While I generally avoid mutual funds like the plague, I don’t avoid the stock market altogether. I’ll split what I do in the stock market into two categories: long and short. Either way, I’m honest with myself in admitting that no matter what I do in the stock market, it will be speculative and risky.

Long

“Going long” means buying a stock and expecting its price or income to rise so I can sell later for a profit. There are millions of people who have access to the same information as you, and that is generally reflected in the price of that stock. If you know something non-public about the company, trading it may be illegal for you. I’ve bought individual stocks before; I just treat the situation honestly; it is speculative in nature, and I only make such trades with very small portions of my portfolio.

I don’t go long on mutual funds because I don’t know what I’m going long on. It is virtually impossible to know what I’m actually investing in when I buy shares of a fund.

Short

Selling Short… A short position is the opposite of a long one. Instead of buying low and selling high, selling short is a matter of selling high and then buying low. For me to do this, I borrow shares of a stock and simultaneously sell them at the market price in expectation of a price decrease. To close this position later, I just have to buy back shares of the same stock at the then market price and pay back the borrowed stock. If during my position the stock price declined, I profit; if the stock price increased, I have a loss.

Ex: ABC Company seems to be doomed. It’s currently trading at $50, but I think it will go much lower over the next couple months. I sell 100 shares short. This means I borrow 100 shares and simultaneously sell them for $5,000. A few months later I see the stock price has declined to $35. To close my position, I buy 100 shares back for $3,500. I pay back the borrowed shares and retain the $1,500 profit, less fees and commissions.

I like short selling more than going long. I often notice stocks crashing down faster and more predictably than they spike up. It also might be easier to confidently predict the demise of a company than the thriving of one. In the past, I liked a wind energy stock, but felt more strongly about the decline of home builders and mortgage lenders. So to me the better investment was to sell home builders and mortgage lenders short. Wind energy may really take off… but who knows if the company I’m looking at will be a forerunner. On the other hand, when the mortgage market is headed downhill, just about any mortgage company is going to be hurt, and it’s very easy to target those who readily admit to holding subprime notes.

Buying Put Options… Buying a put option is similar to short selling in that it is done when you expect a stock price to decline. Buying a put option means buying the right to sell a stock at a certain price. You don’t actually sell it right away; you just pay a premium for the right to sell it at a certain price in a certain window of time. If the stock price goes down, you can sell the option for a higher premium than you paid or you can exercise your option to claim the profit. I don’t like put options as much, because if a stock is already falling, then the premium you pay to buy the put rises because the seller of the put option knows it’s falling. That same already falling stock can be sold short (as soon as its price has an up tick) with no premium to pay.

Inverse Index Funds… An index fund is one that attempts to closely mimic the price movements of an entire group of stocks (an index) such as the S&P 500. Most index funds allow you to effectively “go long” on all the stocks in the index. An inverse index fund enables you mimic selling short an entire index. Such a fund is invested in a way that attempts to have price movements that are the opposite of the chosen index. So an inverse S&P 500 fund will go up in price $1 for every $1 decline in the S&P 500. It will also go down $1 for every $1 rise in price of the index. For extremely leveraged speculation, you can even choose a double inverse index fund – where the fund goes up $2 for every $1 that the chosen index declines. It also goes down $2 for every $1 rise in the chosen index.

The Window of Opportunity

The wild thing is that many people who own stocks or mutual funds aren’t even aware of short positions, leaving them with only long strategies. This benefits me because when a stock or fund is declining in value, financial advisors are often telling people to hold on for the long term. This keeps the price from falling too rapidly. As a result of the “hopers”, there is enough time for me to see the decline and still have time to profit from short selling it before its downward movement concludes.

Investing – the placing of assets to build wealth in a way where overall return can be maximized and risk minimized confidently, competently, and consistently.

Saving – the act of reducing spending in an effort to accumulate wealth.

Surrendering – the placing of money into a situation where you have little to no understanding of where your money actually went… and thus little or no control of what happens to it.

