Three More Secrets of the World's Best Investors

The 'rich man' and the 'poor man'... The trouble with 'Mr. Buy and Hold'... Blaming Porter Stansberry... What you need to know about 'the game'... The most important secret...

Editor's note: Today we're bringing you another portion of a classic essay from Stansberry Research founder Porter Stansberry...

In Monday's Digest, ahead of Porter's brand-new free presentation on Tuesday, we shared the first "real secret" of successful investing. It's from an essay Porter originally wrote back in the August 2009 edition of our flagship Stansberry's Investment Advisory newsletter.

Then, just on Tuesday, Porter debuted his latest market outlook... including what concerns him about the long-term health of the U.S. economy... and his playbook for navigating what he expects next in the markets. You can watch a replay of the entire presentation here.

Today, I (Corey McLaughlin) want to share three more of "The Seven Real Secrets of the World's Best Investors" that Porter wrote about, again with some light edits. (I can't give away all seven, but the four you'll have after today can get you pretty far... Investment Advisory subscribers do have access to the original issue here.)

If you watched Porter's event, one of these secrets will sound familiar. If you haven't watched yet, read this essay, then check out Porter's new video. You'll be more prepared to understand it and the weight of the risks that he sees for investors' portfolios today.

Richard Russell was the dean of the financial newsletter industry...

For nearly six decades starting in the 1950s, he wrote Dow Theory Letters. If you've never read his famous essay "Rich Man, Poor Man" before, stop whatever you're doing and click on this link to read it.

To explain the power of compound interest, Russell notes that if a 19-year-old put $2,000 each year into his IRA for seven years in a row and then never contributed another penny to his retirement, he'd have $1 million by the age of 65, assuming he earned 10% a year on his account on average. If another investor started saving for retirement at 26 – the same age the first investor stopped contributing – and he put $2,000 into his IRA every single year until he was 65, he still wouldn't catch up to the first guy.

Now, lots of folks who see this information think, "Oh, it's too late for me. I don't have enough time to compound my wealth." No, that's not true. What this presentation really means is that you have to start now. You have to learn to be a saver. You have to make sure your money is earning interest all the time. Most of all, you must realize if you're borrowing money (without a positive "carry," meaning earning a higher percentage return than what it costs to borrow that money), you will never, ever be rich.

Russell wrote:

And because the little guy is trying to force the market to do something for him, he's a guaranteed loser. The little guy doesn't understand values so he constantly overpays. He doesn't comprehend the power of compounding, and he doesn't understand money. He's never heard the adage, "He who understands interest – earns it. He who doesn't understand interest – pays it." The little guy is the typical American, and he's deeply in debt.

The little guy is in hock up to his ears. As a result, he's always sweating – sweating to make payments on his house, his refrigerator, his car, or his lawn mower. He's impatient, and he feels perpetually put upon. He tells himself that he has to make money – fast. And he dreams of those "big, juicy mega-bucks." In the end, the little guy wastes his money in the market, or he loses his money gambling, or he dribbles it away on senseless schemes. In short, this "money-nerd" spends his life dashing up the financial down-escalator.

But here's the ironic part of it. If, from the beginning, the little guy had adopted a strict policy of never spending more than he made, if he had taken his extra savings and compounded it in intelligent, income-producing securities, then in due time he'd have money coming in daily, weekly, monthly, just like the rich man. The little guy would have become a financial winner, instead of a pathetic loser.

[Editor's note: This is one of the "real secrets" of the world's best investors: Set up your wealth to earn you compounding returns, and get started right away. And, as Porter says in his new presentation, the best way to compound wealth over time is by holding shares of high-quality, capital-efficient businesses that "routinely reward shareholders with large dividends."

The problem is, though, most people don't follow this recipe of buying high-quality, capital-efficient stocks. It's too boring. Or some other investment or trend sounds more exciting... So, here are two more secrets you'll probably need...]

We have two kinds of customers here at Stansberry Research...

