I’m very pleased to announce the debut of the 2010 edition of my bestselling book, The Neatest Little Guide to Stock Market Investing. This is the book’s fourth edition, with more than 200,000 copies sold, making it one of the most popular stock books ever written.
Once a book becomes so well established, updating it gets tricky. On the one hand, the author must be careful not to break what’s already working so well. On the other hand, life moves quickly and even a bestseller needs to be kept fresh and pertinent to current news. Let me tell you how I approached the task when revamping this title for its 2010 edition.
The most obvious new information was the near collapse of the financial system in 2008. That wreaked havoc on even the best-planned portfolios, as every investor will recall. Did the market crash invalidate the book’s permanent portfolios? The star of them, Maximum Midcap, had performed splendidly from 2002 to 2007 in the Fed-liquidity-driven market run, turning $10,000 into $28,495. The same strategy left untouched, however, plunged 68% in 2008. Those who did not watch the market carefully as the subprime housing bubble stretched thin and burst, suffered heavy losses. Too many sold at the strategy’s lows, just before its breathtaking recovery from March. From its low in March to its high this month, the strategy has gained 228%. It already recouped its losses from the great crash for those who stayed put, but became a veritable money machine for those who got out and back in at the right moments.
This new edition helps readers find those right moments.
I realized that the book was missing a set of tools I use every day to keep tabs on market health and the risk level of investments I hold: technical analysis tools. Charting is a primary part of most stock investors’ approach to timing, and a certain element of timing is needed in every investment program. In my desire to keep the book light and easy in its earlier edition, I chose to skip technical analysis in favor of fundamental analysis, the checking of a company’s debt levels, marketing plans, and valuation in an attempt to know if it’s a bargain or not. The latter comes more naturally to people, in my opinion, because it’s close to how we manage our own personal financial lives. Technical analysis can seem arcane.
My challenge then was to introduce just enough technical analysis to help readers avoid plunging years like 2008. I researched extensively to find the charting methods that combine the best accuracy rates with the easiest usage. Some techniques have high accuracy but are extremely hard to interpret or monitor for anybody not working the market full time. Others are simple to use, but not very accurate. The sweet spot occurs when a measure is fairly accurate and fairly simple to use.
Once I found a subset of measures in that sweet spot, I ran regression tests on them in combination to validate what my own experience had already shown to work pretty well. The tests did confirm my own experience, and I chose a group of three fairly accurate, fairly simple measures that become even more accurate when used in combination, with two of the three firing the same signal being the call to action.
Those three measures are the simple moving average, MACD, and RSI, and they’re introduced and explained in this book’s hallmark style in a new section in Chapter 4 called “Limiting the Downside with Charts” on page 131.
One thing I do between editions of the book is collect feedback from readers, and I learned over the past two years that, while many people like the firepower of the permanent portfolios, others wanted me to present a less stressful, methodical strategy for extracting steady profits from the market. This is a tall order, to be sure. The axiom holds that the more return an investor seeks, the more risk he or she will need to take (within reason, of course). Balancing the risk and reward of a portfolio is the art of the successful investor. Is there a low-stress way to map out the money growth we need and then keep that growth on track?
Yes! I’m proud of a new system introduced in this edition that uses a technique called value averaging to achieve a steady rate of growth. I didn’t invent the approach. I took research presented in a 1988 article by Michael Edleson, who later expanded the concept in his book Value Averaging: The Safe and Easy Strategy for Higher Investment Returns, and applied it to the new market products available today. The result is a system that we’ve been using in The Kelly Letter all year to extract 3% quarterly growth out of the S&P; SmallCap 600 index of smaller companies.
Why 3% per quarter, you may wonder. That rate becomes a 12.6% annual growth rate, which is 20% higher than the S&P; 500’s long-term rate of 10.5%. That level of outperformance — thanks to the magic of compounding — turns a substantial profit over time. Yet, it’s modest enough to keep the amount of new money required to a low level.
I’ll give you a nodding acquaintance with the strategy here. You’re probably familiar with dollar-cost averaging, which is just adding the same amount of money to an investment on a steady basis. For instance, you might add $100 per month to an index mutual fund. It works well for a couple of reasons. First, you build a capital base over time and, second, the steady payments automatically buy more shares when the price is cheaper and fewer when the price is more expensive. If the shares are $5 in October, $10 in November, then $8 in December, your $100 would have bought 20 shares in October, 10 in November, and 12.5 in December.
Value averaging asks this question: instead of just sending the same amount of money when the price is cheaper, why not send more? Then, the benefits of buying more of the cheaper shares will be magnified, right? You bet, and that’s what we accomplish with value averaging. We put in place a framework for knowing whether we need to send more money, less money, or even pull money out of the investment to keep it on track to reach our growth rate target. In our example, that target is 3% per quarter.
The beauty of the new strategy is that it enables investors to ignore much of the natural volatility of the market but — even more important to investors these days — the artificial volatility inflamed by shenanigans of government, banks, and big business. The game has changed a lot in the last two years, with the strokes of pens from the Treasury and the Fed having much more to do with the direction of any stock than the stock’s product or marketing plans. In such an environment, which is nearly impossible to forecast, tried-and-true growth rules are invaluable. I hope you benefit from the ones explained in this edition, which are presented in “Value Averaging for Steady Growth” on page 110.
Beyond those big strategy enhancements, the 2010 edition brings a thoroughly updated list of websites and resources, extends the book’s classic examples with fresh data so you can see how the situations have changed or remained constant through the fire, and shares reflections from master investors Bill Miller and Charles Michaels, each of whom navigated the rough market and emerged wiser for it.
All in all, a compelling bundle of information for just $10.88, one that I believe you’ll find useful as you reconfigure your portfolio for a new decade. As always, I welcome your thoughts and suggestions once you’ve had a chance to buy the book and implement its techniques.
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