10 Investing Facts You Probably Don't Know -- but Should

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Individual investorThe securities industry spends hundreds of millions of dollars a year in advertising, but that doesn't mean the general public is getting the straight scoop. Nor does the blanket coverage from the financial media ensure that the public is shielded from misinformation. So, as you contemplate investing for the New Year, here are 10 facts you probably don't know (but should):

1.
This wasn't the "lost decade": All the talk about the "lost decade" is complete nonsense. Investors who bought and held a globally diversified portfolio of low-cost stock and bond index funds did just fine. Dividing that portfolio into 60% stocks and 40% bonds, while not suitable for everyone, is an average asset allocation and is routinely used by defined-benefit retirement plans. The annualized return for that asset allocation for the past decade was approximately 6%. Investors in a portfolio of 100% stocks, invested in the same globally diversified manner, had an annualized return of almost 8%. But, yes, it was a "lost decade" for those who invested all of their assets just in the S&P 500. I don't know why anyone would do that. I also don't understand why any "expert" would use that index as a benchmark for the entire market. It isn't.

2. "Great" companies can be lousy investments: Consider Lehman Brothers, WorldCom, General Motors, Conseco and Chrysler. Companies that are "great" one day can tank the next. There's no way to tell who's next.

3. The S&P 500 Index is very unstable: While most investors understand that companies enter and exit the S&P 500 index periodically, few understand just how unstable it is. In the 41 years from 1957 to 1998, only 74 of the original 500 companies were still in the index.

4. Most investment clubs underperform the market: An extensive study of the performance of 166 investment clubs showed 60% did worse than the market. There are many reasons for joining an investment club, but superior investment performance shouldn't be one of them.

5. Mutual fund out performance can be explained by luck, not skill:
This is the big one. When mutual funds tout their great performance over the past five years, they want you to believe their fund managers have superior stock-picking skills. Not true. A recent study found no evidence of skill in the performance records of over 2,100 funds. The study's ramifications are profound. If outperformance is based on luck, there'is no way to predict the next lucky fund. Investors should avoid all actively managed mutual funds and invest in a globally diversified portfolio of low-cost stock and bond index funds instead.

6.
Most investors should not hold individual bonds: Most investors would be far better off selling their individual bonds and buying a low-cost, short- or intermediate-term bond index fund. They would get greater diversification, superior management of their bond portfolio, more liquidity and lower cost. A study by Vanguard summarizes these advantages.

7. Most investors should not hold individual stocks:
An individual stock has the same expected return as the index to which it belongs, but it can have up to twice the risk. That's because holding an individual stock entails risks that are unique to that stock, like corporate dishonesty or the death of a key executive. You can get the same expected return, with less risk, by investing in the index. Same return, less risk. You would think it would be a "no-brainer." Yet investors, egged on by their brokers and looking for the next monster stock, continue to gamble with their money by investing in individual stocks.

8. Warren Buffett does not "beat the market": I'm a huge fan of Buffett. Most investors believe his company, Berkshire Hathaway (BRK.A), has consistently beat the market. Not true. The index with approximately the same standard deviation (a measure of risk) as Berkshire Hathaway is the Emerging Markets Value Index. For the 10 and 20 years ending Dec. 31, 2005, Berkshire Hathaway stock underperformed that index. You can see the analysis here.

9. Warren Buffett advises investors to invest in index funds: Over the years, Buffett has repeatedly recommended that investors stick to low-cost index mutual funds. He even prefers them to ETFs, as he explained in an interview on CNBC in May, 2007.

10. Chasing big returns causes the brain to react just like snorting coke: Both activities are addictive. This explains why investors act so irrationally and fall easy prey to brokers and advisers who claim they can "beat the markets." The brokers are drug dealers, and the investors are addicts. You can compare the brain images of investors looking for a big score and drug addicts doing the same thing, here.

The next time you're confronted with an investment decision, take a look at these 10 facts. Then fundamentally change the way you invest.

