Building Wealth Finance professor Jay Ritter was making $50,000 a year in the '80s doing almost nothing...
Ritter and some other notable academics had found a way to capitalize on the fact that small stocks consistently performed better than large ones in January of each year.
They pooled their money and formed a small partnership that bought a futures contract on small stocks and shorted a futures contract on larger stocks.
In 1984, Ritter made $50,000 for himself in a few months with this trade. He made the trade again in 1985 and earned even more. His profits for the year even exceeded his assistant professor salary.
Ritter put the trade on again in 1986 and it started off well. Then he got a call from his broker that began, "Are you sitting down?"
The market had turned against him.
In an afternoon, Ritter had lost one-third of his annual salary, wiping out the profits for the year. He was able to get out of that year's trade and earn a little more than just break-even.
But the next year is when things really went wrong. He tried to improve his trade... and in a few months, he was losing $5,000 each day. According to his math, it didn't make sense.
Then Ritter and his partners figured out that futures didn't behave the way they thought. They had the formula wrong.
Even worse, someone outside the group had figured out their strategy... and was taking them to the cleaners.
That person was a man named Fischer Black.
You may have heard of Fischer Black. He's one half of the famous "Black-Scholes" formula for pricing options. (Scholes received a Nobel Prize for the work, but Black had passed away and Nobels aren't given posthumously.)
I worked with Black in my time at investment bank Goldman Sachs. I came on while the Ritter trades were happening, and this was the kind of thing that our team did all the time.
In this case, Black improved on a mathematical formula. But his true insight was more than that.
Black was able to see how the market was moving and see how others were trading. He was able to understand how others are thinking and use that to his advantage.
This is the most important skill you can have as an investor.
There are a thousand ways to make money in the markets. They don't all take a doctorate in finance or a huge research staff.
The skills you need to improve your retirement investment returns are much simpler. I bet you already have them.
All you need is common sense, a keen eye for people's behavior, and control of your emotions. With these three skills, you'll quickly be on the path to building wealth.
In fact, complex formulas or advanced strategies can get you into trouble when you run into someone with a sense of "how things really work."
Fischer Black taught me some of the most valuable investing ideas I've ever learned. And I think this approach can give you a new way to think about investing.
Most investors buy at the top in a frenzy... and sell at the bottom in a panic. They lose a lot of money doing this. To profit from fear, you should stick to a good asset allocation.
While others try to find the next big thing and chase highly paid mutual fund superstars, you should use index funds and pay low fees.
When I worked with Black, he taught me one important way to reduce risk and maintain returns... on nearly any stock or fund in the market.
Personally, I use this approach to consistently earn safe income in the options market. While most traders use options to gamble wildly on the movement of stocks, I take the opposite approach.
Since most traders are so hyped to place their bets, they often overpay for them. By understanding the way they think, I love taking the other side of these trades and getting overpaid... just like Fischer Black taught me to do.
I'm going to be sharing this technique – totally for free – in a presentation on Wednesday, January 20 at 8:00 p.m. Eastern time. I'm going to walk through – step by step – how we can use the psychology of the market to earn consistent returns.
It doesn't take a complex formula. But you do need to add a few new tools to your toolbox. Fortunately, I've built a career explaining these techniques to investors.
Click here to sign up for this free live webinar, and we'll send you a reminder before the show.
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What We're Reading...
- Jay Ritter revealed his story in a 1996 journal article as a tribute to Fischer Black. It's called "How I Helped to Make Fischer Black Wealthier."
- Something different: The fascinating math behind why you won't win Powerball.