How to Become Smarter (52 page)
Whenever someone is trying to sell you a secret of easy money that will give you financial freedom for the rest of your life, you can do a little math. Let’s say we believe the seller’s claims that there are piles of money out there that anyone can put in their pocket without much effort. Then why would the seller yield all these piles of money to you? If the amount of easy money is sufficient to give you financial freedom, then there must be at least $30,000 per year of “unclaimed money” lying around somewhere. Why doesn’t the owner of the secret just pocket all this easy money, leaving nothing to you? Is this because the supply of the effortless money is unlimited? No, that’s impossible because the seller of the secret is not the richest person in the world. Besides, trading profits are always limited because large transactions will start affecting the price of a financial instrument. Is the promoter offering you access to the effortless $30,000 because you will pay him $20 (for a book), $100 (for software), or even $3,000 (a fee for “an advanced seminar”)? That’s ridiculous. To the promoter, forgoing the effortless $30,000 in exchange for $3,000 doesn’t make any sense. If presented with a choice, any idiot would take an easy $30,000 instead of a more difficult $3,000 that one has to earn by providing a seminar. The situation will be even more laughable if you multiply these figures by the number of potential buyers of the secret of financial freedom. Therefore, when someone is promising you financial freedom for a small fee—for example, if they are trying to sell you an option trading technique—the promise of easy money is always false and the technique is useless. Otherwise the promoters would not have put it up for sale.
The only situation where selling the secret system to the public would make sense is when the system stopped working and became unprofitable for some reason. The inventor can still honestly claim in his advertisements that the system has made a lot of money. What the inventor will not tell you is that the system will never make money again. Note that it doesn’t matter if the parameters of the trading system are optimized to fit the past market data. Put another way, if backtesting shows that the system would have made enormous profits in the past, this does not mean that the system is going to be profitable in the future. Since markets are random, they are under no obligation to adhere to the patterns or formulas prescribed by any trading system.
There is also this “big secret” that
maybe
your trading approach does not have to right 100% of the time. If it predicts the market correctly 55% of the time, then it can be profitable if you always bet the same small percentage of your trading capital. Another “big secret” that some authors are selling is that your trading system can be profitable if it loses many small trades but wins a few big ones. These ideas are not new and, as beautiful as they are, the market is still random and will not bring consistent profits. There are already a great number of players trying to make money this way. According to the “crowd effect,” if there is a profitable trading method and many traders start using it, it will stop being profitable.
If the above arguments still have not convinced you that no one is going to sell you an authentic secret of successful trading, you can do the following. Ask the seller of trading techniques to show you his trading records for the last three years. You can ask him at least to name the average return on capital for the last three years. There are companies that will verify authenticity of any trading records for a fee.
You can look at the table of contents of a book that promises to teach you how to trade. If you do not see a chapter or section that describes the author’s trading achievements, then the book will not provide you with any useful information. If the author does describe his own trading results (not just one successful trade, but total results for the past three or more years), you can do some research on the Internet. You can find out if the author is a fraud or not. The vast majority of writers about trading and technical analysis have no trading achievements at all, even though they often call themselves “professional traders.” It is amazing that some of them can sell hundreds of thousands of books and hundreds of seminars without ever proving to anyone that they can trade successfully themselves. These clever folks are selling pure hope. They cannot give you a
proven
profitable trading system and they have never had one. Yet they will promise to teach you how to make a living by trading.
In conclusion, trading of financial instruments is an occupation where only a small minority of participants will be able to make a living. The majority of people will lose money. Therefore, it is best to avoid investing your savings in this activity.
P
REPACKAGED
P
ROFIT
S
YSTEMS
.
The same “crowd effect” applies to many profit schemes that various seedy elements sell to the public in the form of books, seminars, videotapes, or software. This includes real estate profit systems, multilevel marketing schemes, and internet profit systems. These methods worked well for the few people who invented these schemes or were the early adopters. By the time you see a profit system advertised in books, newspapers or on TV, the system is no longer profitable. There are too many people who are using it (“competitors”) and the crowd effect (competition) has eliminated high profits. Now the system is either not profitable or provides only an average return on investment. A return on capital of about 10% per year is an average investment return available in the stock market in the long term. This kind of profitability cannot make a person self-employed without substantial startup funds. If your living expenses are $20,000 per year, then you need to invest at least $200,000 just to stay afloat, if we ignore taxes and unforeseen events. It makes no sense for an inventor of a successful profit system to sell the know-how to the public if the system provides an above average return with low risk. (It’s not all nonsense; for example, there are some good books on the real estate business. These books discuss risks in detail and do not promise to make you rich [
816
].)