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abbaking123

After reading this article, I started to surf the web to see at what point the columnist, Daniel Solin, had been fired. I thought for sure there would be a retraction and apology from Daily Finance for the publication of such an error-filled, egregiously written article. The article should have been labeled, "10 Things That I Don't Know and Willing to Share with the World." So, let's go point by point Point 1. This wasn't the "lost decade": -the "lost decade" is a reference to how the US Stock market performed not general overall market performance -a portfolio into 60% stocks and 40% bonds...The annualized return for that asset allocation for the past decade was approximately 6%. WRONG! Of course the author did not list one mutual fund, index or ETF to prove his point. He just gave a generalization of a 60/40 split. During those 10 years, he would had to rebalance the portfolio to maintain that 60/40 split. Did he rebalance yearly, quarterly, monthly?? He doesn't say. So, he gives a random return with no substantial facts at all. This blanket statement alone has would get him fired from any reputable firm -Investors in a portfolio of 100% stocks, invested in the same globally diversified manner, had an annualized return of almost 8% WRONG AGAIN – what international funds, indexes, ETF is he talking about. Why won’t the author list this portfolio that gave this kind of return? Why, b/c it doesn’t exist. This is one of those “advisors” that I would walk-out on after this statement, especially if he can’t prove it with hard data. Point 2 "Great" companies can be lousy investments: of course he didn’t mention Apple, Exxon, IBM, Amgen, Google, etc. It’s easy to use hindsight and pick those that performed badly but I would be willing to bet he was touting Lehman, Worldcom, etc. prior to them imploding Point 3 The S&P 500 Index is very unstable...In the 41 years from 1957 to 1998, only 74 of the original 500 companies were still in the index. of course the author doesn’t mention that many of those companies merged, takeovers, etc...AT&T is in the S&P 500 but was bought out by SBC. Now, SBC no longer exists as it took on the AT&T name...so, SBC is no longer in the S&P 500....of course, the author doesn’t mention these things. Point 4 Investment Clubs under perform I would probably agree with this. I would rightly agree that if the author was head of an Investment Club that it would be bankrupt by now. Point 5 Mutual fund out performance can be explained by luck, not skill Again, another blanket statement. I’m not an advocate of active managed funds but to say they you have a better chance throwing darts than a mutual fund manager researching and picking stocks is ridiculous. Outperforming an index one time might be luck but there is plenty of evidence that many fund managers have done significantly better. Once is luck, twice is skill Point 6 Most investors should not hold individual bonds I agree, in general – but this decision should be based on the individual investor and the type of bond considered Point 7 Most investors should not hold individual stocks see point 6 Point 8 Most investors should not hold individual stocks... The index with approximately the same standard deviation (a measure of risk) as Berkshire Hathaway is the Emerging Markets Value Index. -after Point #1, this has to be the most ridiculous statement. Unlike the author, I can’t stand Buffett. The day his “folksy”-Dairy Queen-Diet Coke-taxpayer bailout money goes to the grave will be a good day for all. But to compare BRKa to the Emerging Markets Value Index based on standard deviation is beyond incredulous. Of course the author does not give a timeframe of this comparison. Was the index standard deviation six months ago higher? Is then the comparison still legitimate? What about two years ago or five years ago? Since Buffet has been publishing his Annual Letter to shareholders, he compares his Book Value to the S&P500 book value and he has more than doubled the return. Again, why hasn’t the author been fired by now? Point 9 Warren Buffett advises investors to invest in index funds This is true (the author can’t fudge this one up). At least Buffett is correct on this one Point 10 Chasing big returns causes the brain to react just like snorting coke Again, another blanket statement in which the IFA uses studies of drug users to active investors as compared to index investors. Again, Index investing is a way to go but the link to the IFA is just ludicrous (and grossly biased). How about linking to the AMA or some other qualified scientific journal? This article is without a doubt one of the worst investment articles I have read in a long time. This is the reason that I wrote this. I hope that investors will at least read many of the other user comments about how ridiculous this author’s statements are. At least I know whose books and advice to steer from.

December 13 2010 at 9:32 PM Report abuse +1 rate up rate down Reply
klowry923

please define the term, "etfs"

December 04 2010 at 1:46 PM Report abuse rate up rate down Reply
reno1910

If your investment horizon is the shelf life of a stale loaf of bread, then very few will ever get satisfactory returns. Adult patience combined with six grade math skills using Low P/E, Low P/S, high price/dividend have led me to consistently beat the market and reduce volitility. I'm not Buffett, but if I can beat the Index what does it say for all of the mutual fund professionals?

December 03 2010 at 12:03 AM Report abuse rate up rate down Reply
bolten2

hindsight is always 20/20

December 01 2010 at 1:34 PM Report abuse rate up rate down Reply
fmeyer11

Eight years ago I bought Apple at $13, I still hold it and it is $317 today, Two years ago I bought Ford at $2, today it is $16+. I guess I am a fool for buying these individual stocks. BTW I still hold them, but sold enough so that my original principle is off the table. Oh by the way about a month ago I bought Salesforce.com at $115, it is $145 today, must be more stupidity. Do your homework on stocks and it is pretty freaking far from a crapshoot in Vegas, sheesh.

December 01 2010 at 1:28 PM Report abuse rate up rate down Reply
fmeyer11

No way to tell which good company will fail is an inane statement, if investors would actually do research, listen to conference calls, etc then they might very easily get an inkling that a company is in some trouble.

December 01 2010 at 1:23 PM Report abuse +1 rate up rate down Reply
TODD

you have better odds making money playing poker in Las Vegas than you do trusting wall street thieves. The market is a scam.

December 01 2010 at 1:18 PM Report abuse +1 rate up rate down Reply
Tonerking

Daniel has it wired with the index stocks. What most people are missing is that anything connected with healthcare like United healthcare and especially Pacificare and subs, Secure Horizions are going to tank--bigtime under the new Obama plan. Pacificare (United healthcare) had big management problems and now that sore in the corporate profit body is festering because of the future government control. I'm glad I got out last year.

December 01 2010 at 12:56 PM Report abuse +1 rate up rate down Reply
hardingfrn

Wow! 20-20 hindsight! Imagine that!

December 01 2010 at 12:48 PM Report abuse rate up rate down Reply
strobe9

I don't care for any financial print, television, and radio. I'm an active trader and the market tells me everything i need to know to profit. If i see a market behaving erratically or exuberantly, I may peek at news just out of curiosity, but the point is that I will already have acted beneficially. All of these experts tell you that you must do extensive research prior to investing as if having an educated bias is going to affect the outcome. This leads the typical investor to believe that knowing more translates into being right. I trade to make money not to be right, although it's very satisfying when they happen to coincide. An objective view of the market, constant non-complacent risk management, and unemotional decisions will have you taking as much as you want from the market.

December 01 2010 at 12:20 PM Report abuse +2 rate up rate down Reply