The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (41 page)

A lot of investors are concerned about the economy and agree with much of what we say. However, since the alternatives like gold are uncomfortable, and other alternatives like TIPS or cash don’t earn much money, they decide it is best to do nothing and just stay in the market. Unfortunately, this is a big mistake long term. As we just explained, you can get caught in a market downdraft and not be able to get out quickly. Also, the fact that there are no good alternatives doesn’t mean you should stay in and lose a lot of your money. There’s a popular myth that there is a bull market somewhere all the time. This simply isn’t true and hasn’t ever been true.

When Charlie Merrill (co-founder of Merrill Lynch) told his colleagues in 1928 that it was time to get out of the market it wasn’t because he had spotted a bull market elsewhere. He didn’t tell his colleagues to move out of stocks and put the money in another investment. He told them to get out—period. Yes, there weren’t many good alternatives other than cash. Even gold was a bad alternative. And, yes, he was early. Many who took his advice probably kicked themselves for missing out on the big gains in stocks that their friends were getting after they sold too early. But, he was still right. Long term, his colleagues that simply got out of the market were much better off than those who stayed in. Having a good alternative to stocks was quickly shown to be irrelevant. The key was to get out before you lost your money.

We end this book with our best and most important cartoon. Everybody loves a bubble and
no one
wants to lose it. That’s perfectly reasonable. But when the bubbles burst, it’s time to move on and recognize that a new era of investing has begun. Unfortunately, what many people want is to think that the bubble will somehow come back. This is fantasy (a great fantasy, but a fantasy nonetheless). Even worse, it makes you blind to other bubbles. So we use the cartoon below as a fun way to tell an important message.

Leave this book with a laugh. Humor has been and always will be a valuable commodity. You’ll need even more of that in the future and, unlike other commodities, it won’t fall in value, even with a greater supply. There will always be strong demand for good humor.

Epilogue

If, after reading this book or any of our books, you think America has made mistakes, you’re right. If you think America has somehow lost its ability to change and improve itself, you’re wrong. In fact, the United States is still, and will likely be for decades to come, the most resilient, flexible, and dynamic economy in the world. That’s due in part to one of the world’s most flexible, dynamic, and strongest political systems.

While the short term may be filled with many seemingly insoluble problems, don’t be fooled. The long term is very bright indeed. More than any other country, the United States has been able to forge a path toward greater productivity and higher standards of living. Many countries have benefitted from the groundbreaking work of the United States. China didn’t grow so fast because it was able to innovate on its own. It grew so fast because it adopted the methods of free markets and efficient industrial production, many of which were pioneered or perfected by the United States.

Other countries around the world have grown and benefitted as well by simply watching the United States and learning how it’s done. Not only can they learn directly from our universities, but they can visit our country, see our government, form joint ventures with our corporations, and receive our investment and the business acumen that often comes with it—everything you need to move any developing economy forward.

No, we’re not the only country who has pioneered better methods for greater productivity. But no nation has pioneered in more ways than the United States. From our revolution for democracy, which has inspired and changed the world, to our economic system that has led to the most rapid increase in productivity in human history, we have led the world in many of its most important and beneficial changes.

That we have been distracted by our economic bubbles and away from our relentless focus on productivity in the pursuit of easy money is understandable. It’s a regrettable and costly mistake. But it’s a mistake we will learn from.

By focusing again on improving productivity, the economy will rebound to a much, much higher standard of living than today. The United States has shown time and again it can lead itself, and the world, forward in improving both productivity and quality of life. The two are by no means mutually exclusive. In fact, they are mutually dependent.

But, like all our changes in the past, the ones in the future will be no different. They will not be bestowed on us. We will have to make them. They will be difficult and controversial. That’s nothing new for the United States. We have done it before, and we will do it again.

What’s new for the United States is that in this bubble economy, we have lost that willingness to change and to be controversial. To throw out a king and establish a democracy in 1776 was about as controversial as any country had ever been. Now, we have become more like other countries. It’s not that all other countries have done poorly, but they surely haven’t done as well as the United States. Our ability to change quickly, effectively, and beneficially has been far beyond what any other country has shown in the past two centuries.

That ability is still there but will need to be rekindled. After this bubble economy falls, the rekindled spirit of America will rise again.

Appendix: Additional Background on Stocks and Bonds

In Chapter 4 (on stocks) and Chapter 5 (on bonds), we purposely left out some of the more technical details in order to not interrupt the flow of the chapters. Not everyone wants so much information, and we wanted to focus primarily on the evolving macroeconomic story that will lead us to the coming Aftershock. After all, it is pretty easy these days to look up definitions online or in conventional investment books, but harder to find information about what is really going on, from our non–conventional point of view. We saw no point in giving you yet one more mainstream investment guide.

