Finding Balance in a Highly Volatile World

Losing your retirement... Not knowing what an investment can do... Howard Marks' level-headed advice... Finding balance in a highly volatile world... It's not the stock, it's the proposition... Investing is like a savage sport... Building the right portfolio for you...

William Mark went from having a reasonably comfortable retirement to near bankruptcy in just two weeks...

After the financial crisis in 2008, the piping engineer decided to avoid stocks and bonds, which had taken their toll on people's savings... And with retirement in sight, he needed to play catch up with his nest egg.

So he started to purchase leveraged exchange-traded notes (ETNs), issued by Swiss investment bank UBS (UBS).

ETNs are debt instruments that trade like a stock – where the issuing bank promises to pay the ETN holder a return based on an index...

On the surface, ETNs seem similar to exchange-traded funds (ETFs) – as both allow you to bet on the performance of an index. But in reality, they're very different from each other...

An ETF owns a basket of actual securities ‒ stocks, bonds, or commodities ‒ that it tracks. ETNs, on the other hand, don't own the assets they track.

And though ETNs are debt securities, they're not bonds. There's no guaranteed coupon and their performance is correlated to an underlying index – so there can be a loss of principal... sometimes big losses.

Especially, when you add leverage... Many ETNs use a leverage of two to three times. Leverage enhances returns on the way up and magnifies losses on the way down...

For instance, if the underlying index increases 10%, a triple-leveraged ETN will rise 30% on the same move... Or correspondingly, if the index declines 10%, a triple-leveraged ETN will fall 30%.

Banks advertise these products as offering steady payouts with the potential of higher returns, compared to bonds or index tracking funds... But they're really a complex derivative product – often taking on debt and using options to increase leverage...

Most retail investors don't realize the risk...

Institutional investors know better and tend to avoid these products.

Like many retirees, William Mark needed cash flow and was attracted by the potential of high dividends... So he invested in a leveraged ETN, issued by UBS, based on an index of mortgage real estate investment trusts, or mortgage REITs.

Until the start of the COVID-19 pandemic in early 2020, Mark's ETNs performed great... On average, it was generating around 18% per year in dividends. In fact, it worked so well that Mark put almost all his money – $800,000 ‒ into these leveraged ETNs, according to the Wall Street Journal.

Though Mark didn't realize it, he was only able to generate such high returns because of the leverage. He was taking on an extraordinary amount of risk... and he didn't seem to realize it.

When the pandemic hit in early 2020, the leverage that let Mark generate outsized returns turned against him. He got wiped out.

In June 2020, Mark told the Journal...

I'm 67 years old and I'm basically bankrupt in just two weeks.

Mark lost most of his $800,000 retirement nest egg.

The same thing happened to 78-year-old retired college professor James Zhu...

According to the Journal, Zhu invested his and his wife's life savings into a leveraged ETN at UBS – also tied to mortgage REITs.

When the pandemic hit in March 2020, corporations were scrambling for cash. The cost of borrowing for a mortgage REIT soared – drastically altering the business outlook... Correspondingly, the price of mortgage REITs tanked.

Shares of Zhu's two-time leveraged ETN fell from $16 to $0.25... That's a 98% loss in one month.

Typically, the issuing bank has the right to take the ETN off the market if it falls below a certain level. After it fell a significant amount, UBS took Zhu's ETN off the market at around $0.20 per share... The Zhus lost their life savings – around $700,000.

Zhu told the Journal that he and his wife are " too old to play those games." They were "just looking for basic income"...

Mark and Zhu's desperate search for income is a common problem for investors.

Years of low interest rates created by Federal Reserve policies have left financial markets saturated with liquidity. This has led to higher prices of financial assets... and has made finding an affordable entry price into the market more challenging for small investors.

And ordinary investors like Mark and Zhu often end up taking on extraordinary risk in search of a quicker path to a higher yield to fund their retirement.

For a while, generating outsized returns must have felt easy to Mark and Zhu... just buy an ETN and let it ride.

Alas, few things in life tend to be so simple... especially investing. Both Mark and Zhu unwittingly gambled their life savings and lost...

What's worse, their investment catastrophes were completely avoidable and unnecessary... And I (Bill McGilton) want to share with you today how to avoid this happening to you by creating an investment strategy that can maximize your returns, while greatly reducing your risk.

Investment legend Howard Marks is probably the world's greatest distressed-debt investor...

The co-founder of Oaktree Capital Management started the world's first institutional distressed-debt fund back in 1978... Since then, Marks' high-yield bond funds have returned around 19% annualized (after fees)...

