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Investing for beginners is not difficult and it is possible to make money and create wealth for the long term. This article shows how and why.
How to Get Your Teenager to Invest (or Boomer or Millennial)
The earlier you start to invest, the more money you will have. That’s obvious. What’s not obvious is that you don’t have to work hard to get that return (teenagers don’t like working hard), and the returns are exponential (so you’ll have a lot more to TikTok about in a few short years).
The maths is mind-boggling. Starting at 18 with just a thousand pounds (let alone at birth, like my son) makes a difference of millions compared to someone starting at 50, by the time both retire, dependant on contributions and average market returns. Investing alone can make millionaires. Let alone all the hard work needed aside from that.
Why It is Not Too Late or too Risky to Start Investing
You may think it is too late to start? Or too risky. The best way to reduce risk, is to pick stocks from a global market place. (See below). Also hold for 12 months then review. That time-frame mitigates the risk of short-term falls which happen even in quality companies.
Don’t forget, your SIPP and ISA can invest in foreign companies and the currency risk and commissions is negligible. You use the same brokers as you do for UK stocks.
Fund Managers to Invest Your Money – No!
When I used to cross-examine fund managers on Bloomberg TV I reserved a special vitriol. Why? It wasn’t personal. It’s just that I was fed up with getting emails from private investors who saw their investments entrusted to fund managers whittled away year after year in poor performance.
And just because you’re on TV you have the added credibility of “as seen on TV.” But we never looked at their fund performance, we only knew they were fund managers. The program “booker” who takes the bookings doesn’t vet the quality. It’s 5pm, we’re on air in a couple of hours. Who’ll come on? They’re on!
We should have got monkeys to give their stock views. Actually, looking back, sometimes we did.
More Problems with Fund Managers
Since you are reading this book, you are probably someone unwilling to let a fund manager burn your cash. Consider the fund management industry. Here is a profession which gets paid irrespective of results; even if they lose you money. It’s guaranteed.
But what do you do if you are too busy to manage your money. Surely you give it to a fund manager? No.
They’re supposedly the best equipped to manage your funds. Billions of dollars are entrusted to them, and they have global resources at their disposal. So should you assign some of your money to fund managers?
After all, there’s been a recent proliferation of fund supermarkets. The hearings of the case brought by Unilever’s pension fund against Merrill Lynch’s Mercury Asset Management (MAM) subsidiary alleging fund manager negligence because of underperformance are groundbreaking. If Unilever can be so unhappy, what hope has a private investor, even with novel online tools, of picking a good fund manager?
Not much, according to ample evidence. “The deeper one delves, the worse things look for actively managed funds; 99 percent of fund managers demonstrate no evidence of skill whatsoever,” says William Bernstein in a study of the fund industry published in 2004.
The message is clear, when it comes to investing for beginners, the answer is not to just give the money to fund managers.
Even the Fund Managers Agree
Investment legend Peter Lynch in Beating the Street confirms: “All the time and effort people devote to picking the right fund, the hot hand, the great manager, have in most cases led to no advantage.”
Warren Buffett, in his 1996 letter to his Berkshire Hathaway sharehold- ers, advocated recourse to a passive index tracker rather than fund managers: “The best way to own stocks is through an index fund …”
But the strongest argument against trying to pick a fund manager is performance. Only 9 out of 355 funds analyzed by Lipper and Vanguard beat their market benchmarks from 1970 to 1999. Analysis by http://www.ifa.com/ of the Morningstar database of equity funds found “no discernible pattern of persistence in superior manager performance.”
What about picking the best performers using tables? Unfortunately, all the top 10 performing funds in any year drop from first place to nearly last place among all funds within two to four years, according to a 26-year study by the Dalbar rankings agency.3
Updated in 2001, the study found that from 1984 to 2000, the average stock fund investor earned returns of only 5.23% a year while the S&P 500 returned 16.29%.
