3 Reasons You're Being Set Up to Fail

According to a Prince and Associates survey conducted during the height of the financial crisis, four out of five high-net-worth investors were planning to take money away from their financial advisors. Surprised? I'm not.

The odds are stacked against us
Especially if we have money invested with a mutual fund conglomerate we saw advertised on TV. And, as you're about to see, the cumulative damage to your long-term wealth can be devastating.

Today, I'll reveal three reasons why I believe we have been set up to fail. Plus, why I'm convinced the stakes have never been higher, and why the mantra "You can't make money buying and holding stocks anymore" is nonsense.

If you agree that what I say makes sense, I'll offer an alternative you can consider. So let's start with the No. 1 reason why most U.S. investors fail ...

1. Thinking inside the box
You probably know the Morningstar style box -- that nine-box grid that shows whether your mutual fund invests in large-cap, mid-cap, or small-cap stocks. And whether the focus is on growth or value -- or some blend of the two. OK, fine. Except for one thing.

The more the style box was used to classify fund managers, the more they seemed to me to be pigeonholing themselves (and us) into an investment style. To see how much this might be costing us, consider the path chosen by renegade investor Peter Lynch at Fidelity Magellan Fund. For 13 years, his investors earned 29.2% per year.

Lynch did it by thinking outside the style box. Sometimes he'd stock up on growth, other times value. If he were running Magellan today, he'd as likely buy slumping big pharma Merck (NYSE: MRK  ) as tech highflier Research In Motion (Nasdaq: RIMM  ) ; stodgy large cap Johnson & Johnson (NYSE: JNJ  ) or tiny Cell Therapeutics (Nasdaq: CTIC  ) .

In short, Lynch was a financial mercenary who refused to be hemmed in by some "box." That's how he doubled his Magellan shareholders' money in less than three years, then did it again and again for 13 years. That kind of courage is hard to find today, which brings us to the second reason we've been set up to fail.

2. Following the herd
Why anyone would imagine that "following the herd" could make them money in this market is beyond me. But I can tell you (in six words) why professional money managers do it: Picking stocks is a lonely business.

If you're all about keeping your job, it's safer to buy what others buy. Don't believe me? Guess what American Funds' Growth Fund of America, the most widely held U.S. mutual fund, lists among its top holdings. How about Microsoft (Nasdaq: MSFT  ) , Oracle (Nasdaq: ORCL  ) , and Apple (Nasdaq: AAPL  ) ? I know, shocker!

Of course, it's much the same for any "large-cap growth" fund your advisor will get you into. You don't need a certified financial planner to tell you that owning the same stocks as everybody else is no way to get ahead. Or that you can never expect to beat the market by owning the market. Right?

Here's proof ...
What I've just described is called closet indexing. It's rampant on Wall Street, and investors pay billions in "management" fees each year for the favor. Yet of the 8,000 or so who invested money for U.S. investors in 2008, you can expect 78% to 95% to fail to beat the market, according to Yale University's David Swenson.

I knew it was bad, but 78% to 95%? That surprised even me. But I got that figure from John Bogle's new book, Enough, so I believe it. And at the risk of being labeled a Boglehead, I'll cite him again, because no one speaks more eloquently on the third and most important reason investors fail.

3. Getting killed by costs
I don't just mean the fund management fees we've discussed, but investment turnover, too. Not to mention capital gains taxes and trading commissions.

In his book, Bogle shows how, assuming market returns of 8.5% per year, you can expect these intermediation costs to eat up to 80% of your profits over the course of a 40-year investing career. Again, it sounds unlikely, but Bogle runs the numbers in the book; it's worth checking out.

But here's the point
Whether Bogle's 80% figure is high or low, we can agree: Coupled with the constraints placed on fund managers by the style box, and the understandable temptation to follow the herd, investors have a high hurdle to overcome -- especially if they rely on mutual funds.

Add to that a new, bear-market-inspired belief among certain financial advisors that they can -- and should -- help you time the market, and you can see why I say the stakes have never been higher. I mean, come on. You could argue that these market-timing converts might have come in handy in October 2007.

But we sure didn't need them "rotating" us out of stocks at the bottom, even though it meant racking up transaction costs and missing out on the ensuing huge rally. Of course, that's exactly what happened to many U.S. investors this year. Some may stay out of stocks for years -- and that's a crime.

Now your solution ...
Listen: None of this is rocket science. Neither is my solution -- namely, that you start managing some of your own investments, and thus avoid the three reasons investors fail. If you're a purist like John Bogle, buy a low-cost index fund and be done with it.