Folks who will cut their losses and folks who will not.

And unfortunately, the "will not cut losses" customer is the most common.

Here's what happens. The prospective subscriber sees one of our advertisements, which are designed to catch your eye with whatever stock or sector we think is going to be hot. This stock or sector is, unfortunately, usually too popular by this point to be a great investment. We're typically trying to grab the tail end of a trend – which can be very lucrative. But the key to these kinds of trades is one of the few, real secrets to investing: trailing stop losses.

Our new client, however, grew up on a steady diet of "buy and hold." He believes staying with a stock is a matter of pride and masculinity. He is no quitter. So when we stop out of the story that he originally subscribed to learn about, he doesn't sell. In fact, he starts writing us e-mails every third day asking why we're no longer covering his baby. And of course, he buys and buys and buys all the way down.

Now it's six months later. We've been out of the stock – with a decent profit – for so long we've forgotten why we liked it in the first place. We're walking through the exhibits at a conference when Mr. Buy and Hold stops us and demands to know why we've cost him $50,000 with our terrible recommendation.

"Do you mean the stock we sold months ago?" we ask.

"Yes, that's the one... and don't give me any excuses about stopping out. Everyone knows you have to buy and hold if you want to make money in stocks," the former client says.

For the next several years, we'll see this poor fellow every now and then...

He'll swear to everyone he meets that it is Porter Stansberry's fault he lost a bundle on that stock, which has now tumbled more than 90%. But the man will say, "I'm still buying because I know it's coming back."

The second kind of customer is the one we prefer. He actually takes our advice, which is to determine ahead of time the price you'll sell any given stock. Some stocks demand more leeway. Some situations require a lot less. But the point is, you don't let the market convince you to stay with any given investment because the market can be irrational for a lot longer than you can be solvent.

If you are a good investor, you already know: Losses are part of the game. If the losses are small, they don't matter. If you're not a good investor, you see every loss as a failure. But small losses aren't failures. They are victories – victories against big losses.

And big losses have to be avoided, at all costs. Nobody can survive a big loss.

If I could teach every investor only one secret, it would be to cut your losses and let your winners run...

If you refuse to do these two things, you will never be successful as an investor.

Remember: It is difficult to get everything right in any given trade – valuation, sentiment, timing, position size, etc. When you've made a mistake, admit it quickly and move on. When you get everything right, treasure it. Hold on as long as possible.

When we hire new analysts at Stansberry Research, the smartest guys have the hardest time buying into these ideas. Smart guys think they're smarter than the market. And usually they are. The problem is, you only have to be wrong once to suffer a catastrophic loss. And everyone – and I mean everyone – is wrong at least once every few years. So you have to completely rule out the possibility by being a disciplined investor and cutting your losses. There is no other way.

There's one more thing you have to know about cutting your losses...

That's the next secret – position sizing...

The secret is simple: You adjust your position size based on the maximum risk you're taking. You should never put more than 3% of your portfolio at risk and, ideally, you should never lose more than 1% of your portfolio on any trade. So if you're going to put 5% of your portfolio into a risky stock, you should use a 20% stop loss. If you're wrong, no problem – you've only risked 1% of your portfolio.

If you want to hold a position longer and expect a lot of volatility, you should simply use a smaller position size – all the way down to a 1% position size for stocks that are basically lottery tickets. On the other hand, you've seen from time to time I recommend position sizes up to 25% of your portfolio...

Every few years, an exceptional opportunity will appear in very low-risk stocks. Never put on a trade of this size unless you are certain the position is incredibly safe. If you're not an expert at evaluating a company's balance sheet and its earnings prospects, you shouldn't put on positions of this size – ever. Also, when you put on a jumbo position, you must use a trailing stop loss, which moves your stop point higher as the stock goes up.

Every successful investor uses some combination of stop losses or position-size limits. And yet most individual investors know nothing about these key strategies.