Yet in spite of this, 75% of mutual fund inflows follow last year’s “winners,” according to fund researcher www.morningstar.com. And Lipper Europe at www.lipper.com confidently claims that European fund assets will grow to more than $10,000bn before 2010 from the current $3000bn.
Even Nobel laureates agree on the hopelessness of picking top perform- ing fund managers. Prizewinner Merton Miller observed in a documentary last year about funds:
If there’s 10,000 people looking at the stocks and trying to pick winners, one in 10,000 is going to score, by chance alone, a great coup, and that’s all that’s
Why We Can’t Tell You … 7
going on. It’s a game, it’s a chance operation, and people think they are doing something purposeful … but they’re really not.
All is not lost for fund investors. Research published in October 2001 by Jay Kaeppel of eCharts.com indicated that a simple fund investing strategy can be lucrative. By buying at the start of each month the top five best performing sector funds of the past 240 days, and then starting over again the subsequent month, he turned $50,000 invested on the last day of 1989 to
$692,384 by December 31 2001; an annual 27% rate of return. He used Fidelity’s sector funds. Of course this is a ridiculously simple test and only goes back to 1989.
So what is to be done? If fund managers can’t beat market benchmarks, then we could invest in index trackers and be assured of at least matching the benchmarks. If only it was that easy. Tracker funds can diverge from the index they’re tracking by up to 30%, according to a survey by Chartwell Investment Management. For tracking the FTSE 100 they recommend the Prudential U.K. Index Tracker Trust.
Skepticism about past returns is crucial. The truth is, much as you may wish you could know which funds will be hot, you can’t – and neither can the legions of advisers and publications that claim they can. That’s why building a portfolio around index funds isn’t really settling for average. It’s just refusing to believe in magic. (Bethany McLean, “The Skeptic’s Guide to Mutual Funds,” Fortune, March 15, 1999)
Meanwhile, what about Unilever and MAM? With so much evidence about poor fund manager returns, little wonder that no pension fund has ever before tried to claim negligence against a fund manager for under- performance. After all, the fund managers could turn around and say: “What did you expect?”
Beginners Investing – What Prompted That First Investment?
The top answers from your peers:
My parents/relatives encouraged me
It felt the right time
My income increased and I had money
I started a new job
How Do You Research Stocks if Investing as a Beginner?
This is what scares people and so they think they have to give their money to a fund manager or expensive IFA. No. You can learn yourself. Promise.
One important thing is filter, filter, filter. That means you pick stocks like a spouse. Make sure they tick ALL the boxes. Are they undervalued, growing, paying income, good cash-flows?
Free tools online allow you to filter, filter, filter. Do not pick by journalist stories. Journalists jobs are to get you to click. They are good at spinning stories. They are not professional investors.
Most people get their information from family or a financial advisor or their own research. I suggest the best is your own research. I’ve listed a free tool at the end of this article.
Whilst people are more likely to have funds than stocks, and many just leave it in an account, I suggest stocks will give you the best returns as funds dilute the returns of individual winning stocks by definition.
More Reasons Beginners Should Not Invest with Fund Managers
By day we write about “Six Funds to Buy NOW!” … By night, we invest in sensible index funds. Unfortunately, pro-index fund stories don’t sell maga- zines. (anonymous, Fortune, April 26, 1999)
Statisticians will tell you that you need 20 years worth of data – that’s right, two full decades – to draw statistically meaningful conclusions [about mutual funds]. Anything less, they say, and you have little to hang your hat on. But here’s the problem for fund investors: After 20 successful years of managing a mutual fund, most managers are ready to retire. In fact, only 22
U.S. stock funds have had the same manager on board for at least two decades – and I wouldn’t call all the managers in that bunch skilled. (Susan Dziubinski, university editor with Morningstar.com)
There is one final problem in selecting a winning manager. According to Richard A. Brealey, “you probably need at least 25 years of fund perfor- mance to distinguish at the 95% significance level whether a manager has above average competence.” Another commentator accepted the 25-year time frame, “but only if the pension executive is using the perfect bench- mark for that manager. Using a less than perfect benchmark may increase the observation time to 80 years.” (p. 177, Bogle on Mutual Funds, John C. Bogle, founder, The Vanguard Group)
Former Oakmark Fund manager Bob Sanborn, Yackman Fund’s Don Yackman, and former Internet Fund manager Ryan Jacob; these once- revered fund managers have fallen to earth. (Susan Dziubinski, university editor, Morningstar.com: Five Lies About Fund Manager Talent)
People exaggerate their own skills. They are overoptimistic about their prospects and overconfident about their guesses, including which [invest- ment] managers to pick. (Professor Richard Thaler, University of Chicago quoted in Investment Titans, Jonathan Burton, 2001)
a. Studies show either that most managers cannot outperform passive strategies, or that if there is a margin of superiority, it is small.
