This quote from Benjamin Graham means that over a long period of time, investors will analyze companies’ financials, competitive strengths, and management and accurately “weigh” what a company is worth. But in the short run, markets rise and fall, and investors experience emotions like relief, panic, and joy. In the short run, buying based upon these emotions is “voting.” During the dotcom bubble, investors voted stocks way up, and over time they weighed their value to bring stocks back down to earth.

As Facebook nears its IPO, the analyst and investment community will be busy weighing the value of its shares and trying to judge investor sentiment to arrive at a share price between $35 and $55. Over the long term, Facebook shares will receive a proper price, but in the short term, investor emotions will impact pricing.

What if computers could be made to read human emotion? Since most of us can fall prey to our emotions as we watch the market, what if we could measure market emotion and be ready for market swings? Look no further than the “VIX” index. VIX is a ticker symbol that you can track like a stock. Put it in your Yahoo finance ticker symbols and start watching it. VIX has a complex-sounding definition, but in layman’s terms, it measures fear in the market by the price of puts and calls on the S&P 500.

Consider insurance as a great metaphor. If you are older, term life insurance is more expensive than if you are younger because the risk is greater for the insurance company.  Mutual and hedge fund managers make less money when they have big swings in their portfolios. Unhappy investors pull their money out of funds that have big ups and downs, which reduces assets and lowers fund manager salaries. They want to take their investors for a ride in a quiet, smooth Lexus, not around the track in a high-performance Porsche. So they buy insurance (puts and calls) to smooth out the ride. If the stock market is worried about Greek debt, U.S. deficits, and other matters, the price of puts and calls (insurance) goes up. That’s what the VIX measures.

When investors are incredibly relaxed without a care in the world, the VIX can get down around 10, as it was in 2007. During the height of the financial panic, it reached an unprecedented 80, and then it fell over a year following March 2009 to around 15 in May 2010 until the flash crash happened, and then it spiked back up to 45. It slowly declined to about 15 until last August when the world freaked out about the European debt crisis and our government’s impasse on the debt ceiling. The VIX has since calmed down and has slowly fallen back below 20.

In times like these, when the VIX goes down, it usually goes back up based upon a random and unknowable event. For the third time since the 2008 panic, the VIX has fallen down to a point where investors are so relaxed that they’ve left the office, gone to the spa, and are laying on a massage table. We don’t bet on markets, and our investment strategy is never to time the market. But if you want to get yourself emotionally prepared for swings, watch the VIX. If the past is any indicator for the future, we’re set up for another roller coaster ride soon.

We know that rock-star stock pickers like Peter Lynch in fact used to be able to outperform markets years ago. But global stock markets have changed dramatically over the last fifty years, making it nearly impossible to find mispriced stocks. Markets are now considered “efficient,” meaning that whatever a stock is selling for is probably close to what it is worth. Here are five reasons that have contributed to market efficiency:

The rise of institutional investors. In 1960, only 10 percent of all investors were considered professionals. They were like foxes in the hen house of amateur investors. Professionals could get an edge because there was only one of them to every nine amateurs. TodayL, that ratio is reversed.  Out of ten trades, nine come from professionals. These pros are certainly frantically trying to get an edge through trading. Back in 1960, only two million shares traded daily on the New York Stock Exchange. Today, there are over four billion shares traded daily.

Concentration of professionals. While there were few pros in 1960, today they are highly concentrated. In fact, the top 50 fund companies generate 50 percent of all commissions on Wall Street. That means when an analyst at Merrill Lynch gets a great idea, or finds out some important factoid that no one knows, he calls those firms first and then publishes his research report a day later. That information is quickly priced into the stock. Those top 50 firms get the edge because they pay for it.

Derivatives. The ability to buy and sell puts and calls (also known as derivatives) is a new invention of the last 50 years. The value represented by these derivatives now exceeds the entire value of the stock market. While these securities allow some investors to hedge positions, their existence creates undue movements in the market, spooking investors and adding to uncertainty.

