Tuesday, August 5, 2008

The Key to Making Money in the Market

Today I'm going to let you in on a secret, the holy grail of investing if you will. The key to making and holding on to long term gains in the market has nothing to do with how much you make on your winning positions. Never has never will. The key to making money is in how much you lose when you miss.

As anyone who's read the comments on the blog or any blog for that matter knows there is a never ending line of people who claim to make outrageous gains in the market or they claim to never or rarely ever miss a call.

I can tell you when I see these amazing claims I just have to shake my head. Anyone who claims to make 100% in the market is also going to be the one who loses 100% in the market. If there is anything that history has shown it's that no one and I mean no one can produce much more than 20% annually over any significant period of time. Buffett is one of the best and his 30 year average annual return is in the neighborhood of 25%.

What most investors don't realize is that you can get filthy rich in 15 -20 years by compounding 20% a year. Hell you can get rich by compounding 12-15% a year. All you need is a little patience and good risk management skills to assure your future.

After 20 years compounding at 15% a year you would turn $100,000 into $1,636629.
That same $100,000 compounded at 20% would have you retiring with $9,584,383.

The only way to achieve these kind of long term results by trading is to control risk.
Investing on the other hand is a different ball game. Maybe I'll do a post on that one tomorrow.

Unfortunately most investors can't be satisfied with 10-20% so they take on too much leverage trying to make outlandish gains. Sooner or later this leverage always comes back to bite you in the ass. The bottom line is by trying to maximize your gains you end up guaranteeing your failure.

This is probably the hardest thing for novice investors to accept. We all start investing because we see it as an easy way to get rich. I mean seriously how hard is it to click a mouse? The answer of course is it's about the hardest damn thing in the world to do successfully. In this business you are competing against the smartest people in the world. Does anyone really think it's going to be easy to part them from their money?

My advice to any beginning investor is to keep your positions tiny for the first 5 years. Concentrate on not losing money and forget about trying to make any. That part will take care of itself in time as long as you don't lose your wad. The smartest thing you can do as a beginning investor is make it as hard as possible for the pros to get your money.