Friday, May 7, 2010

Plunging And Soaring

I wish we were talking about necklines here, but we're not.

For those of you unfamiliar with the stock market, what you hear from the talking heads on TV can sound pretty scary. I'm going to give you a two minute education that will hopefully clear things up for you a little bit. Or maybe you'll just say, "huh?" We'll see.

Publicly owned companies issue shares of stock. Millions of them, usually. If you buy 100 shares of Harley Davidson, it would cost you just under $3,000 and you would be a teeny tiny owner of the company but with none of the responsibilities of running the company. You would, however share in the profits or losses of the company.

If lots of Harleys were produced inexpensively and sold at a high price, you might reasonably expect your stock to rise in value. If, on the other hand, you have different fingers like I do... wait. Wrong discussion. If Harley sells fewer motorcycles because of a tough economy and they wind up with a bunch of them sitting on showrooms, then you might reasonably expect the value of your stock to go down.

Those are the unmanaged market factors. What a lot of people forget, is that America is a capitalistic society and that the people that have managed to rise to the top levels of our corporations are generally very smart people that know their only job is to produce profits for the owners of the company (that's you, the stock holder). These very smart people are always thinking. "What can we do to make DoerBitter Dispatch readers more money?"

Well, these folks figure out ways to reduce expenses, how to create interest in their new line of Hogs, how to get butts in the seats. If they can convince 60 year old accountants that this is a new road to cool, then by golly, they have just opened up a new market and sold more bikes and made you more money. Of course, in that example, we might have to take a few extra steps because plaid sweaters and argyle socks clash with eau de Harley, but again, I digress.

As a result of this corporate intelligence in our capitalistic nation, companies grow over time. Sure there are ups and downs along the way, but if you own good companies that you understand, you will make money over time. Ignore the bar stool talk about the huge profit or huge loss your buddy made. They are not investors, they are gamblers and they rely on luck.

Buy quality and hold it for a long time. If something changes; if Harley Davidson decides that square wheels would be an interesting change to their product line for instance, maybe then it is time to take your profit and walk away.

Diversification is very important. You don't want to put all your eggs in one Harley Davidson. They vibrate like crazy. Mutual funds are a common and relatively safe way to buy multiple companies at one time.

$10,000 invested in Harley Davidson in April of 1990 is today worth $275,934. Remember that we have had several "devastating" market crashes during that time period. Remember what I said about ignoring the talking heads on TV? Do find a financial advisor you trust and listen to what he or she tells you. A good advisor will educate you over time, which will help you be more comfortable changing the channel when the news anchor starts screaming hysterically about the latest stock market "free fall".

Ignore the market "plunging" and "soaring" you hear about on the evening news. Invest regularly and ignore the noise. When retirement day gets here, you will find out that capitalism ain't so bad after all.


  1. Why aren't index funds a better option over mutual funds? Mutual funds tend to under-perform the market, as well as having substantial management fees and what not. Where as index funds better mimic the market as a whole and have lower costs of management.

    And what do you think the threshold is where you should start looking away from funds and towards a personal money manager? Make your own portfolio and own stocks directly (as oppose to through funds)?

  2. Index funds are great for an investor that would rather do it himself but sacrifice total return. An index fund will perform exactly the same as the index it mimics, less a small service fee.

    Most people have lives of their own and don't wish to spend eight hours a day being a student of the markets but wish to earn more than just what the market does. Those people hire a financial advisor that can guide them through the myriad choices available and help you avoid the copious amounts of crap that is out there.

    An index fund owns all the stocks in a particular index, including the cruddy stocks. The point of a managed fund is to eliminate the cruddy stocks but keep the good ones. A manager or team of managers must be paid to provide this service, plus your advisor must be paid. For this you pay a sales charge, or "load". In return for this higher cost, you would reasonably expect a higher return than an index fund.

    Well chosen portfolios of "loaded" funds will almost always outperform index funds. The problem is that many investors don't invest well. They buy and sell based on emotion, so very few actually receive the returns the funds actually earn. Discipline is key.

    Hire a knowledgable and experienced advisor and follow his advice. Ask questions. Educate yourself as you go but be very careful not to invest based on emotion.

    As for your second question, the answer is ""never". Why on earth would anyone want to try to stay on top of 75 or 100 individual stocks? Who could do that well? Even mutual funds have research departments and teams of managers. Family estates will hire private managers but really all they are doing is hiring one financial advisor to take care of all their money. $50,000,000 is probably the minimum amount to do this and at that level, expect to pay 2.5% to him plus the cost of the investments.

  3. "90% of Mutual Funds Underperform Through Q3"


    "...the vast majority of mutual funds underperform the returns of the stock market..."


    We can like mutual funds all we want but the research I'm doing says that (on average) if I have $1,000 with a mutual fund and $1,000 with an index fund (i.e., "the market") the index fund will be worth more at the end of the year.

    Yes SOME mutual funds do awesome and a "good" money manager will steer you towards them but the overwhelming majority of mutual funds appear to be bad apples. And those mutual funds couldn't exist if people were't pouring their cash into them.

  4. Well your first clicky was an ETF ad, so it doesn't have a lot of credibility. Your second clicky was Motley Fool where they always promote index funds for the do it yourselfer because you aren't smart enough to pick winners on your own. They also say to never use a broker, although they broke down once and said that if you do, make sure it's an Edward Jones broker (interestingly enough).

    What is so difficult about finding a couple of mutual funds that are in that 10% of yours and then sticking with them through thick and thin?

    I'll tell you what. Human nature. And that is why you need an advisor to hold your hand. Now get off these damned generic, never keep up with one single of my client's portfolios, index funds! They are for beginners, people satisfied with average, lazy people, and stupid people. (Which describes many investors)

  5. How are you (as an adviser) different from the guy managing the mutual fund? I mean a large mutual fund is going to have more money than your average portfolio I would assume as well as a research department, but that aside; it seems like both a personal advisor and a mutual fund manager, take money from their clients and invest it in a "wisely" diversified portfolio of securities.

    From the complete outside perspective, most mutual fund managers can't beat the returns of the average, lazy, stupid people. Is the same true for the guys who do your job?

  6. A fund manager judges the merits of individual companies as to their future growth potential, dividend return, and strength and stability.

    A financial advisor has to determine the short and long term goals of his clients, learn all aspects of their financial status, learn their risk tolerance, then once he has a good idea where they are trying to go, the advisor has to create a roadmap to help them to safely get to where they want to go.

    This means vetting the tens of thousands of investment choices. Some advisors fancy themselves modern day cowboys and actively trade stocks. This is advanced gambling. Others sell products that produce high commissions and may or may not be good for the client.

    A good advisor will discard most individual stocks, any mutual funds that cannot produce a long track record of above average returns with the same fund manager, mutual funds with significant style drift, investments where the fees involved bring the return to a below average return. This eliminates most mutual funds and almost all annuities.

    Many investors get excited about fees but they need to focus on their overall return net of fees and taxes. That is what matters.

    In summary, fund managers and financial advisors do dramatically different things. Both populate the financial world but are as different as octopi and whales and there are far fewer excellent advisors just as there are far fewer excellent mutual fund managers.

  7. Note: The excellent advisor will also be knowledgable in the preparation and execution of charitable giving and estate planning strategies for the passing of assets to the next generation while minimizing the effects of taxation. A fund manager would look at you and say, "huh"?

  8. THANK YOU for that annuities comment. Almost all of my professors have been talking about how awesome bonds and annuities are and I'm like "Are you kidding me? I made more on google stock in 2 weeks than that will return in 5 years!"

    I am intolerant of low risk tolerance.