Chapter 1
The Basics

It is a sad commentary on the state of our nation that when the Federal Reserve surveyed 5,000 people in 2016, it found that 46% of them could not easily come up with $400 to deal with a medical or other emergency.  Just as alarming are the stats on how well prepared Americans are for retirement: Most people in their 40s or 50s have little or no savings, have no plan to grow significant assets and must contemplate surviving retirement on meager Social Security payments or the generosity of their children. 

This book is not for those people. 

I’m writing for logical thinking investors who are determined to accumulate a substantial amount of money over time. I’m writing for patient people  ─  people who can think l o n g – term. Maybe you run your own business, or have a medical or dental practice.  Maybe you earn a six-figure salary at a big company and have been both saving and maximizing your 401(k) plan or IRA, as you should. Or maybe you had a big windfall — the sale of that business or the death of parents who left you a portfolio of stocks and a $2 million house you intend to sell.

Whether you have high regular income or a sudden cash infusion, you need to know how to invest.  What people do in such circumstances depends on how much they know about markets and investing.  Most know so little they call up Schwab or Fidelity, or Morgan Stanley, (or their brother-in-law) or a private financial planner/advisor and yell, “Help!” And those guys and gals will be happy to help if you are willing to turn over control of your portfolio to them and pay them a percent or more of your assets every year to manage it — even if you are losing money on their brilliant investments.  Worst of all, they will blindly follow conventional thinking and diversify your assets into 60% stocks and 40% bonds, (when did Buddah say “60% stocks, 40% bonds”?) or find a way to include hedge funds, venture capital or other “alternatives” ─ thereby insuring mediocre performance.

I’m here to tell you that you don’t need all those “experts”— all you need is an account with a discount broker and a notion of what the best performing investments are.  An expert you should revere, however, is John Bogle, the genius who convinced millions of investors that, over time, the best investment is an index fund. He chose the S & P 500.  Bogle is an investing icon, but his basic premise can be refined if you look at the data — and that is one reason I’m writing this book.  I know what you’re thinking  ─  here’s the batboy trying to improve on Babe Ruth. But……….…the batboy didn’t have to be Babe Ruth to notice a small but significant refinement that could add to the Babe’s performance. And, by the end of this book, you will know what to buy and when to buy: Hint, it’s small cap value ETFs ( I prefer smart beta SCVs) and whenever you have cash.

But before I present my argument, here’s a brief primer on the world of investment.  But before we get to the meat, let’s savor some hors d’oeuvres. And if you have patience and persistence, get ready for the champagne and caviar.

The Stock Market

Most people, when they think of investing, think first of stocks.  For investment purposes, companies that go public — that is, offer shares to outside investors — are divided into those with a large-market-capitalization (large caps), a mid-market capitalization (mid caps) and a small-market capitalization (small caps).  A company’s market cap is the number of shares outstanding multiplied by the price of those shares. Although definitions vary, Investopedia defines a large-cap stock or company as one valued at $10 billion or more; mid-cap as $2 billion to $10 billion; small-cap as $300 million to $2 billion.  The largest company in the world in mid 2019 was Microsoft, with a capitalization of more than a trillion $.

Mid-cap stocks, as a class, haven’t been studied nearly as extensively as small and large caps. Since mid-caps tend to follow the pattern of small-caps, and research comparing small cap vs. large cap stocks is plentiful and persuasive, I have combined mid-caps with small caps.

Note that none of these valuations have anything directly to do with a company’s earnings, aka profits.  As has been known since the first share of stock was sold hundreds of years ago — and especially since the Internet boom and crash of the late 1990s and early 2000s ─ a company may be highly valued by the market without ever having made a profit.  A well-known example of this was Tesla , the California-based maker of electric cars and solar batteries.  Despite years of unkept promises by founder Elon Musk, investors who regarded Musk as some kind of tech messiah had driven up Tesla’s market value to more than $50 billion as of early 2018. Ironically, those who, seeing all that red ink, shorted the stock early on — i.e., bet that it would fall in price ─  were burned by the “irrational exuberance” of the Tesla stock buyers. To be fair, Tesla has reported small profits recently.

In addition to large and small cap, analysts break down stocks into two additional categories: growth and value.  Growth stocks are defined as companies whose revenues and earnings are expected to rise rapidly, and the stock prices are higher based on that premise.  Those projections can be highly suspect. Value stocks are shares of companies that have solid revenue and earnings, but are expected to grow at a lower rate.  Analysts use different measures to decide if a stock qualifies as value: its price to earnings /ratio (P/E), price to earnings growth ratio, book value per share, and various other factors.  In recent years, growth stocks have outperformed value stocks. I’ll show that, over long periods, the reverse is true, especially if you invest in small cap value.

I’m not going to give much space to bonds because over all recorded 20-year periods they have underperformed stocks. That said, there have been rare short periods, especially in times of deep recessions and drawn-out bear markets, where it has paid to own bonds. So my heretical takeaway recommendation is that you ignore advisors who tell you that you should have 40% of your money in bonds, or that your bond holdings should match your age.( Where in the Koran does it say “have 40% in bonds”?) Remember, when thinking decades, not days, for the most productive lifetime investing, bonds are a no-no.

