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How to Be a David to Wall Street Goliaths

InvestorEducation / Learning to Invest Oct 25, 2013 - 08:56 AM GMT

By: Don_Miller


Does the little guy ever really stand a chance in the market? Well… did David take down Goliath?

The mainstream media likes to peddle stories about the little investor who always loses money in the stock market. When the mechanics or teachers or dentists of this world try to compete with the big boys on Wall Street, they always seem to fail. Ordinary people like you and me appear doomed to lose our shirts when we try to compete against folks with sophisticated trading tools (and mathematical geniuses to run them). But are we?

This Call May Be Recorded for Training Purposes

Professionally managed mutual funds usually fail to beat the S&P 500. In the May issue of Money Forever, which focused on minimizing unnecessary fees in one's portfolio, we shared some noteworthy statistics with our subscribers:

"Actively managed mutual funds just don't have the best track record, largely because of the high fees. Over the last five years:

  • 65.44% of active, large-cap fund managers failed to outperform the S&P 500
  • 81.57% of mid-cap managers lagged behind the S&P Midcap 400
  • 77.73% of small-cap managers were outperformed by the S&P SmallCap 600"

Ouch! Not a great record considering the fees they’re raking in.

When I think back on the many times I spoke with stockbrokers who wanted my business, they always implied that I needed professional investment help – their help. When I'd mention statistics like the ones above, stockbrokers would jump on them as further proof that the little guy doesn't stand a chance on his own. If those genius fund managers can't beat the S&P, how could I?

I recall asking one overly aggressive broker why he was wasting his time with me. I told him, "If you are so damn good, you could make a lot more money managing a fund yourself." He was so naïve that he thought I was serious. When I realized I was getting an earful about his career aspirations, I quietly hung up the phone. That is one call I hope his employer recorded for training purposes.

The implied promise from the mutual fund industry and their co-conspirator brokers is that, in exchange for high fees, they will deliver a better performance than the overall market – better than you could produce on your own. It's a great theory, but few (if any) funds consistently outperform the market.

There are multiple reasons why their promises never pan out. First, the larger a fund gets, the harder it is to deliver. When the fund grows into billions of dollars, it must keep investing, either deeper into positions it already has or by widening its base with additional picks. At a certain point, the greater size becomes a disadvantage. The fund loses a lot of flexibility.

Managers of large funds are under constant pressure to grow their funds as they make more money. Many of the funds with larger fee structures use some of those fees to compensate stockbrokers. Sure, the funds may do well before fees are applied, but once everyone takes his cut, the picture isn't quite as rosy. At that point, folks are better off buying an exchange-traded fund (ETF) based on an index with much lower fees, all from the convenience of their home computers.

I recently watched a Frontline special on retirement, which highlighted just how much these fees impact our portfolios. The producers suggested that fees are a major cause of the poor performance of many 401(k) accounts. While fees are certainly a major reason why the financial industry fails to deliver on so many of its promises, I want to focus on another issue today.

Who Defines Success?

Many major firms like Morgan Stanley or Fidelity offer dozens, if not hundreds of funds to choose from. Let's suppose a company puts a new manager in charge of a fund, and he doubles its size. Imagine this happened in a good year where the S&P went up 12%, but the fund only made 10% net. Oh, darn!

Now, do you think they'll fire the fund's manager or give him a bonus? Just think about the fund prospectus, where they'll want to boast about double-digit returns. The prospectus won't contain an apology to investors; it will say that the fund's performance was terrific.

The problem will then compound when brokers like the hotshot I mentioned earlier tell folks like you and me about the amazing fund that made double-digit returns last year. He'll tell prospective clients they really need to send him their money now, before they miss out on a great opportunity.

Personally, I like my stockbroker. However, I always keep in mind that at the end of the day, the number that means most to brokers is the number of shares they trade in a day, and not whether the market moves up or down.

So, the bottom line is: brokers and fund managers want our investment capital. We take all the risk, they earn high fees, and we get whatever is left over. See, they are pretty smart after all… using our money to make a lot of money for themselves.

It Doesn't Take a Rocket Scientist (or a Fund Manager)

So, do we stand a chance? In a word, absolutely! Individual investors have many of the same trading tools as mutual funds, but not all of the disadvantages. We just need to know how to access our toolkit. We are each managing our own personal "mutual fund," and we have a real say in how well it performs. Plus, we get to keep all of the profits.