Certified Financial Analysts (CFAs). Did you know that an entire field devoted to studying the pricing of stocks has developed over the last 50 years? This certification arms the analyst with highly sophisticated tools for studying stocks and analyzing their value. Today there are over 300,000 CFAs all over the world, armed with the IQ points, tools, and training to figure out how a stock should be priced. Their work gets quickly priced into stocks, quickly bidding up the bargain stocks.

Democratization of information. Two major events have made the same information available to everyone: Regulation FD (Fair Disclosure) and the Internet. Until about 2001, analysts and large fund managers would receive “whispers” from company management. An analyst who received a whisper from a CEO was able to inform his clients, who would trade and profit on this information. That’s why analysts were paid way more ten years ago. Reg FD put strict restrictions on insider trading and as a result, there is now little whispering. At the same time, the Internet, e-mail, and even Bloomberg terminals have made information instant and available to everyone.  The minute a material piece of information is out, it is picked up by anyone who wishes to buy or sell based upon this new “datapoint.”

If you own Apple or Google because you use the products and think there’s a “long way to go,” realize that you are taking undue risk. If markets are efficient, it means that you’ve bought the stock for exactly what it is worth. You have no edge. And worse, if you pay for a fund manager to make better picks than the overall market, you are wasting your money. You’ll make more in the long run by owning a fund that owns every single stock in a given market. If you want to own emerging markets like Russia, Brazil, India, and China, buy VWO from Vanguard, and own all 900 relevant companies in these countries. Don’t try picking 20 or 30—own them all! This is called investing in indexes, and for these reasons, we recommend only index exchange-traded funds (ETFs) to our clients.

While traders fret and squabble over the next best stock to buy or sell, smart portfolio managers focus on the big picture, spreading money across broad asset classes including U.S. stocks, foreign developed stocks, emerging market stocks, real estate, bonds, inflation-protected securities and sometimes commodities. Asset allocation is supposed to reduce risk within a portfolio by spreading bets across investments that move independently of one another. While one part of your portfolio zigs, the other zags, helping you make money (and preserve capital) in all environments.

Recent critics of asset allocation, however, have pointed out that due to factors such as globalization, many assets including stocks now move in lock step. This trend, they say, is illustrated in the 2008 crash when all sorts of assets fell in tandem, supposedly revealing that the benefits of diversification are ephemeral.

A quick look at the core stock classes in 2008 shows that pain was evenly spread across every major category with U.S. stocks down 36.2 percent, foreign developed down 43.4 percent, emerging market stocks 52.9 percent, and even the nontraditional classes of REITS and commodities hit with declines of 37.6 percent and 31.9 percent respectively. Where is the non-correlation in this asset allocation? These facts, the critics point out, prove that the asset allocation models of the past are now bunk and in need of a desperate overhaul. 2008 is said to have sounded the death knell for all of modern finance. In response, one idea that has gained traction among some managers is the notion of adding global currency as a new type of uncorrelated asset class.

Is Asset Allocation Dead?

Did Modern Portfolio Theory (asset allocation) really die in 2008? MPT does not guarantee that an investor will make money every year. It really does not even say that asset classes will always be uncorrelated. What it does say is that on average, over time, asset classes perform differently, and a diversified portfolio will exhibit less variation in returns than a portfolio with one asset class. This diversification should lower risk, help investors stay the course and achieve their goals over the long haul. Did this hold true?

A look at some diversified portfolios shows that it did. In 2008, bonds returned 5.2 percent. Disciplined investors who kept a strong allocation to bonds experienced much less pain during this historic downturn. A 50/50 split between bond and equity allocation would have reduced losses by more than half. Less pain means a lower likelihood that an investor will panic and abandon their planned course during turbulent times. But woe to those who did bail out. In the following year, U.S. stocks were up 25.2 percent, foreign stocks rallied 31.8 percent and emerging markets gained a whopping 82.6 percent.

More diversified portfolios declined less than the markets over 2008 giving diversified investors the courage to stay with their plan. Those who stayed the course reaped a robust reward the following year.

For a dead idea, MPT worked pretty well.

Should You Add Currencies into Your Mix?

Some MPT advocates suggest that currencies as the new answer for a truly diversified portfolio.