Bogle doesn't believe we can beat the market with individual stocks. But I do. In fact, I've seen it. Motley Fool co-founders David and Tom Gardner have been recommending stocks of all shapes and sizes in Motley Fool Stock Advisor for seven years now, with remarkable results.

Since they started in March 2002, their recommendations have outperformed the S&P 500 by nearly 10% on an annualized basis -- while the market has been dead flat. I have some ideas, but I'd be a liar if I told you I knew exactly how they do it. But I have seen it with my own eyes.

If you're ready to break free
It certainly helps that David and Tom Gardner are two very different investors with distinct styles, even if they are brothers. Short of finding another Peter Lynch, they may offer your best bet to break from the style box that hems in most professional investors and steer clear of the herd mentality on Wall Street.

And even if Bogle's right and you can't beat the market picking stocks, you can avoid the third, most deadly threat to your long-term wealth: crippling financial intermediation costs. Especially now that you can get David and Tom Gardner's top stock picks for 30 days absolutely free.

And if, like most investors, you do decide stay on, it won't set you back 80% of your rightful profits. Most important, you'll get the advice and support you need to stay invested, even when those who should know better cut and run. To learn more about this special free trial offer to Motley Fool Stock Advisor, click here.

Fool writer Paul Elliott owns shares of Merck and Johnson & Johnson, a Motley Fool Income Investor recommendation. Apple is a Motley Fool Stock Advisor recommendation. Microsoft is an Inside Value recommendation. The Motley Fool owns shares of Oracle and has a disclosure policy.


Read/Post Comments (27) | Recommend This Article (132)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 08, 2009, at 5:58 PM, holosys wrote:

    In other words, if you gradually went broke over the years buying and holding a basket of blue chip stocks, they must have not been true blue chip! We should have bought the relatively few winning stocks that in hindsight are now winners. Those doing well in their portfolios did what everyone should have done! If not, then tough luck… it's your own fault.

    For example, if everyone in the United States had purchased Apple stock back when it was under $20 per share, we would all be rich, and Obama wouldn’t have had to bail out the U.S. and unemployment would have been negligible. All U.S. citizens could have retired rich if we all had the common sense to put all our money in Apple stock back then… forget investing in any other stock!

    So if I understand correctly, those of us with a basket of falling stocks have only ourselves to blame. We had our chance to invest in those stocks that did well in hindsight, and we blew it. We will only have a future if we start investing in the right stocks, such as Apple and Google, companies that will never fail. Google under $20? Impossible. Apple reaching a 52 week low of just under $6? That only happens to other companies. Take GE and Juniper, examples of companies that kept splitting in the 90’s. They were once over $150 and $350 a share, the former making my dad a millionaire on paper. Obviously in hindsight they weren’t winners, because if they were winners, they would be up there with Apple and Google. Learn a lesson from Yahoo’s orgy of splitting? Not necessary. Google will never follow the path of Yahoo.

  • Report this Comment On October 08, 2009, at 6:33 PM, XMFRael wrote:

    agreed. beating the market is hard. but making money in stocks over the long run shouldn't be.

    i still believe in staying invested and keeping down costs..that said, i think you CAN beat the market (though you can't time it). and it's fun when you do.

  • Report this Comment On October 08, 2009, at 8:30 PM, emptygestures wrote:

    I don't know so much about RIMM but I do not that cell therapeutics is a stock to stay far away from. Last month the CEO sold off a third of his shares. What does that say about his confidence in his company.. A company without any drugs out yet and has no revenue.. The company is holding on by a thread.

  • Report this Comment On October 08, 2009, at 9:10 PM, orchid5 wrote:

    All I want to know is why this article does not have "ADVERTISEMENT" printed across the top in large letters.

  • Report this Comment On October 08, 2009, at 10:02 PM, bybargains wrote:

    I don't usually read these advertisements anymore because they just tell you what happened not what is going to happen. They don't help me make up my mind about how to invest going forward. This one sounded interesting but like all the rest it is just an advertisement to get you to buy another service. I guess the service I paid for isn't any good so I need to spend even more money to get "the real stuff".

  • Report this Comment On October 09, 2009, at 11:14 AM, thisislabor wrote:

    "I have some ideas, but I'd be a liar if I told you I knew exactly how they do it."

    Actually, to be quite frank, you gave out your secret on how they do it before you tried to hide it from us:

    "Picking stocks is a lonely business."

    They put the work in. One stock prospectus at a time.

    At least that's MY theory on how they do it.

    It is actual LABOR to properly go through a form 10K and figure out what is going to happen with this stock and whether or not it is mispriced or whether or not it shows long run future potential.

    - this is labor

  • Report this Comment On October 09, 2009, at 11:23 AM, shcdmd wrote:

    Why isn't this article labeled as an advertisement?