b. It will take Joe Dart’s entire working career [calculated to be 32 years] to get to the point where statistics will confirm his true ability.
c. In the end, it is likely that the margin of superiority that any professional manager can add is so slight that the statistician will not easily be able to detect it. (Zvi Bodie, Alex Kane and Alan J. Marcus, Investments, 5th edn, McGraw-Hill, p. 374)
Most depressing of all, the “superstar” fund managers I encountered in the early 1990s had a disconcerting habit of fading from supernova to black hole: Rod Linafelter, Roger Engemann, Richard Fontaine, John Hartwell, John Kaweske, Heiko Thieme. I soon realized that if you thought they were great, you had only to wait a year and look again: Now they were terrible. (Jason Zweig, “I don’t know, I don’t care, Indexing lets you say those magic words,” CNNMoney.com, August 29, 2001)
Yet even the smartest, most determined fund-picker can’t escape a host of nasty surprises. Next time you’re tempted to buy anything other than an index fund, remember this – and think again. (Robert Barker, “It’s Tough to Find Fund Whizzes,” BusinessWeek.com, December 17, 2001)
Why We Can’t Tell You … 9
None of us is as smart as all of us (anonymous quote hanging in the office of James Vertin, Head of Wells Fargo Management Sciences Department and backer of the first equally weighted S&P 500 index fund in 1971). After twenty years of watching investment practitioners dance around the fire shaking their feathered sticks, I observe that far too many of their patients die and that the turnover of medicine men is rather high. There must be a better way. And there is!” [index funds] (Also from James Vertin in Bogle on Mutual Funds, John C. Bogle, founder, The Vanguard Group)
Santa Claus and the Easter Bunny should take a few pointers from the mutual-fund industry [and its fund managers]. All three are trying to pull off elaborate hoaxes. But while Santa and the bunny suffer the derision of eight year olds everywhere, actively-managed stock funds still have an ardent following among otherwise clear-thinking adults. This continued loyalty amazes me. Reams of statistics prove that most of the fund industry’s stock pickers fail to beat the market. For instance, over the 10 years through 2001, U.S. stock funds returned 12.4% a year, vs. 12.9% for the Standard & Poor’s 500 stock index. (Jonathan Clements, “Only Fools Fall in … Managed Funds?,” Wall Street Journal, September 15, 2002)
Contrary to their oft articulated goal of outperforming the market averages, investment managers are not beating the market; the market is beating them. (Charles D. Ellis, “The Loser’s Game,” Financial Analysts Journal, July–Aug 1975)
The evidence on mutual fund performance indicates not only that these 115 mutual funds were on average not able to predict security prices well enough to outperform a buy-the-market-and-hold policy, but also that there is very little evidence that any individual fund was able to do significantly better than that which we expected from mere random chance. (“The Performance of Mutual Funds in the Period 1945–1964,” Michael C. Jensen, Harvard Business School, Journal of Finance, 1967, 23(2): 389–416)
Invest Like a Millionaire When You Are Not One
Read my book (free) Investing Unplugged. It’s an international bestseller, published by Palgrave Macmillan. I teach you more about what you need to do. It’s free at www.investing-champions.com
Alpesh Patel
Founder www.tradermind.com
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