Take currency returns over the past year. While Mexican peso was is down 7.8 percent against the U.S. dollar, the Japanese yen was up 7.5 percent and the Swiss franc up 6.7 percent for the same period. A quick study of currencies demonstrates that they are in fact highly uncorrelated to stocks. Should we then conclude that they belong in your retirement portfolio?

For the average investor, the answer is no for two simple reasons:

1. A diversified portfolio of stocks and bonds already provides exposure to global currencies. Large U.S. multi-national corporations may trade in U.S. dollars, but they conduct business in foreign lands using foreign currencies. By default they are already affected by currency exchange rates. Furthermore, beware of holding investments that trade in currencies other than the dollar as you are exposing yourself to both the risk of the underlying companies as well as the foreign currency. That presents a lot of risk to understand, let alone manage.
2. Currency values are tied more to inflation speculation than economic growth. History demonstrates that economic growth does not necessarily result in a stronger currency. If you think corporate profits are hard to predict, try predicting inflation. It’s a daunting task best left to the pros.

Placing all your eggs in one basket remains as bad an idea today as it did forty years ago when the fathers of MPT first began suggesting diversification strategies. Although 2008 was a rough spot for all investors, those who stayed true to diversification through the tumult are smiling today.

If so, consult your favorite Wall Street broker, mutual fund, or become a stock picker yourself. Either way, within 20 years, say goodbye to 33 percent of your money and many of those dreams.

How could this be true? Most people confuse investing with gambling. Gamblers try to “beat the house.” Investors want to be “the house.” Imagine a casino in Las Vegas called World Markets Casino. World Markets offers all kinds of gaming options—blackjack, poker, roulette, craps, slots—along with great food, entertainment, and well-appointed rooms.

Guests have a lot of fun at World Markets—the excitement of gambling, the thrill of winning and losing. Some come in with various “systems” like statistical models and card counting systems to beat World Markets. Others talk to God. Poker players have their favorite seat.

There was a Grandma who dropped a quarter in a slot machine and won $250,000. Another person who had never played blackjack hit 21 in his first hand, made $50,000, and proposed and married his girlfriend all in one great evening.

It’s fun being at World Markets—just look at the posters and marketing brochures.

But most guests don’t just play, win, and leave. They continue playing and that’s what World Markets counts on. Like all casinos, it has special “house” odds. Sooner or later World Markets will win more money than it will lose due to human nature and statistics. Depending on the game and how wagers are placed, the casino earns up to a 35 percent commission from the winnings. It is impossible to do consistently, but guests come year after year to try to beat the house.

Suppose you buy stock and invest in the imaginary World Markets, Inc. (WMKTS). Investors care about one thing only: making money. They’re not concerned with having fun or discussing the night they had the “hot dice” at the craps table. They could care less if they ever hear the noise of a winning pull at a slot machine. They just want to know that they’ll make money year after year after year.

World Markets investors never know from night to night where they’ll make money. Some nights there’s a guest with a streak of luck on the craps table and the casino loses money there. But that same night, perhaps World Markets is making money on blackjack. On nights where guests are beating the house on all tables, the casino is still picking up antes from the poker tables, and making money on food, hotel rooms, and entertainment.

World Markets investors are “the house,” and ultimately those investors always make more money investing in the house than its guests who are trying to beat the house. It’s just a statistical fact.

But how is it that most people invest their own money as if they were gamblers at World Markets, instead of investors?

Most investors attempt to “beat the house” of world asset markets—U.S stocks, bonds, real estate, foreign stocks, emerging market stocks—by picking stocks on their own, giving their money to a broker who they believe is a good “stock picker,” or investing in a mutual fund that has a great track record.

But reams of studies from experts have confirmed that investors do worse than the house by the money they spend trying to beat it. Investors leave an average of 2 percent of their money every year at World Markets and pay more taxes because buying and selling stocks creates taxable income. Over time, due to mathematical laws such as compound returns, investors can lose 33 percent of their money over 20 years—just like a guest at World Markets Casino.