    I'm getting tired of opening a link to an article that sounds interesting, but ends up trying to sell something. I thought that was what Motley Fool was all about, seeing that individual investors are NOT Fooled.

    If this is the Motley Fool business plan, please state it, so at least we will all know it and can then decide if we wish to continue to be Fooled or not. If we know what the Motley Fool policy is, at least,we can then decide whether to relegate the Motley Fool's e-mails and the domain to spam, automatically or not. Don't you owe this honesty to your readers?

    Even if this is not printed, I would appreciate an answer from you editorial and/or business staff. Thanks.

    hogdoc

  • Report this Comment On October 09, 2009, at 11:29 AM, thisislabor wrote:

    TMFRael, I actually think you CAN time the market but only for specific stocks.

    and not perfectly well but I strait called it on cheesecake factory when I told my accounting teacher that they were going to manipulate the stock price down and then back up. we were analyzing that specific stock's form 10k for the whole semester.

    they told me I was assign meaning to things because I was on amp at the time - and I tell you I made money off that deal.

    same thing I did with my time frames on kodak two or three years back back.

    but then again we spent a whole semester analyzing one form 10K. - both times.

    If you sit there and ask why would they do this or that, and come up with a reason for it for 2 or 3 days on specific form 10k you can get a good feel for what will happen to a stock price.

  • Report this Comment On October 09, 2009, at 11:34 AM, thisislabor wrote:

    What is the deal with people thinking this is an advertisement???

    seriously people?

    get a clue.

    the guys is reflecting on the nature of his job and the people in it. and some of the reflections apply to him - the thinking in the box. and some to us - the circumventing fees to save our retirement plans.

    he is trying to give us some advice for our lives, it may not be perfect advice for each person, or in the format you like, but look at what he is doing.

    the fact that he has to sell the services that they do offer at the end of it, is a non-issue to me.

  • Report this Comment On October 09, 2009, at 11:57 AM, XMFRael wrote:

    Thisislabor... Agreed, that is how David and Tom do it. What i don't know is HOW they do it. Lots of guys research stocks, put the work in, and get paid big money for it -- but few manage to beat the market to the extent David and Tom have. I admit, when I first met them i was a skeptic, but i have seen it.

    As for timing, i can agree on individual stocks -- maybe. My concern is over this new craze among planners who think they can get folks in and out of stocks to avoid "bear" markets and make money in "bull" markets.

    As for The Motley Fool policy, I'm not sure I follow -- but I'll tell you what I know. Fool writers are free to encourage readers to try TMF products so long as:

    1. We sincerely believe in what we say

    2. The article meets our editorial standards

    I'm not sure I understand how a mention of a product makes an article less "interesting" -- but I'll give it some thought. Bottom line: we believe in the value of our premium products... and believe that the free trial model is a good deal. It seems like a win/win for our readers to me.

  • Report this Comment On October 09, 2009, at 12:28 PM, thisislabor wrote:

    oh, well now I *sort of* feel bad. I didn't realize you TRULY believe in the products you sell. oops?

    oh well, all the better for me. :)

    I *sort of* figured you were required to mention it, as part of the nature of the job.

    -

    half the time it is their own personal set or self-reference checks that make them see: "you lieing to earn a dollar"

    -

    speaking of internal self-reference checks you can see it in the way I responded. I thought you were required to sell things, too. ontop of write articles. : )

    at work I am required to sell other financial products I don't agree with, but for my main job I have absolutely no ethical problems with.

  • Report this Comment On October 09, 2009, at 12:31 PM, thisislabor wrote:

    it is their own frame of reference that inhibits them.

  • Report this Comment On October 09, 2009, at 1:02 PM, bernbern0 wrote:

    Fools, fools, fools! I am continualy amazed by the carping of those true fools complaining that these articles are ploys for selling paid services. Those foolish enough to believe that should stop reading these articles. And yet I see these same foolish names being repeated over and over again. You complainers sound so childish! Just quit reading. No one is forcing you to read this stuff. Of course they're trying to get you to sign up for one of their paid services. I have no connection to The Motley Fool, but I do find value in their free articles!

  • Report this Comment On October 09, 2009, at 2:02 PM, XMFRael wrote:

    thanks thisislabor... actually that specific part of my response was to the other guy. i should have been more clear.

    Thanks again to you and bernbern for writing and reading.

  • Report this Comment On October 09, 2009, at 7:39 PM, XMFRael wrote:

    at the risk of selling again... have you guys checked this out...

    http://www.fool.com/investing/general/2009/10/09/the-white-h...

    interesting call for comments you might enjoy.

    pe

  • Report this Comment On October 10, 2009, at 1:51 AM, cordwood wrote:

    Will the moaners re ads in MF please state that they refuse to read magazines,newspapers,or watch TV that contains advertising,Actually I'm tired of your advertising the fact that you have this neurosis...believe its called Bellowing Syndrome...the abreviation of which is obvious.