An example will illustrate this point. Let’s say someone came up with an authentic business idea that will allow you either: {a} to triple your money within a year with negligible risk (0.01% chance that losses will occur) or {b} to earn $50,000 per year with zero investment required. Suppose the business requires one hour of self-employed work per day. This sort of business can give anybody financial freedom right here right now. Does it make sense for the inventor to mass-market this business idea as books, promotional videos, or seminars? Not really. The inventor of an authentic business can hire people to work part-time without disclosing the details of the business to them. She can pay them $20 an hour (the minimum wage in the U.S. is $7.25 an hour). She will gain over $40,000 per year per employee of almost effortless money in business “b” and maybe even more in business “a.” The inventor has a choice. {1} Hire a thousand employees, each of whom will bring over $40,000 of effortless money per year. {2} Try to sell one thousand copies of the book, each bringing about $10 in royalties and creating numerous competitors in this lucrative business. The choice seems obvious, doesn’t it? Even though managing one thousand employees will require some effort, the entrepreneur can hire managers and delegate most of the responsibilities to others. Suppose she has two more options: to sell one thousand promotional videotapes ($100 each) or one thousand seminars ($3,000 per attendee) about this lucrative business idea. Running the actual business with one thousand employees and no competitors is still far more advantageous. Therefore, keeping a lucrative idea secret and implementing it yourself is a far more profitable approach than mass marketing the idea to the public. This is the gist of the secrecy principle. This example demonstrates that no one is going to mass market an authentic secret of easy money in the form of a book, DVD, seminar, website subscription, and so on. Whenever someone is trying to sell you a profit system that will require little or no investment and will allow you to earn higher than average income, this information is guaranteed to be useless.
The secrecy principle does not apply to multilevel marketing (MLM) systems because propagation of information forms the basis of this sort of schemes. Yet the crowd effect (competition) is still applicable. It is unlikely that you can get in on the ground floor of a newborn (or new in your area) multilevel marketing scheme that will go on to become a wild success. Most such schemes go nowhere and your investment will be lost. If you try to join a multilevel marketing scheme that has already become successful (well-established in your area), then you are too late to the game. Society is oversaturated with such systems and there is hardly any room for further growth of these enterprises. Multilevel marketing is an excellent way to lose friends and alienate acquaintances and relatives. You should not envy people who have succeeded at multilevel marketing or at least claim that they have (to sell you on the scheme). It is a lottery and the vast majority of people who play the lottery lose their money. The continued existence of MLM schemes is based on these four misconceptions that MLMers are inculcating in their recruits:
- The majority of people can succeed at MLM.
(If this were true, then only a tiny minority of the population would be working for a living and the vast majority of people would be enjoying comfortable passive income.) - You don’t need any special
talents
to succeed at MLM.
(False. You have to be a good salesman and a “motivator;” we will talk about motivational stuff later.) - There are no limits to the growth of MLM companies.
(False. The size of the population is limited and the percentage of people who would like to be in MLM is also limited.) - MLM companies offer a good price for the goods that they sell to consumers.
(False. MLM companies sell their stuff at exceedingly high prices, which, in my own experience, are not justified by the quality of these goods. Nobody would buy this stuff at a supermarket because MLM prices are way too high.)
The sky-high prices of MLM goods are what generates passive income for those in the upper parts of the pyramid. The cost of purchasing MLM goods (for reselling) is lower for those in the upper parts of the pyramid than those at the bottom of the pyramid. This is due to a special system of discounts. The bottom of the pyramid voluntarily transfers its money to the upper parts of the pyramid. Even with the discounts, MLM prices are still a rip-off. If the price is 2 to 3 times higher than a price at a supermarket and you receive a 20% discount, you are still paying too much. Therefore, it is disadvantageous to be at the bottom of an MLM pyramid. Now imagine the situation where 100% of the population in your geographic area (your city or state) participates in an MLM scheme. It makes no sense for those at the bottom to stay in the system, if they are thinking rationally. This is because a substantial portion of their income automatically goes to the upper parts of the pyramid and because there is no chance that they will assume a higher position in the pyramid. It makes even less sense for somebody who visits this geographic area to
join
the MLM system. This is “absolute saturation.”
We can make a reasonable assumption that about 5% of the population are interested in joining MLM and all of them have already enrolled in some MLM scheme. This is “realistic saturation.” This is a situation where further growth of the number of people enrolled in MLM is either impossible or too slow. (Population growth in the United States is about 1% per year.) Because MLM companies have existed for decades, it is likely that your geographic area has already reached a “realistic saturation” point. “Realistic saturation” has the same implications as “absolute saturation.” It makes no sense to join an MLM system at this point. The only two situations where it makes sense to join an MLM scheme are:
- MLM has never existed in your geographic area. (For example, the territory of the former Soviet Union in 1991-1992 after the collapse of the communist system.)
- MLM has existed in your geographic area, but the MLM scheme in question is far more attractive than existing schemes. Some MLMers will be willing to switch to the new system.
The latter situation is possible but unidentifiable. Success or failure of any one scheme is difficult to predict and all of these schemes claim to be “the best and fastest-growing.” What you see at MLM meetings, where it seems like everyone in this business is enjoying unlimited prosperity, is an illusion. What is invisible to you are huge masses of people who tried this stuff and were never able to obtain any serious income from MLM. Either they are not good salesmen or they were too late to the game (MLM has reached a saturation point in their geographic area). A typical speaker at MLM meetings will be telling stories about how everyone was discouraging him from going into MLM, and yet he achieved big success because he was properly motivated. What you need to keep in mind is that no amount of motivation will lead to success if MLM has already reached a saturation point in your geographic area. (There are too many competitors and no potential recruits are left for you to sign up.) Another important point to consider is that if one person in a hundred succeeds at MLM, this does not mean that everyone can succeed at MLM. It is true that anyone can win a lottery, but the probability that this will happen to any given person is too small. Besides, who is going to produce all the goods and services in the fantasy world where everyone is living off of passive income from MLM? Also keep in mind that MLMers are good salesmen and will say anything to get you to sign up because their livelihood depends on it. (Yes, they can lie and make up “inspirational” stories.)