So how do you become an investor in World Markets instead of a gambler? Buy and hold a collection of exchange-traded funds (ETFs).

For every $100,000 invested, you’ll pay $200 in yearly fees, instead of $2,000 in fees to money managers, financial advisers, and broker commissions. You can invest like smart investors and endowments at Yale, Harvard, Princeton, and Stanford. You’ll never have to pick a stock or mutual fund again. And you can dial the risk levels of your portfolio up or down to whatever level you feel comfortable.

Be the house, not the guest.

And, as usual, the average retirement investor feels caught off balance and a few steps behind the curve. What is the ordinary investor to do? It does feel a bit like 2008 again, doesn’t it? Is it too late to take a cue from the pros, pull up stakes on a long-term investment mentality and find a nearby bunker to hunker down in with a bag of bonds now returning less than the rate of inflation?

At times like these, simple positive thinking doesn’t seem to extract the thorn of worry from the back of the investor’s mind. As much as he conjures up Bobby McFerrin’s “Don’t Worry Be Happy” chorus or hums a bar of “Hakuna Matata,” the worry seem to still creep in at unexpected moments like a terrible and relentless rot.

Investment anxiety, however, can be tamed. They key is having a clear understanding of those things that should and should not be on your list of worries. Let’s begin with what not to worry about – the direction of the markets.

I Don’t Know and I Don’t Care

The famous financial columnist, Jason Zwieg, once wrote powerfully about how index investing liberates the investor from the anxieties of trying to predict market movements. His words from 2001 are as relevant today as they were then:

Indexing enables you to say seven magic words: “I don’t know, and I don’t care.”

Will value stocks do better than growth stocks? I don’t know, and I don’t care – my index fund owns both. Will health care stocks be the best bet for the next 20 years? I don’t know, and I don’t care – my index fund owns them. What’s the next Microsoft? I don’t know, and I don’t care – as soon as it’s big enough to own, my index fund will have it, and I’ll go along for the ride.

Indexing enables me to say, “I don’t know, and I don’t care,” liberating me from the feeling that I need to forecast what the market is about to do. That gives me more time and mental energy for the important things in life, like playing with my kids and working in my garden.

When it comes to worrying, one should only worry about what he or she can control. Although countless have tried to control the public markets through worry filled hours of mental consternation and sleepless nights, markets rarely, if ever, obey. Therefore, the current vagaries of the market need to be ignored in exchange for the science of long-range planning based on hard, cold investment facts. It may seem like the world is falling into a hole, but investment science indicates otherwise.

Those who have the courage to ride the markets through the ups and downs, holding their course over decades, will be handsomely rewarded.

I Do Know and I Do, In Fact, Care

There are some aspects of investing that, in fact, are worthy of serious retirement investor’s attention. Two elements within the intelligent investor’s control are asset allocation and investment costs.

While millions of Americans tune into Jim Cramer’s Mad Money to watch him race about with his shrieks, squeaks and squeals, proclaiming what stock to buy or sell, the intelligent investor understands that the research is conclusive – 90% of investment returns are rooted in asset allocation, not stock picking. Therefore, the intelligent investor focuses his energy on identifying six or seven asset classes, with as little correlation as possible – U.S. equities, foreign developed stocks, emerging markets, commodities like gold and energy, real estate investment trusts, inflation-protected Treasuries, bonds and possibly more.

The investor then works carefully to identify, based on his risk tolerance, time horizon and other factors, the appropriate mix of theses assets classes for his portfolio. Once the portfolio is constructed, the investor rigorously maintains his allocations over the years, making adjustments only when his needs dictate a need for investment policy changes – not because Cramer bonked his bonker or because of any other market madness.

Finally, the intelligent investor overcomes investment anxiety by driving all unnecessary investment costs far from his portfolio. While market movements cannot be controlled, costs can be. Therefore, the investor makes sure to use low cost index funds and ETFs as essential building blocks for a diversified portfolio. Instead of paying one to one-and-a-half points for mutual funds the intelligent investor is able to achieve global diversification for around one fifth of one percent annually.

