How to Safely Make 20% a Year – Year After Year

“Porter, I love reading your letters, but I don’t have time to follow up. I’m traveling around the world making movies. Even if I weren’t too busy, I’ve got a knack for making the worst possible investment decisions, at exactly the wrong time.

“What if I just paid you $10,000 a year to manage my account? You’re finding stocks anyways, and you’ve got a great team of researchers around you. You could put my money to work with almost no extra effort...”

We were eating at the Old Ebbitt Grill, a Washington D.C. landmark.

The man across the table was worth about $10 million, which seems like a lot of money, but really isn’t in the world of independently wealthy people. His liquid portfolio was “only” worth about $5 million. Put into muni-bonds or a similar array of safe fixed income, the man could have easily generated $350,000 a year or so in mostly tax-free income. But that wasn’t nearly enough. He wanted to earn around $1 million a year (20%) – or more.

When he tried to invest aggressively, he got burned and ended up losing $1 million. He lacked the discipline to limit his positions. He got into volatile stocks without trailing stops. He made all of the mistakes of the typical nonprofessional investor, starting with the idea that to make a lot of money you have to take big risks.

He didn’t trust brokers or mutual funds. He was smart enough to know that paying those guys $50,000 per year (1% of his liquid assets) wasn’t enough money to keep them focused on his best interests. He wasn’t going to be anyone’s top client. And he was no fool.

I wasn’t interested in his offer. But what I told him allowed him to accomplish his investment goals. And it could do the same for you...

“I don’t manage money because doing so would immediately cause me to have the same kinds of ethical dilemmas that keep you away from brokers. I mean, would I put my clients into stocks first, or my subscribers?

“That’s not to mention that your offer is one-fifth of the average rate for sub-par, closet-indexing money managers... and probably about one-twentieth of what I would charge, were I in that business.

“Besides... you don’t need to pay me anything to get our best ideas. You’re already an S&A Alliance member. You get the S&A 16 Model Portfolio each quarter. All you have to do is follow the model portfolio, and you’ll make 10%-20% most of the time. You’ll almost never lose money.”

His reaction to my suggestion brought to mind the story in the Bible about the Syrian general with leprosy.

The king of Syria sent one of his troops to the king of Israel, asking him to heal the general. The king of Israel delegated the task to the prophet Elisha, who told the general that he had to bathe seven times in the River Jordan. The general didn’t believe him. And he stubbornly refused to try it. Finally, the soldier he sent to Elisha asked the general what he had to lose by trying it. And, of course, as soon as the general went for a dip in the Jordan, he was healed.

No, I don’t think I’m a biblical prophet. I like the story because I’ve found time and time again in my life that easy solutions are the best – the only ones that really work. If you’re like most people though, you’ve gotten so tied up in complex solutions to your financial affairs that you probably don’t even know what you own, what account it is in, what it has been earning each year, or even what it is all worth.

And that, my friends, isn’t going to lead you to financial freedom... which is just the way your bankers, brokers, lawyers, and accountants want it. Because as long as you’re tied up, tied down, in a fog, and lost, you still need them.

You can manage your own money, easily. And you can be very successful doing it. It doesn’t need to consume you, scare you, or take all of your time.

Here’s what I recommend:

Take all of your savings and figure out how much you want to put “at risk.” The amount should be as large as you can possibly afford, because it’s the amount of money you invest that will largely determine the amount of money you can make every year. For myself, I keep about 10% of my net worth set aside in 90-day T-bills and gold bullion coins.

This is my “lockbox.” It’s enough money to support my family and me for more than a year, assuming no further income. The lockbox lets me sleep at night. No matter what happens in the world, I’ve got a year’s worth of expenses saved. That’s enough for me. If you’re already retired, your lockbox will probably be much larger – perhaps five years’ worth of expenses. Or more. You’ll have to decide what’s right for you.

Now, here’s the fun part. Look over our newsletters and others you receive. You’re going to pick 16 stocks to buy. You’re going to allocate all of your liquid investments equally into these 16 stocks. And you’re going to break down your portfolio of 16 stocks into four categories: value, growth, income, and “macro.” You’ll be left with a diversified group of high-quality stocks, and you won’t have so many stocks that you can’t follow them easily...

Let me show you how to do this.

The first four stocks you’re going to buy should be value stocks. You could pick these by reading the pages of Porter Stansberry’s Investment Advisory,True Wealth, Extreme Value, or Inside Strategist. Each of these newsletters carries investment ideas based on value, although only Extreme Value carries value recommendations exclusively. You only have to buy four, so make sure you understand the business you’re investing in.

Take a little note card and write down the main reasons for your investment and what you expect to happen in the business over the next year. Write down what price you’d consider selling at if the price goes up. Write down what adverse developments would make you consider selling. It should take you about an hour to do this with each stock. That’s about one weekend afternoon. Make the investments when you feel that you’re prepared and are knowledgeable about what you’ve bought and why you’ve bought.

