Last Thursday, in Message #1031, I encouraged you to make a commitment to increase your income by at least 10% this year. Let’s say, just to keep the numbers round, that it amounts to $10,000. Here’s what you should do with that extra money: 1. Set aside the portion of the $10,000 that the government wants — $2,500 to $4,000. That leaves you with $6,000 to $7,500 net after taxes. 2. Allocate 10% of your net after taxes ($600 to $750) to reward yourself with a bonus for meeting your goal — perhaps with the purchase of something you’ve been wanting for a long time. 3. Invest the rest in stocks and bonds.

Let’s talk now about that — about investing in stocks and bonds. As you probably know, I have spent a lot of time in the investment-advisory business. Not on the financial-planning or brokerage side, but as a consultant to investment book and newsletter publishers. I’ve also created, marketed, directed, and spoken at more than 100 investment seminars and conferences. All that experience has taught me one important lesson: You can’t make money by looking for 10-to-1 returns.

If you want to get wealthy as an investor, you have to have more reasonable expectations. Here is what I recommend for your stocks and bonds this year: Bonds It’s tough to put your money in bonds. The yields are low. Quality bonds are expensive. To get more than 5% in munis, for example, you have to go out a long way — more than 15 years. Still, I’m investing in bonds. Why? Because I have so much of my wealth tied up in real estate and small businesses. These investments have given me consistently high returns — probably in the 15%-to-20% range overall — so I would rather put my “extra” money in super-safe investments.

Since I buy only top-rated municipal bonds and don’t trade them (I just wait till they expire), I feel that they are safe. But to make them safe against the falling dollar, I’ll have to invest in overseas funds this year. I don’t know much about them, and that’s a bad thing. I’ll probably lose some money learning. But I’ll ask around and make some small investments and let you know what happens. By the way, I like to “ladder” my bonds — i.e., buy them so that every year of my retirement I will have a certain number that are coming into maturity.

Right now, for example, I have bonds expiring starting from 2007 (the planned beginning of my “second retirement”) and going to 2022. That means that for 15 years after I retire, I’ll have a bunch of money coming to me tax-free. It should be all I need — and if it is, I’ll be “good” till I’m 72. Since I plan to live till I’m 92, I have to either buy 20 more years’ worth of bonds or roll over those in the early years of my second retirement if I don’t need them. Since bonds represent only a portion of my retirement assets, I should be OK. At least that’s how I look at it. I will also have rental income equal to or greater than my income from bonds during that period of time. That will last till I die — unless I decide to sell those properties. I’m not counting on being able to sell any of my businesses. Not because they aren’t worth anything — they are, and similar ones have sold very well in the past — but because I don’t feel that I can count on them the way I can count on real estate or government-backed bonds. I recommend that you put some of your extra money in bonds — even if you are very young.

Stocks I have trouble predicting the profits of companies that I own — businesses that I know as well as I know my children — so how can I presume to know the future earnings of someone else’s business? And even if I could predict the earnings, how could I know how they would be reflected in the share price? In the past 10 years, stock prices have been all over the place. I do believe that they will normalize themselves from time to time (in terms of P/E ratios, for example), but that is a general theory of how the world works. I don’t trust my theories enough to bet on them too heavily. So while I do believe in the stock market, I’m going to invest in it very cautiously this year.

Over the long haul, history tells us, we can expect to make about 9% or 10% on our money if our stock investments perform, on the average, as well as the market as a whole. You may be able to achieve that goal — 9% or 10% — by finding a good adviser or a good stock-investing system and sticking with it. You might even do a little better than that. I know dozens of well-known stock pickers personally and have followed their careers for decades. But right now, there are only a handful of people I watch and trust. This is not because the others weren’t smart (some were brilliant), or honest (some to a fault), or knowledgeable (some were positively erudite) but because sooner or later — and usually when things were “going against them” — they abandoned their sensible investing programs and jumped on whatever trend happened to be hot.