Editor's note: In his new free presentation, which debuted on Tuesday, Porter not only shares his latest outlook on today's market, the economy, and the country... but also discusses two of the "secrets" mentioned today in more depth. As he says...

The two mistakes that everybody makes is they sell their winners and they hold on to their losers... The other problem, which is related, is that they put way too much of their portfolio into really volatile stocks.

The good news? Our company founder has a solution. In his new broadcast, Porter offers the opportunity to try a simple investing tool that can take a lot of this decision-making out of your hands – for the better. He explains. Get the full details here.

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In today's mailbag, feedback on a piece of mail in yesterday's edition, and thoughts on our report on the latest from the Federal Reserve and our "quote of the week"... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Amen to Bernard B. His letter is spot on. Stupid politicians and Fed officials destroying the great gift that was bestowed upon our country (U.S. Dollar)." – Subscriber Thomas V.

"People are suffering from 2+ years of high inflation. That doesn't go away because it gets down to 3 or 4 or 5% or even the previous goal of 2%. Those savings are permanently lost unless we get a period of deflation to correct it. Don't think or tell people it's getting better just because it hurts 'a little bit less'." – Subscriber Robert S.

Corey McLaughlin comment: Robert, thanks for the note. Hopefully, I've said this enough times over the years... But just to be clear, we report what the Federal Reserve says about inflation and other things because enough investors in the market care, that it influences behavior. However, often, what the Fed says does not reflect reality for many people it claims to serve.

Just because the inflation rate is lower than it was two years ago doesn't mean inflation still isn't happening. Even on an "official" headline level, there's also a big difference in compound growth between 2.5% and under 2% where inflation was most of the previous 15 years.

"I don't pretend to be nearly as erudite as Mr. Sowell, but given his quote, wouldn't it also make sense that every good idea currently being circulated has been tried and proven successful before, and will likely be successful again?" – Subscriber Sherwin R.

McLaughlin comment: I think so! Your comment reminds me of another idea I like: "betting on things that never change." We wrote about it a few years ago, and our Dr. David "Doc" Eifrig wrote about it in a recent issue of his Retirement Millionaire newsletter.

Doc's point was that rather than making an investment bet on the outcome of November's presidential election, you're better off focusing on what will remain constant when making portfolio decisions. As he wrote...

Everybody's always looking for the next big shift in markets or business. It feels like the only opportunity comes from change. And a presidential election represents a mammoth potential shift...

But the problem is that anyone professing enough certainty in the outcome to make a significant investment is kidding themselves... or kidding you...

Instead... we want you to think about the power of investing in what won't change. That kind of certainty lets you invest confidently and reap bigger benefits.

Jeff Bezos, the founder and former CEO of Amazon (Nasdaq: AMZN), espouses this strategy and provides its most striking example...

I very frequently get the question: "What's going to change in the next 10 years?" And that is a very interesting question; it's a very common one. I almost never get the question: "What's not going to change in the next 10 years?" And I submit to you that that second question is actually the more important of the two – because you can build a business strategy around the things that are stable in time.

Bezos says customers always want fast shipping and low prices. And they'll never want slower shipping. And that insight allowed Amazon to invest billions into its two-day and one-day shipping programs and get a bigger edge on the competition.

So, what will do better for your investments? A [Donald] Trump or [Joe] Biden trade that may pay off, but may head in the wrong direction?

Or a timeless business that will benefit either way... in which you can invest more capital and earn greater profits?

So, Sherwin, I think you're spot on. As Thomas Sowell said – and we quoted yesterday – "virtually every stupid idea that is in vogue has been tried before and proved disastrous before."

On the flip side, good ideas tend to be good ideas.

Sometimes they might not "work" because the time or place or execution isn't right, but proven principles – like knowing your customers won't ever want slower service – won't go out of vogue.

If you can find companies or people who understand this, and are putting the "things that don't change" to work in a growth industry and with an eye on rewarding shareholders, consider giving them a good look.

Good investing,

Porter Stansberry
Baltimore, Maryland
August 1, 2024