Marks is generous with his investment insights... He pens detailed letters and puts them on his website for all to read. These memos contain valuable insights for investors.

One of the things that I like about Marks is how he looks at investing. He incorporates a gambling perspective into his approach...

Now, this doesn't mean he gambles his clients' money... far from it. What it does mean is that Marks makes it his business to understand the probability of the success of any given investment... and, thus its corresponding payout.

In his January 13, 2020 memo, "You Bet!", Marks describes how he studied blackjack and poker among many other games ‒ not because he's a gambler, but because it was fun for him... He is fascinated with probabilities... And he applied what he learned to investing.

Over time, Marks came to understand that to become successful at investing, it's necessary to become comfortable with uncertainty and unpredictable events.

So rather than being sure that something will work, it's better for an investor to focus on uncertainties surrounding an investment – just knowing that a less-than-optimal result may occur... and what that could mean.

That doesn't mean not taking risk...

It means understanding what can go wrong and what the downside can look like.

For Marks, it ties into being a good decision-maker – which is an essential trait for a good investor... This includes being able to organize data, evaluate the likelihood of success and failure, weighing risk-and-reward potentials, and being honest about what you know and don't know...

Someone might get lucky jumping on a hot stock or ETN for a short ride... But over time, luck will run out if an investor doesn't employ the criteria used by a good decision-maker.

Marks says superior investors will have certain basic skills – like being able to...

Assess revenue and profit potential, where we stand in the cycle, the fairness of an asset's price and the margin of safety it affords. No one gets these things right all the time, but the superior investor does so more often than most.

A good decision-maker has a much higher probability of investment success – as he can access how certain he is about an investment and its payout potentials... Plus, he can organize risk across his portfolio.

According to Marks, investing is not about picking winners. It's about identifying superior propositions where there's a mispricing.

Marks says people often say to him... "XYZ is a great company with a bright future, so I bought the stock."

Marks sees that as "picking a favorite but ignoring the proposition."

What's the 'proposition?'

As Marks puts it...

While in investing we generally aren't offered explicit odds, the attractiveness of the proposition is established by certain factors... such as the price of the asset, the ratio of the potential payoff to the amount risked, and what we perceive to be the chance of winning versus losing.

So just because XYZ is a good company does not mean it is always a good investment...

Marks goes on to say that superior investors have the skills to figure out winners... But the best investors, he says, understand "situations where the proposition is too favorable relative to the underlying fundamentals."

This could be a scenario in which a company is cheap relative to where it looks like its price might go... Or the stock seems to be highly priced already but can go even higher because the company has so much potential.

In summary, Marks says this...

Success in investing doesn't come from buying good things, but from buying things well, and it's essential to know the difference.

Now let's see how many of Howard Marks' maxims William Mark and James Zhu violated...

Unfortunately, quite a few... They didn't understand their ETN investments, they never considered what could go wrong, and they never calculated what it could cost them if things did go wrong...

Blinded by what they needed, they never considered what was realistic under current market conditions.

But their worst decision of all was not taking what Nobel-Prize-winning modern-portfolio theorist Harry Markowitz calls the only free lunch in investing... diversification.

Diversification is the key to a long-term successful portfolio. And the magic to diversification is this... If you're going to chase higher returns, one of the best ways to reduce risk is to allocate your money over a number of positions and asset types... It reduces exposure to disappointing returns in any one position.

The potential for higher returns is still there. But a single mistake won't wipe you out....

Serious investors will take it a step further by factoring in uncertainty by sizing each position according to risk.

Had Mark and Zhu invested only a portion of their portfolio in ETNs, they would have taken a loss, but it would have been proportional. It may have hurt... but it wouldn't have been catastrophic.

Serious investing is like playing a sport...

But in a way, it's much more savage...

In professional sports, athletes play with other athletes of the same caliber... These are talented and highly trained individuals – surrounded by people hired to improve their performance.

To put it into perspective... imagine LeBron James playing basketball against your high-school-aged son...

This is what happens every day in financial markets... Banks, hedge funds, and institutions – with armies of researchers and analysts – compete head-to-head with individual investors.

But it doesn't have to be that way...

Stansberry Research provides individual investors with top analysts and researchers...

We offer investment-research products that provide individual investors with information and insights so that they can find the right mix of investments to build a portfolio that finds the right balance between risk and return.

Our diversified team of editors and analysts provides research across a number of industries...

Like Howard Marks, we're not just looking for winners... Our team is constantly scouring the market for superior investment propositions – with favorable odds for outsized returns.

