Wealth transfer is a phenomenon that typically occurs during the "reversal period" following the end of a significant economic trend. Take, for example, cycles like the late 1990s stock market and the 2000s real estate bubble. As we know, both of these events ended in busts. During subsequent recoveries, however, huge sums of wealth transfer from the naive to investors with an understanding of history and business cycles. This phenomenon has repeated for centuries not just years. What is it that the more fortunate have going for them? How can we recognize what separates them and emulate their success? Wise investors and those with good wealth management advice see cycles and volatility as normal and profit from it.

I think it is helpful to first look at ourselves. Many people invested in gold and silver after their prices rose significantly during the Hunt Brothers mania in the early 1980s. Others invested in high-yield bonds in the late '80s, Asian stocks in '93-'94, technology stocks in '97- '99, large caps, blue chips, passive indexes like the S&P 500 in the late '90s, and real estate in the 2000s. A lot of those same people then sold those "investments" after they didn't work out so well.

Unseasoned investors chase investments when the media, relatives or friends report how much money has already been made during such trends. When these same sources report things are "really bad" or "different this time" the emotional reaction is often to sell at a loss, move to cash (or other perceived "safe havens" such as gold today, after it has run up more than 300% in the past several years) and lick one's wounds. If some of this sounds familiar based on your own or someone else's experience, congratulations! Consider yourself normal.


What separates successful investors and the self-made wealthy from the common man? What is it that enabled the tremendous wealth transfer from less fortunate sellers to successful investors like Andrew Carnegie, John D. Rockefeller, J.P. Morgan, John Templeton and Warren Buffett? Along those same lines, why do you suppose it is that over long periods during which really bad things take place (including, but not limited to World Wars, the Great Depression, assassinations, terrorist attacks, natural disasters and man-made disasters, not to mention less dramatic events like recessions, inflation, deflation, stagflation, deficits, higher taxes, Democrats taking over, Republicans taking over, gridlock, etc.), markets are able to climb these "walls of worry" while apparently ignoring all this important stuff?

There is a common thread that separates investment success from mediocrity. It is the same phenomenon that propels investments themselves higher against what, on the surface, appear to be dire conditions. In a word: fundamentals. In a sentence: the ability to separate the essential from the unessential [information]. In other words, it is the ability to weigh ALL the evidence rather than reacting to a subset. The press, politicians or others often have a vested interest in what information is disseminated and what is not. Successful investing requires the discipline, skill and diligence to identify and weigh all strengths, weaknesses, opportunities and threats.

In the case of the movement of broad investment market trends, contrary to what the financial media might have us believe, the common thread that has separated periods of rising prices from those of falling prices has had very little correlation to inflation, economic growth or exogenous events like the headwinds described above. For example, from 1933 through 1936, the Dow Jones Industrial Average rose 200% despite the country being mired in the depths of the Great Depression. From early 1942 through early 1946, the Dow rose more than 130% despite the attack on Pearl Harbor and the U.S. being drawn into WWII. More recently, from 1982 to 1999, the Dow rose an incredible 1,214% despite stagflation, inflation, the price of gold soaring tenfold then collapsing, a stock market crash (October 1987), the Exxon Valdez disaster, the largest earthquake since 1908, the first Gulf War, the junk bond crisis, the savings and loan crisis and a recession. (Worth noting is that all of these advances were solely the prices of the Dow stocks and did not include the very significant contribution of dividends provided to investors.)

The single common thread present at the beginning of every period of extended stock market advance was historically low starting prices of stocks relative to their measures of valuation, such as their earnings or sales at the beginning of each period. For example, the P/E ratio (price-to-earnings ratio) of the stocks in the Dow average began those three periods at 11, 9 and 7 respectively, the low end of their historic range. The reverse situation describes the worst bear markets of the past 100-plus years. That is, at the beginning of the worst periods for the U.S. stock market, such as 1929 to 1932, 1937 to 1941, 1966 to 1982 and 2000 to 2009, the P/E of the Dow began at 28, 18, 21 and 42, the high end of their range. (Source: www.crestmontresearch.com)

Model Investors

In the case of uber-successful investors, they also had a similar common thread. They, too, obeyed fundamentals and weighed all the evidence.