  • Report this Comment On October 10, 2009, at 2:19 PM, SageOrFool wrote:

    The best advice is of no use fallen on deaf ears. The trouble is in having to give advices even when it is best to be silent.

  • Report this Comment On October 11, 2009, at 6:16 PM, thisislabor wrote:

    SageOrFool,

    hmm,

    When I was kid I had made the comment to a counselor one time "I'm smart enough to know what to do, I'm just not smart enough to do it"

    As I slowly mature and grow older, I find certain situations where I am not smart enough to know what to do. And, honestly, in those situations I try to reference a biblical bases for any action (or non-action?) that I take. It doesn't always work out the way I thought it would, but it does always seem to work out for good.

    ....

    I would hate to say it is a play on words, but advice is made from two words, add and vices. perhaps it is a reference on experience, when you have had this same vice before you can then add to that other persons knowledge base your vice that you had and how you overcame it so they can overcome theirs.

    however, if the correct action is no action then to give advice is to add vices, litterally.

  • Report this Comment On October 11, 2009, at 6:27 PM, thisislabor wrote:

    "The best advice is of no use fallen on deaf ears. The trouble is in having to give advices even when it is best to be silent."

    this sentence I am keeping in my file of quotes. lol

  • Report this Comment On October 13, 2009, at 12:53 AM, traderbach wrote:

    I too am very tired of being drawn into an 'article' only to find it's a pitch for the Motley Fools Advisors or Gems or some other expensive service. In fact when I first came to investigate the Fools site I was really put off at this kind of stuff. Please put up front something like 'Motley Fools Advisors Advice for the Day Says ..' because those of us who know what we're looking for find such thinly veiled pitches insulting. That said I would lke to stress that I have the greatest regard, & feel genuine gratitude, for the Fools community. It's a great platform for really debating what is value & what is not & I've learnt a lot from commentary & blogs etc. I therefore would ask please do not cheapen such great work w/ such ploys!

  • Report this Comment On October 13, 2009, at 7:47 AM, kayakmastr wrote:

    This carping about selling a product through these articles is such BS! When I go to read the Comments, I expect discussion of the issues in the article. The carping is distracting! The carpers don't like the promotion at the end of an article. I don't like the carping in the Comments. The Fool's writers seek to educate, enrich, and amuse. They generally do a great job on all three! When you come to the promotion, just stop reading if you are not interested in that particular product, just like you do with newspapers and magazines, and take home the good insights most of the articles provide.

  • Report this Comment On October 16, 2009, at 3:36 PM, thisislabor wrote:

    You, know, for what it's worth, I don't think it's even advertising. I think they really believe in their product and probably purchase it themselves.

    It would be a personal recommendation, not andvertisement in that case. You know, like what you would do for a friend?

  • Report this Comment On October 16, 2009, at 3:38 PM, thisislabor wrote:

    Nah, they probably don't know actually. nm, i'll move right along.

  • Report this Comment On October 16, 2009, at 3:42 PM, rawdawgbuffalo wrote:

    so in other words the dollar is just <a href='http://rawdawgb.blogspot.com/2009/10/ink-and-paper.html'>... and paper</a>

  • Report this Comment On October 16, 2009, at 4:27 PM, UtahMotled wrote:

    Timing the market for the SUPER big moves is not difficult if there is cash on hand that can be invested on the upswing. I'm talking about the huge moves that take place after a crash such as the dot.com bust, 9/11, and the mortgage crash which might only happen maybe 10 times in an entire adult lifetime. Each one was a no-lose proposition even if only investing in indexes, let alone quality stocks.

  • Report this Comment On October 16, 2009, at 8:10 PM, thisislabor wrote:

    I think the author meant more like buying individual stocks yourself, and buying and holding indefinately. That is not to say you shouldn't review your portfolio biannualy or so, or every couple months.

    I think it was more like if you select individual stocks and hold, you keep transaction costs down for yourself. Those eat into profits, so if you don't spend money moving into and out of the stocks you should stay ahead of the mutual funds..... at least on average statistically.

    I may have misinterpreted the article, but that is what I got out of it.

  • Report this Comment On November 18, 2009, at 4:43 AM, henryhall22 wrote:

    Very interesting to hear the views of Mr Bogle: I had long thought that investing in index funds was a perfectly sound option. An interesting article; as a eurozone investor I would love it if you could cover international markets more.....

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