Additionally, by removing all unnecessary intermediaries that stand between the investor and his money, agency risk is dramatically reduced. The investor no longer needs to fret that some money manager is going to go AWOL with his retirement dollars or that he is going to become an unwilling participant in the next episode of the ongoing Wall Street saga of investor meets crook.

Like Wilkie Collins, the famous English novelist, once said, “Peace rules the day when reason rules the mind.” By accepting your inability to control or predict the markets, and embracing your ability to drive down fees and construct wise allocations, you too can shirk Wall Street madness and say goodbye to investment anxiety.

The Eagles, The Long Run

The Eagles understood something about relationships that many investors have yet to learn about portfolio management. Success is measured in the long run.

In both romance and investing, bright beginnings inevitably turn to tougher times that test our metal. What we do in such moments as investors will significantly impact our retirement outcome and reveal if we are the type that runs for the door or hangs tough to see a better outcome.

The principled investor buys equities based in policy driven portfolio management, not inspiration. With cold-hearted accuracy, these investors know that as soon as they make their purchase, their investment is as likely to go down as up. They don’t care. They are thinking about a five, ten, twenty, even thirty-year time horizon.

The inspired investor, however, is in a sense looking for a touch of magic in their purchase.  It may be the investments PE ratio, technical characteristics or even an insightful analysis from a trusted expert that makes this investment irresistible. There are countless reasons the inspired investor falls in love, but in every case, the same expectation is shared – that this new object of affection will break free of the market’s gravitational pull and float skyward towards unfettered wealth.

When such an investor finds his special equity, he can’t help but feel a smidge of infatuation with his new purchase. In this early phase of the investment cycle, the investor is dancing with Cinderella under the stars in all her glory. But even for Cinderella midnight must eventually come.

When that inevitable moment strikes and sends his darling plummeting, the inspired investor is gripped with horror as he watches his Cinderella like vision of beauty and grace turn into a soot covered house cleaner tumbling down the boulevard like a tattered pumpkin towards what appears to be an ignominious demise. At such a moment, we learn if the investor is merely a one-night stand specialist or a truly inspired prince who is in it for the long run.

Are U.S. Companies Really Worth 15% Less Than One Week Ago?

Infatuated investors are also those that suffer the greatest whipsaw effect. As the fret mongers and deep-dive analyzers abounded this week decrying the demise of American ingenuity and business, their dour chorus crushed many an investor’s inspiration, turning it to disillusionment. As quickly as these inspired souls rushed in, they now in turn rush out with similar enthusiasm.

This whipsaw effect was sadly illustrated once again in this week’s market crash. And strangely, this crash was accompanied by the pundit’s singular focus on the bad news leaving the story about corporate earnings mostly unnoticed.

It is early in the second quarter earning season with just 143 of the S&P 500 firms reporting. And the reports are promising. 75% of firms have reported earning above expectations. 13% have met expectation and a mere 13% have missed targets. Historically, only 62% beat expectations.

Furthermore, the earnings details are also quite encouraging. Average earnings for those reporting is 9.2% over last year – good but not shockingly good. Take into consideration, however, that Bank of America had to settle a lawsuit that represents a one-time, non-recurring expense, remove that singular expense from the calculations, and earnings skyrocket to a very encouraging 15.2% over last year.

More firms must still report and surely it will not all be good news.  But apart from the dour media makers, reality tells us that U.S. companies are essentially earning 15% more while the public markets just decided that they are worth 15% less.

Buy, Hold and Rebalance

Buy low and sell high. It is a simple principle to understand, but much more difficult to follow, especially in times like these. We can all look back at ’08 and recall the many testimonies of those that ran for the door when the DOW was at 7,000, just to in turn stand on the sidelines, paralyzed, as the markets moved back up to 12,000. Don’t be that investor. It is easy to get out but very difficult to know when to get back in. If you miss a few critical days of market movement, you miss most of your portfolio growth.  As others run for the door in fear, follow Buffett’s famous adage and be bold to buy. For the flint-jawed long term investors, now may be the perfect time to trim winners and buy losers in principle driven rebalancing act.