What about the often-repeated sentiment that the little guy needs the superior skills or intellect of brokers or money managers? Hah! I totally disagree. If you are smart and hardworking enough to build a nest egg, you can certainly manage it. There is a major difference between being dumb and being an uneducated investor. While the professionals may have more financial education and experience, they are neither smarter nor more capable than you or I. Frankly, I resent that sort of condescending attitude.

Does that mean we all need to hit the books, pass the Series 7 test, and get our broker's licenses? Of course not. It just means we need to do our homework and fill in any knowledge gaps.

I shudder when I think back on my early days as an investor. I was still a working man, and when my broker would call he'd have to leave a message on my answering machine – surely you remember those relics. We didn't have cellphones in those days, so I would race to a pay phone during a coffee break, use my telephone calling card, and call her back. My broker would tell me about this or that wonderful opportunity, and I would decide whether or not to invest in less than five minutes. While my broker would only give a few quick bullet points, I assumed this was just a summary based on a lot of in-depth research. It turns out I was way off base.

A few years later, many of the big brokerage firms got in trouble with the Securities and Exchange Commission. Apparently, they would buy large blocks of stock in a big-name company. Each morning some guru in their New York office would get on the squawk box and tell all their brokers about the hot pick of the day. Brokers nationwide would then tell retail investors that this pick was a "strong buy." Their office would receive a fax with bullet points to read to people like me over the phone.

The fact that a major brokerage firm recommended a stock was the reason the stock jump would 3-5 points. Brokers would point to the sudden uptick in price as confirmation of their wisdom. Most folks never understood that the stock they were buying came out of their brokerage's inventory. In short, the brokerage houses were making money on that 3-5 point jump, not us.

There Are No Secrets to Investing

Is protecting your life savings worth the time and effort required to learn how to be a smart investor? Yes! Do we want to totally delegate that responsibility to someone who is part of a system that has not performed well in the past? No!

Is there a secret to being a successful investor? No; the information is out there for the whole world to see. Like everything in life, it just takes time and commitment. We've all worked hard for our money; all those years spent in the office or on the road should be motivation enough to learn.

Many folks ask me where they can find the right stocks for their portfolios. In a recent article for the Casey Daily Dispatch, I shared an analysis of the results from an assortment of Casey Research newsletters. Long story short, they all have phenomenal track records. These sector experts can find the proverbial needle in a haystack, and their past performances prove it. Their recommendations, coupled with the picks in the Money Forever portfolio, are where I recommend everyone starts.

Don't get me wrong – I'm not suggesting you follow me or anyone else blindly. Study the in-depth research that runs through every Casey publication, sift through the stories of visits to mines and oil fields, and decide for yourself where you should put your money.

It is really so simple. I often wonder why more folks don't catch on. Never buy in to a company or industry you do not understand. Continue to ask questions until you reach or pass your personal threshold for comfortable investing. Life is full of good deals, so we don't have to act in haste. Another good deal will always come along. If the one you passed on does well, don't sweat it. You probably passed on it for the right reasons.

In addition to finding solid investments, we have to put our picks together in a way that minimizes risk and maximizes return. No matter how good an investment sounds, it's never wise to go all in. I know folks who have piled a lot of money into what they thought was a "sure thing." They all end up saying something like, "It seemed like such a good idea at the time."

Over the last few issues of Money Forever, we have covered the basics on allocating one's portfolio properly, with a special focus on how to protect your retirement portfolio. After all, seniors no longer have the benefit of time to recover from risky investments gone awry.

For many retirees, fear of losing money, independence, and dignity is ample motivation to read and learn. An education is an ongoing process, not a one-time event.

A Money Forever Education

Quite a few of my friends see putting time into managing their investments as a major commitment, one on par with a full-time job. As an active investor, I can tell you it's not. But it does entail putting in a few hours a week researching, monitoring your portfolio, and making adjustments when necessary. And that's how many of our Money Forever subscribers view it: they enjoy their lives and do all the things retirees do, but they also commit to managing their retirement portfolio because no one will ever do it better than they will.

In recent issues of Money Forever, subscribers learned the nine best ETFs to replace expensive mutual funds, how reverse mortgages work and how to know if one is right for them, and the nuances of annuities, both fixed and variable. Money Forever isn't just about investment recommendations; it's an education to make sure you do stand a chance in the market… and that you can come out ahead.

I'd like you to consider giving it a try. We offer a 90-day risk-free trial period, and you can get a full refund if you feel it's not for you after all. And of course, you can still keep all the reports and issues as my way of saying thank you. Click here to take a look, and we'll get you set up today.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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