January 8, 2005

You can beat the market

This is what I've come to decide. I've been reading up on my favorite financial website, The Motley Fool, and the wealth of knowledge there has been helpful to me. They take a patient, disciplined approach to saving, investing, insurance, retirement, education, taxes, whatever. I've been looking at their investment information most recently, and I was even spurred to pick up a few of their books at the library. I'm currently into The Motley Fool Investment Guide. The main goal of The Motley Fool is to get people to take control over their money, because they believe a little knowledge and research (most of which is free) will enable individuals to outperform brokers who make their money not by investing wisely, but by inducing clients to make trades. You see, a full service broker is paid a hefty sum each time he buys or sells a stock for you. Cut down on those fees, and your overall returns immediately make a big jump up, even if you end up buying the exact same stocks or mutual funds.

Another of their big things is steering people away from actively managed mutual funds. They say this because 80% of all actively managed mutual funds are less successful than the S&P 500. Understand what this means. It means that 4 out of 5 (highly paid, I might add) people who manage money and choose stocks for a living are unable to consistently beat the market. There are a lot of reasons for this, and most of them have to do with management fees and commissions, which put managed funds in a hole from the beginning. The best mutual fund to own, according to the Fool, is a passively managed S&P 500 index fund. This fund perfectly tracks the S&P 500 benchmark that so many funds fail to beat. I personally have some money in one of these, and it's doing way better than the 1.5% interest I'm gaining in my savings account, which is way less than the 10% yearly historical return of the U.S. stock market.

However, the Fool says you can do better. They want people to pick their own stocks so that individuals can wallop the S&P 500 with a moderate amount of time invested. Aspire to be better than an S&P 500 index fund, they say. There is a system to it all. Look for companies in good financial shape (low debt, lots of free cash flow). Investing in stock is not the same as playing the lottery if you've done your homework. The goal is to find companies that are undervalued (according to stock price) and purchase their stocks, knowing that the investment may take a while to pan out. The trick here is that the only money that should be invested in stock is money that can be safely left alone for 5-10 years, minimum. That way, investors can ride out the rough patches while benefiting from the bull markets. Money you might need in six months should be in your savings account earning that 1.5% I talked about earlier.

An object lesson: Between 1973 and 1974, the market had a meltdown. The S&P 500 lost 47% of its value. $10,000 became $5,300. Bad news all around.....sort of. It was bad news for people with money in the market that shouldn't be, but not so bad for everyone else. Money invested in the S&P 500 in 1970 grew at an annualized rate 13.5% between then and 2000, and that includes the meltdown period mentioned above. Put it this way - if you put ten grand in the S&P 500 in 1970 and didn't touch it until 2000, you would have had about $450,000. Now, things went south (though not as badly) again after the tech bubble burst, but long term investors will continue to wait it out, watching their money grow, maybe even putting more money in as as to take advantage of the down times.

The moral of the story is this: there has been no better place to invest your money than the U.S. stock market. This is true throughout history, and it will continue to be so in the future. It's better than bonds, savings accounts, money markets, CDs, and anything else you can think of. The trick is to know where you money is going, and to not buy a stock because your uncle said he heard a thing from a guy who has a cousin on the board. I'm considering moving some money out of the index fund and looking to buy individual stocks for the first time. I'll let you know when I actually do it, and I will keep you apprised as to my progress. Until then, go get The Motley Fool Investment Guide and make The Motley Fool website a regular stop on your daily internet travels.


Anonymous said...

Life is like a mop. Sometimes life gets full of dirt and crud and hairballs and things and you gotta clean it out. You gotta stick it in here and rinse it off and start all over again. And sometimes life sticks to the floor so much that a mop, a mop, it's not good enough. You gotta get down there with like a toothbrush, you know, and you gotta really scrub 'cause you gotta get it off. But if that doesn't work, you can't give up. You gotta stand right up. You gotta run to a window and say, "These floors are dirty as hell, and I'm not gonna take it any more."
Stanley Spudowski's outlook on life from UHF.

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