When all hell broke loose for Prince Charming, he knew that the slipper in his hand belonged to a woman he was not going to let go of. As an investor, do you know that your investments are worth holding onto? If in fact you own a globally diversified portfolio of low-cost index funds or ETFs, you can rest assured that today’s pumpkin will in fact transform into tomorrow’s carriage, yet once again.

Take politics, for example. Philip Tetlock, a psychology professor at the University of Pennsylvania, conducted a study that became a book called Expert Political Judgement. He tracked about 80,000 forecasts from nearly 300 political experts over 20 years regarding political events in many countries. He tracked the outcomes of their forecasts against a group of college undergraduates making subjective predictions and a group who just made random guesses. The experts did slightly better, but not much. Nevertheless, they got on TV frequently and built their names and reputations.

Christina Fang, a professor of management at NYU’s Stern business school, tracked the Wall Street Journal‘s Survey of Economic Forecasts to find out how accurate these highly paid analysts’ forecasts were when billions of dollars were at stake. Surely this would lead to more accurate predictions. Her paper, “Predicting the Next Big Thing: Success as a Signal of Poor Judgement,” draws some stunning conclusions.

Fang concludes that rather than being an indication of good judgment, accurately forecasting a rare event, such as business success, may in fact be an indication of poor judgment. On National Public Radio, she said, “If you look at the extreme outcomes, either extremely bad outcomes or extremely good outcomes, you see that those people who correctly predicted either extremely good or extremely bad outcomes, they’re likely to have overall lower level of accuracy. In other words, they’re doing poorer in general. … Our research suggests that for someone who has successfully predicted those events … they are not likely to repeat their success very often. In other words, their overall capability is likely to be not as impressive as their apparent success seems to be.”

Consider how those who predict make money on Wall Street. Because there is no way to hold financial forecasters accountable for their incorrect predictions, they get more out of making wild ones. Wild predictions pay because the downside of being wrong is zilch, but the upside is lifelong fame. When those who make them are right, they get to manage more money, sell more books, and garner tremendous publicity for many years to come.

Consider the 2008 market crash. The best-selling books today are being written about those who called the crash such as John Paulson and those featured in Michael Lewis’s book The Big Short. Those who were right will continue monetizing their correct prediction for many years to come. They are today’s seers. But literally hundreds of pundits on CNBC got it wrong. Who were they? We’ll never know—no one has any incentive to embarrass those who were wrong. Imagine seeing a pundit on CNBC with statistics showing how accurate their predictions were, like baseball statistics each time a player walks onto the mound.

We face a showdown between Congress and the president on lifting the budget deficit ceiling. The fact is, no one knows when or what deal will be cut. Those who are predicting this outcome are guessing. The ultimate effect on stocks and bonds in the short or long term is also unknown. But we keep tuning in, hoping for an answer, listening to confident and educated individuals making predictions.

As avid index investors, we make only one prediction: In a global, capitalistic economy, investors are rewarded for the risk they take in deploying their capital. If in bonds, investors will be rewarded as a lender. If in small-cap stocks, investors will be rewarded for increased equity risks. This prediction is rooted in empirical evidence and fundamental principals of our economic system. The rest is expensive and distracting noise. Predicting the ebbs and flows of that noise only serves to help money managers increase their assets under management and financial authors to sell more books and newsletters.

So next time you find yourself glued to a financial soothsayer making a prediction, stay far away from the trade button.

Unfortunately, for every account of failure turned to success, there seems to be a deep reservoir of plain old ugly failure that leads to nowhere. Whether it is the ignominy of WebTV, the demise of the billion dollar USFL and XFL football leagues, or the more recent demise of Bear Stearns, Lehman Brothers, and IndyMac Bank, the choices are plentiful.

Particularly intriguing are failures from leaders that somehow find a way to snatch defeat from what otherwise appears to be the inevitable jaws of victory. In this year’s Indy 500, JR Hildebrand was one turn away from winning the prestigious race on his first try. Then, within sight of the checkered flag, the 23-year-old Californian made the ultimate rookie mistake. After successfully racing 499.8 miles, he slammed into the wall on the final turn, and Dan Wheldon drove past him to claim an improbable Indy 500 win.