So here are some of those more technical details we left out of the chapters. This is hardly an exhaustive guide, but it will give you a bit more background on stocks and bonds if you have an interest. For more information than the brief explanations here, we recommend you visit some educational web sites, such as
www.investopedia.com
and others.

Basically, when you buy a stock, you are making a bet that the future earnings of a company will grow. The company initially sells stock certificates in order to raise capital, and the stockholders then own a part of the company. After the initial offering, company stocks can then be sold and bought on the stock market in a giant trading game, where those who want to bet on more future growth are buyers and those who are done with their bet (at least for the moment) are sellers. Like any investment, traders naturally want to sell for more than whatever they paid to buy—that is the only way to make a profit on your stock investment. Once you sell and realize a profit on your investment, you generally have to pay taxes on that capital gain.

Of course, there is much more to the story. Here are the stock topics we will discuss in this appendix:

• Understanding the public offering
  
• Knowing the difference between common stock and preferred stock
  
• Options for buying stocks
  
• Making sense of stock and company data
  
• Using a registered investment adviser
  
• Securities Investor Protection Corporation (SIPC) protection
  
• Knowing your options for “short” selling, including put options and long-term equity anticipation securities (LEAPS)
  

The goal of any well-run company is to keep growing. In order to do this, a business requires capital. In the early stages, a business might rely on earnings, private equity, bank loans, or bonds. But, eventually, many businesses turn to the public offering, allowing common investors to buy shares in the business in exchange for the opportunity to profit from the company’s growth. These investors may also get a voice in determining the company’s direction, but with only a percentage of the company’s value up for grabs, and shares going in various portions to numerous investors, the voice is a small one.

To begin an initial public offering, or IPO, a company generally goes through an investment bank, which assesses the value of the company and underwrites the sale. That is, the investment bank purchases the portion of the company that’s being sold—assuming all risk for the company’s value—then divides up the shares and sells them to the general public, the “primary market.” The bank then collects a small fee while passing on the proceeds to the company. By “small fee” we mean percentage-wise. If you were an investment bank selling $16 billion worth of Facebook shares, for example, a 7 percent fee would amount to more than $1 billion. Not a bad payday.

Once the initial shares have been purchased, they are tradable on the open market, or “secondary market.” All the major stock markets you’ve heard of—the New York Stock Exchange, the Nasdaq, the London Stock Exchange, for example—are secondary markets.

Common stock
is generally what we mean when we discuss the stock market. A common stock represents an ownership share in a company, which, in addition to investing the shareholder in the future of that company, often grants the shareholder certain voting rights, such as in electing the company’s board of directors.

Note that we said that common stock invests the shareholder in the future of that company. That’s important because, generally speaking, the company doesn’t owe common stockholders anything other than due diligence in managing the company’s affairs. If the company grows and the value goes up, the shareholders are happy. If it falters and the price goes down, they may be unhappy and they may complain, but there isn’t much they can do about it, other than sell their shares at a cheaper price and take their money elsewhere. This is why common stock is among the most volatile investments: plenty of room for growth, but plenty of room for losses, too.

Common stocks are traded on stock exchanges all over the world. The oldest exchange in the United States is the Philadelphia Stock Exchange, established in 1790. The largest exchange in the country, and in the world, is the New York Stock Exchange (NYSE), located on Wall Street, along with the American Stock Exchange, or the “Amex.” Other major exchanges in the United States are located in Boston, Chicago, Cincinnati, and San Francisco. You’ve probably also heard of the Nasdaq, the world’s first electronic stock exchange. A primary exchange for high-tech business, the Nasdaq has among the highest trading volume of any market in the world.

Many common stocks pay dividends on a quarterly basis, dividing up their profits among shareholders. Some pay more than others. High-dividend-paying stocks can be a strong incentive for investors, but keep in mind that dividends are optional, and if a company starts to struggle, common stock dividends are often the first thing to go.

Preferred stock
, in addition to representing a share in the company, also represents a debt obligation from the company to the shareholder. Before any dividends are paid to holders of common stock, the company must pay a fixed dividend to preferred shareholders. And in the event of liquidation and any monetary distributions that might come from it, preferred shareholders are in line ahead of common shareholders, who usually won’t receive any compensation at all (although preferred shareholders are still behind bondholders).