One product that has helped many individual investors find success is Portfolio Solutions – where we offer full investment portfolios consisting of what we think are the finest investments in the market.

Portfolio Solutions is a great and simple service to help individual investors manage a risk-adjusted portfolio.

It provides the opportunity for high returns – while reducing risk through diversification, risk assessment, and position sizing...

We have different portfolios – some designed for capital appreciation, while others focus on maximizing income generation.

The market is extremely volatile right now... Tech stocks have gotten crushed, down around 10% for the year... but they might come back soon... Gold and silver have been stagnant but function as an important hedge for risk-averse investors.

We can never know exactly what the market has in store ‒ and that's the value of having a well-constructed portfolio... It isn't easy, but it's extremely satisfying to sleep at night knowing that you fully understand your risks and feel confident in your ability to grow your wealth each year.

It's the feeling we've been delivering to readers for five years now with Portfolio Solutions...

Joining Portfolio Solutions today with this special offer is a simple step that you can make to have a massive impact on your wealth in 2022... If you're managing your own portfolio and want to learn more about how to get it better positioned, you can do so by clicking here.

New 52-week highs (as of 2/1/22): Bunge (BG), Continental Resources (CLR), Freehold Royalties (FRU.TO), Cheniere Energy (LNG), McCormick (MKC), Osisko Mining (OBNNF), Shell (SHEL), Suncor Energy (SU), United States Commodity Index Fund (USCI), and Viper Energy Partners (VNOM).

In today's mailbag, feedback on yesterday's Digest about the latest event from True Wealth editor Dr. Steve Sjuggerud, Retirement Millionaire editor Dr. David "Doc" Eifrig, and our Director of Research Matt Weinschenk... Plus a little more discussion about professional sports teams with long odds to win a championship... Do you have a comment or question? As always, send your thoughts to feedback@stansberryresearch.com.

"Corey, Your recent Digest about asset allocation being the most important aspect of portfolio returns was excellent. You really captured the essence of [Steve, Doc, and Matt's] presentation.

"I honestly have to admit that it was the best presentation I have ever watched from Stansberry Research ‒ as far as I felt it was more of a discussion of many insights and less of a marketing approach to get us to invest in one of the portfolio solutions.

"Of course, the information was so compelling that it does make me think of the value that Portfolio Solutions would provide me. At this time, I am not prepared to sign up for it, but I certainly understand how it could help me to have more peace of mind and not be so concerned with which new recommendations in the various newsletters would best fit into my portfolio.

"I especially liked it when you said...

It's well worth the watch... Not only did Matt discuss this nugget of investing wisdom that we just shared with you, but the trio offered up plenty of illuminating insights...

"I concur emphatically with that comment. Even if someone is not interested in getting the portfolio solutions that are offered, it was still very worth watching.

"Everything I have subscribed to so far is very much worth what I have paid for it. I am sincere when I say that I am grateful to everyone at Stansberry Research and how they have treated me as a subscriber. Thank you." – Paid-up subscriber Francis M.

Corey McLaughlin comment: Thank you for the note. I'm biased of course, but this is the kind of thing we love to hear... I'm glad our recap of the event in yesterday's Digest came across clearly to you.

If anyone wants to check out the new presentation from Steve, Doc, and Matt that Francis is talking about, you can watch a replay or read the transcript here... It is worth the watch.

"I realize that the Detroit Pistons and Detroit Lions' odds of winning their respective championships [mentioned in Monday's mailbag] are long, but strange things can happen in sports. All you have to do is look at last week's AFC championship game.

"Here was a team [the Cincinnati Bengals] that won two games two years ago and just four last year, had not won a playoff game in 30 years, and never on the road with a quarterback in his second year, who was coming back from major knee surgery last January...

"They pulled off the biggest comeback in championship history to get into the Super Bowl, with their rookie kicker just four years out of high school. You just can't make this up.

"So keep up the support! In the meantime, go Bengals, or as they are saying in Cincinnati... 'Who Dey!'" – Stansberry Alliance member Jim P.

McLaughlin comment: Jim, I totally agree, and this is one of the things I love about sports... that the unexpected frequently happens.

Enjoy the next two weeks and the hype for the Super Bowl and good luck to your team, the professional football franchise now formerly known as the Bungles. (To our non-U.S. subscribers, we're talking about American football.) I can relate...

I've been wishing for many, many years for the gift of my childhood-favorite football team the New York Jets to get back to the big game (the last time was 1969), but all I have gotten is consistent disappointment.

Bill McGilton
Kyiv, Ukraine
February 2, 2022