Building on that, my philosophy of wealth building contains 4 simple truths:

1. Investing primarily in the stock market is only possible on a large scale (like Warren Buffett) or with nonpublic information. The latter is illegal and can result in imprisonment.
2. In the current inflationary environment, saving US dollars results in a loss of wealth… even in a CD or money market fund.
3. The average person’s investable assets are inside retirement accounts, such as IRAs or 401(k) plans.
4. The average person cannot invest until they restructure their retirement accounts to have unrestricted investment options.

What you’ve called investing may have actually been saving and surrendering under my definitions.

Investing into a stock may be a matter of speculative investing, but investing into a mutual fund is more a matter of surrendering. The latter is what is most applicable to average Americans because 85% of IRA wealth is held in mutual funds.

Mutual Funds = Surrendering

Over time it has become increasingly apparent that it is difficult, at best, for an average person to truly understand where their “investment” money actually went. In the dot-com crash of 2000, it was discovered that many mutual funds were much more invested into internet technology stocks than previously disclosed. In 2003, it was discovered that several major mutual funds were taking part in illegal late trading. In 2007, it was discovered that many mutual funds were more heavily invested in subprime mortgages than previously disclosed. Fund managers who haven’t met their performance expectations are often faced with a difficult choice: lose their job or swing for the fences (invest their fund’s money radically differently than disclosed in an effort to “catch up”). Additionally, just type in “mutual fund scandal” into any search engine, and you can find 101 reasons why money placed into mutual funds is surrendered. In a recent Fortune article, even Warren Buffet laughs about how, on the extreme side, of things sometimes there are “…750,000 pages to read to understand one security.” On fund managers, he even comments, “When you start buying tranches of other instruments, nobody knows what they hell they’re doing. It’s ridiculous.” When asked “If big financial institutions don’t seem to know what’s in their portfolios, how will investors ever know when it’s safe?” Warren replies, “They can’t, they can’t.”

Saving = Loss of Wealth

If you save money and put it into a CD or money market fund that earns 3.5% in an inflationary environment of 11.5% annual currency debasement, you’re losing 8% per year.

Investing

Well, that’s what the rest of my writing is mostly about. But, Step Uno is to stop saving and stop surrendering.

The stock market does not go up 10% per year in the long run

• The math is just plain wrong. Lying averages tell us if you average the annual returns of the stock market it will equal its performance… but, as the name implies, it is not true. Lying averages tell you that if you are aiming for a 10% average return, and you have a 20% loss one year, it will take a 30% gain the next year to get back on track. Truthful math will tell you it will take a 50% gain just to get back on track for a 10% average annual return. Think about that in light of the stock market activity in 2000, 2002, and 2007.
• Any returns less than inflation is truly a loss. With inflation currently at 11.58%, you’ll need a 21.58% annual return to grow your wealth at 10% per year.

Just look at the last 10 years of data…

On the chart above, the red line reflects the inflation rate as published by the U.S. Bureau of Labor Statistics. This calculation interestingly excludes certain factors such as the price of oil, food, and in the future, anything else that rises rapidly in price due to inflation. Social Security benefits are increased according to figures based on these BLS calculations (you may as well remove the “L”). Most of us actually eat food and use gasoline, so luckily there are other sources that track inflation as indicated by the blue line.

During the last 10 years, there was a stock boom and bust. Overall, the S&P 500 returned 4.18%. As you can see above, inflation during that time fluctuated between 8% and 12%. If you had invested $100,000 into an S&P 500 index fund from 1998 to 2008, this is how it would look:

…a loss of $37,417. So you lost 37% or 3.7% per year rather than experiencing the mythological 10% return of the market.

What if you could earn a predictable income in excess of 10% annually? Would it be worth wiping the slate clean, dropping the conventional adage, and learning how to understand financial statements and private financial instruments? What if you could build your wealth using methods employed for centuries by the world’s wealthiest individuals?