A bond is simply a debt instrument through which a government, a quasi-government agency, or a company, raises money to fund its operations.  The U.S. government issues notes, bills, and bonds with maturities ranging from 4 weeks to 30 years.

There are also municipal bonds of many types, and they are used to fund local, state or multi-state entities (like the Port Authority of New York and New Jersey).

The lure of federal government and local or state municipal bonds is that they are “safe” and that, with municipals, the interest they earn (in most cases) is tax-free, so when you buy them you feel you are putting one over on the tax collector.  The fact that you’re earning very little compared to what you could get from stocks is too often ignored. . The statement “40% in bonds reduces risk” is a myth.  REAL RISK is not owning the most productive stock class (small cap value) over l o n g periods. That’s what this book is all about.

Then there are corporate bonds, which vary from very safe (AAA) to high-yield or “junk”. Junk bonds are issued by companies that are rated by Moody’s and Standard & Poor’s as at higher risk of default than the AAA companies like Johnson and Johnson or Exxon Mobil.

Mutual Funds

The first modern mutual fund was the Massachusetts’ Investment Trust, launched in 1924.  The Wellington Fund, now part of Vanguard and founded in 1928, was the first fund to include stocks and bonds.  The popularity of mutual funds has waxed and waned over the decades.  They became mass investment vehicles in the 1970s, propelled in part by the 1974 creation of IRAs and the 1978 introduction of 401Ks. 

Nationally, 401(k) plans now hold trillions of dollars, the great bulk of it in mutual funds.  Big companies often match a portion of the money contributed by their employees.  There are now more than 10,000 mutual funds, and they offer a maze of stocks and bonds, commodities, real estate, private equity, funds of hedge funds and on and on.

Mutual funds come in two flavors — actively managed and passive. Passive funds track an index.  Every fund was actively managed until the mid-seventies, when a Chicago bank launched a fund modeled on the Standard & Poor’s 500.  (Minimum investment $100,000.)  In 1976, John Bogle of Vanguard created the first index fund for the common man, replicating the S&P 500.  He was derided at the time (“Bogle’s folly”). Eventually it became clear that the majority of active managers trail their benchmarks, and those that do outperform eventually succumb to the law of gravity. Though the majority of funds are still actively managed, the trend toward passive investing is clear. At present, actively managed mutual funds are experiencing capital outflows, while assets in index funds are increasing rapidly.

Venture Capital, Hedge Funds, & Other Alternatives

So you don’t want to be Warren Buffett. You would rather be Peter Thiel.  He is the venture capitalist who co- founded PayPal and was the first outside investor in Facebook, where he turned a $500,000 nugget into a $1 billion gold mine. Venture capitalists are wealthy people who are on the prowl for the next Facebook — that is, start-up companies with potential to become blockbusters.  This is a truly risky business, as even Thiel would tell you. Keep this in mind: By the time a venture capital offering is available to you, it has been passed over by many layers of more sophisticated investors. So…..keep your money and your children’s money in small-cap value ETFs.

The hero-investors that pre-dated venture capitalists were hedge fund managers. Hedge funds are unregulated pools of money that their managers invest in, well, whatever they want to.  The name comes from the notion that those managers hedge their long bets — that prices of whatever they are buying will rise — with short bets, that prices of an alternative list of investments will fall.  Yet few hedge funds are really hedged, as is proved every time there is a major market downturn and most hedge funds fall along with the S&P 500.  Hedge funds do NOT outperform the market! And, as an added negative, they charge 2% on all your money for management, PLUS 20% of your profits.

Stay away, I say: Remember, the oceanfront mansions in the Hamptons belong to the hedge fund owners, not their customers.

Another investment alternative is real estate, mostly represented in the investable market — investable by you and me, that is — by real estate investment trusts, or REITs.  REITs are required by law to distribute all profits from their investments to shareholders, the biggest ones usually being the men running the REIT. They can be good investments, but their historical returns are volatile and don’t match what you will earn from…..wait for it…..small-cap value ETFs.

Finally, also listed under alternative investments are purchases of such commodities as wine, coins, stamps and art.  This is how those venture capitalists and hedge fund managers spend their money.  If you want to emulate them, you had better know your Manets from your Monets, or you will be separated from your Money.

Here’s the TAKEAWAY: Exchange Traded Funds are so central to my investing ideas that they merit a separate chapter. Spoiler Alert! That chapter will conclude ETFs are the BEST way to invest your stock dollars

In Conclusion

This chapter could go on forever, but your time is best spent learning how to make your money multiply with a simple and safe strategy in your lifetime. So forget about hedge funds, and venture capital. Don’t even consider options, commodities, real estate investment trusts, and emerging market small cap junk bonds. Don’t swing at the 102 mile-an-hour fastball when there’s a juicy soft pitch (Smart Beta Small Cap Value ETFs) waiting for your home-run swat.

Enough fluff ─ Let’s get to the real stuff ─ ETFs, Smart Beta ETFs, and the Smart Beta Small Cap Value ETFs.