully driven market-beating performance using this strategy for over three years now—and these were a very hard three years.
Buy and Hedge is your path to investment success!
Before you begin the first chapter, we want to explain a few terms we use:
- When we use the word "Option," we almost always capitalize it because we are referring to the financial instrument called an Option. An Option is a financial security that is a derivative that represents a contract sold by one party (the Option writer) to another party (the Option holder). The Option gives the holder the right to either buy or sell an underlying security for a set price by a set date. When "option" is not capitalized, the word is being used in the traditional sense: a choice between two or more things.
- This book often uses the words "investment" and "position," but we do not use them interchangeably, even though the industry often does. Instead, for clarity, we have created a hierarchy between the two. Investment is the parent of positions. An investment is made up of one or more positions. Here's an example: I am bullish on Microsoft, but with a small hedge. The positions could be 100 shares of MSFT and one Option contract on MSFT that provides the hedge. The investment is the exposure you want to create to some investment vehicle. The positions are the specific investment vehicles you want to own in your portfolio to make that investment a reality.
- This book uses the word "we." "We" always refers to the authors. It is not the collective "we." It is the authors only. When we use "you," "investor," or "one," we are referring to the reader—the individual investor who will implement the Buy and Hedge strategy after reading this book.