People (Mark Hulbert among others) who study investment advisers will tell you that very few gurus beat the market over time. Any individual stock picker may get hot for a while, but very few post above-market returns over a long period of time. Those who are consistently successful share one trait: They stick to their stock-picking systems even when the market seems to turn against them. (Warren Buffett refused to abandon his fundamentalist approach to buying stocks even when the media — enraptured by the Internet gurus — were questioning his sanity. Now, he is once again being regaled as a financial genius.)

I look for four other traits in a stock story or a stock picker or a stock-picking system:

1. I like to buy value. As I said above, I believe that — over the long run — stock prices will, by and large, reflect earnings. Therefore, I like advisers and advisory systems that keep P/E ratios in mind.

2. I prefer companies that have profit schemes I can understand. You can’t know enough about another person’s business to predict its outcome. But if you can at least understand how he plans to sell his product — and if you have some similar experience in your own business life that you can compare that selling scheme to — you have a better chance of avoiding flakes, fakes, and fast faders. (The reason I bought very few Internet stocks is that I could never make sense of their marketing plans. For the most part, they violated everything I’d learned about selling.)

3. I am skeptical of good stock stories. Being a marketing man myself, I’m a sucker for a good tale. But I know from the inside out that a good stock story usually says more about the storyteller than it does about the stock itself.

4. I know that no matter how sound my investment seems, I will never know enough about the stock (including the market’s reaction to it at any given time) to be sure that the price will go where I want it to go.

For that reason, I favor trailing stop-losses. Although I do have in my portfolio some stocks composed of very substantial, very solid companies — stocks that I intend to hold on to for the long term — I believe from what I’ve read that to get a higher-than-average yield from the market, you have to pick stocks that have lower caps and are more likely to grow. And since this approach involves more risk, you need to mitigate that risk by setting and keeping trailing stop-losses. To further reduce my risks with stocks, I break my ongoing stock investing into two parts. Half of it goes into additional very big, very reliable companies that I plan to hold for at least 10 years. The other half goes into stocks selected according to the criteria mentioned above, following the advice of a stock picker I trust. When I hear a recommendation that captures my imagination — and meets the standards I’ve embraced — I’m happy to make an investment. But it’s never more than 1% of my invested net wealth.

ETR regularly features the investment advice of Steve Sjuggerud, editor of True Wealth and a senior adviser to the Oxford Club. I not only know Steve well and trust him completely, I have also watched his recommendations over the years and have been enormously impressed by them. He shares my conservative posture toward stocks yet he knows how to make money with them — much better than I could. He’s also been very good at timing the market. He pulled his readers out of the market before the Internet bubble collapsed and he went back in time to enjoy the recent run up. (I stood by and didn’t make but 3% or 4%. He has had a great year.)

In addition to Steve, I’ll introduce you to the other financial experts whose opinions I value when they tell me something I think you should know about. And, occasionally, I’ll tell you about some of the new stars I hear about — usually bright, young investment analysts who are making a lot of winning calls. In such cases, I won’t be recommending them with confidence — just letting you know that they have a hot hand right now, in case you are (as my colleague Bill Bonner recently put it) “feeling lucky.”

One final thing. I do intend to invest in a trend: the collapse of the dollar. I’ve been persuaded by everything Bill Bonner has been saying in the Daily Reckoning, and I’ve seen the success Steve has had betting against the greenback too. A friend of my son (who is visiting with us as I write this in Nicaragua) is making a fortune investing outside the dollar. He just came down from checking his anti-dollar portfolio on my computer and announced that he is “richer than he’s ever been.” I told him to cash in his earnings and bury his windfall in the backyard. He told me I was jealous. He’s probably right. When I get done writing this, I’m going to ask him how he has been doing what he’s been doing. If he tells me, I’ll tell you.

[Ed. Note.  Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]
Mark Morgan Ford

Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Wealth Builders Club. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.

Mark Morgan Ford

Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Wealth Builders Club. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.