Transforming inevitable success into ignominious failure is not reserved for corporations and sports stars. Possibly the saddest example may be found in the everyday retirement investor. Recent research by Michael Mauboussin, Columbia University professor, has revealed this in three simple numbers: 9, 7.5, and 6.

Nine percent is the annual historic growth of the S&P 500. The average investor could simply buy and hold the S&P 500 Index, go play golf, and look up in twenty years to see a nice achievement—9 percent returned year after year.

If, however, a retirement investor is not happy with this 9 percent success, he can hire a professional mutual fund manager to actively manage his money in an effort to beat the market. This brings us to our second number—7.5 percent, or the historic annual returns of actively managed mutual funds. The spread between the historic returns of the S&P 500 and the historic returns of actively managed mutual funds is 1.5 percent or the amount collected in fees by these Wall Street pros.

And now on to our final number: 6. According to Mauboussin’s findings, 6 percent is the actual historic return that everyday retirement investors in America achieve over time. What is the cause you may ask? The research reveals that this shocking underachievement is rooted in one simple ailment – efforts to time the market that go awry.

Poor market timing is rooted in the emotions of fear and greed—the two mortal sins of investing. While investment giants like Warren Buffet have long understood that the wise investor should “be fearful when others are greedy and be greedy when others are fearful,” the everyday investor underachieves by following the opposite principle.

When markets are flying high the everyday investor allows greed to kick in, leading these underperformers to hold on for more or even double down on their winning stocks. Unable to embrace the portfolio management discipline of trimming winning picks and buying losers, these investors set themselves up for the next big market adjustment. Eventually, the bubble bursts. When such market corrections hit, the everyday investor lets fear take the helm. Fear demands that the underperformer exit his position and rush to the safety of cash or bonds. In doing so, the cycle is complete, leaving the everyday investor with fewer retirement dollars and more sleepless nights.

If you prefer to worry more, sleep less and lose money, you now know how the everyday investor consistently achieves these aims. For those inclined towards more peaceful living and higher returns, low cost global diversification and disciplined rebalancing win the day.

In the last 80 years, stocks have returned about 10 percent, while bonds have returned about 5 percent. An average balanced portfolio should therefore return around 7.5 percent over a long time period. If you grow your money at 7.5 percent each year, you’ll double your money every 9 to 10 years. Let us call these “returns before advice and taxes.” This is the baseline.

Paying for investment help can be very expensive. If you pay mutual fund and advisory fees of 2.5 percent, you have a silent “business partner” who is taking a third of your 7.5 percent investment profits for advice. Over a 20-year period, unless these advisers are making up the difference, which is statistically close to impossible, you lose big money—slowly, quietly, and imperceptibly. Your account will grow in good years, but it won’t grow enough. Over time, you’ll notice that everything is becoming more expensive and your portfolio is “small” when years ago it seemed much larger.

If investment advice doesn’t do you in, taxes will. Mutual funds and advisers never report investment returns “after tax” because this would dramatically reduce returns. Most mutual funds are trading machines, generating huge amounts of short-term capital gains. But taxes are never factored into the advertising. Let’s say that federal and state taxes are 40 percent on short-term gains and 20 percent on long-term gains. You invest in two funds. Let’s call them the “Furious Trading Fund” and the “Buy and Forget Fund.” If Furious is up 15 percent, you’ll net 10 percent after tax. But Buy and Forget only needs to be up 12.5 percent, to net you same 10 percent after tax. Furious has to do 20 percent better than Buy and Forget just to get you to the same place!

Smart investors don’t pay much in taxes on their investments because they don’t trade in and out their positions. They spread their money around the world in different types of stocks and bonds in percentages based upon their objectives (called “asset allocation”) using exchange-traded funds (ETFs). They own a core portfolio with most of their net worth consisting of 10 to 15 ETFs to get nearly complete diversity in stocks, real estate, commodities, and bonds. Each ETF represents an entire stock or bond market that is an essential ingredient to a portfolio. They hold these same ETFs forever.