We did this same thing last January 2006 for our Alliance subscribers. Each quarter (four times a year), we publish a new version of the S&A 16 Model Portfolio, which shows our Alliance subscribers how we’d build a balanced portfolio based on selections from across all of our newsletters.

We picked Arch Capital (reinsurance), RadioShack, Bladex (a Panamanian trade bank), and Tejon Ranch (California land). With the exception of RadioShack, all were Extreme Value recommendations. Quite frankly, we didn’t pick very well. RadioShack was sold at a loss, and Dan decided to exit the reinsurance business, so we sold Arch Capital far too soon, with only a small gain. But Bladex paid big dividends, and Tejon is up more than 25%. On average, our value picks were up 8% this year.

But let’s get back to building your perfect portfolio...

Just as you picked four value stocks, do the same thing the following Saturday afternoon, except instead of looking for value stocks, pick four growth stocks. What’s the difference? Growth stocks aren’t as cheap as value stocks (typically). Instead of buying to take advantage of a huge discount to current intrinsic value, you’re buying because you believe the company’s intrinsic value will grow rapidly, making an investment today valuable tomorrow.

You’ll find these kinds of opportunities in almost all of our publications. Again, write down your main reasons for buying – where is the growth supposed to come from? Write down the future price at which you’d happily sell and write down what adverse developments would make you want to sell. Once you’re comfortable that you know what you’re buying, make the investments.

We did the same thing in January’s S&A 16 Portfolio. We picked Rayonier (timberland), Nokia (cell phones), Convergys (outsourcing), and Lexmark (printers). With the exception of Rayonier (True Wealth), all of these stocks were recommended in my investment advisory.

Even though we stopped out of Rayonier at breakeven (Florida land stocks crashed in the first half of 2006), we still did very well in this portfolio, thanks to big gains in Convergys and Lexmark, both of which were up more than 50% this year. On average, our growth stocks made 32% this year (so far).

Now... moving on to income positions...

Look through the publications you trust or websites that provide solid financial information and find four stocks (or bonds) that can provide you with rock-solid dividends (or coupons). In general, with stocks, I look for yields between 6% and 12%. With bonds, I look for coupons above 8%. Make sure you understand the business and write down your expectations for the investment. Include the dates on which you expect to be paid a coupon or a dividend so you can keep track. Once you’re comfortable, make the investment.

This past January, we had lots of good income choices available when we sat down to select our four income plays for the S&A 16 Model Portfolio. We picked KKR Financial (middle-market financing), Annaly (home mortgages), GMAC bonds (corporate mortgages), and Macquarie Infrastructure Trust.

Our timing was rotten on Macquarie Infrastructure, and we ended up getting “stopped out” at the worst possible time, selling for a 6% loss. On the other hand, when General Motors spun off GMAC, we got a big capital gain, something you don’t get very often in the corporate bond market, driving our total return on these safe bonds to almost 30%. On average, we made more than 19% on our income portfolio, including the loss we took in Macquarie.

The last part of your portfolio should be “macro” ideas. All macro means is that you’re expecting the catalyst in the stock to come from outside the business.

For example, in January’s S&A 16 Model Portfolio, we picked Valhi (titanium), Japan iShares, Time Warner, and Steve Sjuggerud’s True Wealth rare coin set. In each case, we expected forces outside the business to cause its value to appreciate – forces like inflation, corporate raiders, and Japan’s government.

Typically, this is the riskiest and highest performing segment of our portfolio. Two of our macro picks lost money (rare gold coins and Japanese iShares) – making macro the only portfolio where we had two losers. However, Valhi soared as titanium prices continued to increase, and Time Warner rebounded strongly as Carl Icahn and other corporate raiders forced it to cut costs and buy back stock. Overall, we produced average gains of 15% in the macro portfolio.

If you do what I’ve recommended, and you use Stansberry & Associates Investment Research as your primary research tool, I’m confident that your portfolio results will be consistently between 10% and 20% a year – with almost no losing positions. This year, our S&A 16 Model Portfolio (the one I described above) is up 18.5% – trouncing the S&P 500’s 12% gain. We didn’t do anything fancy, we simply picked a diversified list of stocks based on the research we’d already published.

You can do the same.

On the other hand, if you’d rather let us “manage” your money for you, all you have to do is join the S&A Alliance and look at the S&A 16 Model Portfolio. That’s what I advised my dinner guest to do – and that’s what he’s done. If he followed our advice this year, he made 18.5% and he didn’t pay a dime in money-management fees to do it. If he’d made the same gains in a hedge fund, he would have spent $100,000 in fees and paid another $185,000 in “profit sharing.” All he’s paid us this year is his $149 maintenance fee.

In January, we’ll build our next S&A 16 Model Portfolio – the 10th one we’ve published. I hope you’ll be reading... and setting yourself up financially for a great and worry-free 2007.

Best Regards,

Porter Stansberry