Carnegie attained his wealth initially by investing his meager Pennsylvania Railroad wages in the stocks of companies with which the company he worked for did business. Out of the ashes of the Civil War, the success of his investments in the railroad businesses, integral in the rebuilding of America, began what eventually grew to be one of the greatest amounts of wealth an individual had ever amassed. Where others saw destruction and devastation, Carnegie saw opportunity.

Morgan, who came from a completely opposite upper-crust background, increased his family fortune though many endeavors, including helping finance the government during the Panic of 1893 and the banking system in the Panic of 1907. He was rich before these crises and did not need to risk his capital. But he, too, saw opportunity embedded in crises.

Rockefeller was, like Carnegie, born of modest means. He was a self-made businessman and amassed his great wealth in a fashion similar to Buffett. Rockefeller formed a fledgling oil company then began buying out competitors, improving their efficiencies and leveraging his growing empire to get favorable pricing from vendors. Admittedly ruthless, his tactics were similar to Buffett's in that he purchased companies at prices that were low relative to the earnings he expected them to be able to generate regardless of the obstacles emanating from the press, regulators or competitors.

Five Losing Years

FIM Group's mentors, include Benjamin Graham, Sir John Templeton and Warren Buffett, because they are the past century's most notable fundamental stocks and bonds investors. They did not fear volatility, but rather saw volatility as an opportunity to buy assets from frightened people who had little understanding of the value of their holdings. Through each of their disciplined value approaches, they were all massively successful investors even across vast periods of difficult investment terrain. For example, from 1966 through 1982, a period during which the Dow Jones Industrial Average began at 1,000 and ended at 1,000, Templeton earned himself, as well as investors upon whose behalf he invested, more than 1,100%. Within that 16-year period, he had five losing years, but his losses were not permanent because he ignored the fear, embraced volatility and had conviction in the value of his holdings despite the folly of "the markets."

When prices of such investments are pressured down, savvy investors take advantage of such opportunities. None of these great investors sold because so-called pundits said the market was going down or the world was in trouble. Instead, each of them took advantage of such behavior to transfer great wealth from weaker investors to themselves. What is it that prevents common investors from having similar success? Paul Sutherland terms it "The Poisons of Investing." These behaviors include placing too much emphasis on current news, holding investments that are no longer good values, panic-selling, inflexibility/stubbornness, etc... Again, the short answer to a lack of investor success is the inability to weigh all the evidence and invest accordingly.

The Rest of the Story

Let's examine the world's current state of affairs. The bad stuff includes huge debt, bailouts, deficits, higher taxes, health care reform, 9% unemployment, a falling dollar (until 11/09) followed by a rising dollar, similar problems in Greece, Portugal, Spain and Italy, a collapsing Euro, a terrible oil spill and conflicts in Iraq, Afghanistan and Korea. The politicians are saying we are doomed unless we follow their agenda. The financial press is saying we are doomed in order to keep people glued to the tube, papers or other form of media. Yet, for each of these conditions, there are both historical precedents and current balancing factors.

For example, the debt on the U.S. government's balance sheet is around $9 trillion (Source: Bloomberg). Not to downplay this debt as a good thing by any means and the fact that U.S. government debt has ballooned by $3 trillion in the past two years is certainly nothing to sneeze at. But looking at the debt alone ignores several important balancing factors. First, the vast majority of it was used to purchase assets (ownership in financial and auto companies as well as mortgages and other depressed collateralized loans). It is conveniently left out that the values of most of those assets have risen, some dramatically, since the government's investments were made, thus earning taxpayers significant profits. It is also not mentioned that, according to calculations from First Trust Advisors, the assets on the government's balance sheet exceed $150 trillion. If that ratio of debts to assets were the balance sheet of a company (minus a few zeros naturally), or of an individual (minus a few more zeros), they would beconsidered incredibly strong financially. However, the press and politicians get no benefit from highlighting the facts they conveniently leave out.

Successful investors seek out "the rest of the story" rather than merely reacting emotionally to the hype or headlines. The current environment is one in which billions of dollars of wealth will likely transfer from investors not prepared or able to defy their emotions to those who are.

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