But this is far from “buy and hold.” Over time, the relative proportions of each ETF within the portfolio will need to change. If bonds are up this year and stocks are down, it is critical to trim bond ETFs and add to stock ETFs. People age and should start shifting more of the portfolio into bonds: same ETFs, different weightings.

Here’s where taxes are minimized. After owning a passively managed ETF portfolio for one year, all gains that come from selling the ETFs are taxed at long-term rates. And ETFs have a special tax structure that rarely generates taxable income except for dividends. By trimming and adding, you only incur a small amount of long-term tax, but the gains continue accruing tax-free. The smart investor tinkers around a few times a year, but never “gets in and gets out.”

If you keep Uncle Sam and Wall Street at bay, you can keep most of your returns. If you let them into your portfolio, you may well find yourself half as rich as you could have been.

The numbers are in – employment growth down, real estate down, manufacturing down, debt problems at home, debt problems abroad and so the financial pundits have come forth from their glass towered temples to offer their counsel. And like well-behaved cattle, the mooing masses have left their fair pasture and are being herded through the rancher’s gate to some unknown but new destination that will provide the hoped for upgraded cud for the chewing. Or might it be the slaughterhouse?

Herd mentality is well researched and highly documented amongst philosophers such as Søren Kierkegaard and Friedrich Nietzsche , scientist Wilfred Trotter, psychologists Freud and Jung, and economists such as Thorstien Veblen to name only a few. It is easily seen in investing through the cyclical frenzied buying (bubbles) or frantic selling (crashes) of the stock market. These sudden swings are rooted in irrational investing practices and driven by emotion – greed in bubbles and fear in crashes.

New economic data is acted upon within seconds by leading professional portfolio managers armed with cutting edge rapid response technology. These “in-the-know” active managers move the market. The media then reports. Articles grace the front page of national publications and prime-time television. Jim Cramer starts banging and bonking his toys while he yells out “sell, sell, sell,” and the frenzy is afoot.

Our current market is characterized by plenty of mooing these days. Six straight weeks of market losses have not been seen since 2002, and have pushed the Dow Jones industrial average below 12,000 after an exuberant eight-month run in which corporate profits and share prices soared. Just when retirement accounts of ordinary Americans began to look healthy again, bang! We are thrust back into dark times.

And boy, does this type of news preach! This is when the herd really gets moving. Investment advisers are inundated with bleating customers asking to be moved into defensive positions. With herd-like agility, these investors have a knack for timing the lows with perfect precision. Never mind the fact that the system is rigged to slaughter the slow moving cattle that seem to always make their move a bit too late. Still, year-after-year, these retail investors are easily rounded up for the slaughter by the pros that know how to really make a real profit.

Investors forget the fact the stocks do not rise steadily over time. They do so in a rather abrupt series of fits and starts with a few days of large gains sprinkled randomly throughout the year. According to finance professor H. Nejat Seyan, if you missed the ninety best-performing trading days from 1963 to 2004 your annual returns plummet from 11% to 3%. Indeed, you would need to be an oracle to accurately pick the 90 best days out of 14,694!

Suffering from collective irrationality, these investors are like sheep without a shepherd, lacking any sense of long-range vision and guiding principles to anchor their portfolio management.  They are unsheltered, exposed and ready to become prey. They are ships without moorings. Their portfolios are tossed to and from in the market’s choppy seas.

The First lesson of Wall Street is to exploit mass-market psychology by acting in a contrarian fashion. Studies by economists and psychologists have found that investors are most influenced by recent events — market news, political events, earnings, and so on — and ignore long-term investment and economic fundamentals.

As a retirement investor, you have a few clear and simple choices. You can enter the active management fray and compete with the big dogs, you can follow the masses and fall prey to the bloodletting, or you can rise above it all by rooting your investment philosophy in proven science and long-range planning. Driving fees mercilessly down, embracing basic global asset allocation and contrarian rebalancing will deliver you from cud chewing and into a Kwai Chang Caine, Zen-like peace. Instead you can rule your portfolio with long range and academically proven principles, and invest effectively and with peace-of-mind.