This time last year, Tim and I (Austin) were sitting in a bar in San Francisco -- talking about stocks. I swear.
Surprising? Maybe. But even more surprising is that we weren't talking about Ford (NYSE: F ) shares' plunge from $5.20 to $1.99 a share in just eight trading sessions.
The real shocker
Instead, we were talking about what had been perhaps our most interesting meeting. Our topic of conversation wasn't a CEO or a venture capitalist -- just a guy who's no doubt familiar to just about everyone in the business world.
So you can imagine our surprise when this keen observer of business and management trends told us he believes that most people, himself included, simply cannot beat the market buying individual stocks.
The basis for his belief ...
He claimed that he didn't buy individual stocks because many of the companies behind stocks were run by "drunken chimpanzees." It's a fair point: Drunken chimps can't do much.
Yet according to finance professor Kenneth French -- one-half of the team that revealed the market-beating potential of small-cap value stocks such as Patriot Coal and Penn West Energy Trust -- investors paid $99.2 billion in fees trying to beat the market during 2006, and were on pace to spend more than $100 billion in 2008.
Confusing the confusopolies
Let's not forget, we were meeting with this guy at a time when once-proud institutions like Bear Stearns, Lehman Brothers, Freddie Mac and Fannie Mae were here one day and gone the next, thanks to years of reckless risk-taking and managerial missteps.
So it's not hard to see why Dilbert creator Scott Adams quipped that Dogbert, CEO of Confusopoly Corp.. (Ticker: HUH), could convince the world's bankers that an active market for commercial paper would melt Greenland. Or that ritual cat sacrifices were the key to saving America's auto industry.
Laugh all you want, but bankers at Merrill Lynch, Morgan Stanley, and elsewhere are the same Harvard-stupid folks who thought that credit derivatives weren't all that risky. Who's to say they wouldn't believe a cartoon character? Or that they wouldn't find synergies between CDOs and cat sacrifices? They're eerily similar, after all -- both begin with the letter "c."
Bottom line, Adams told us that his severe distrust of weasels -- er, management -- is the main reason why he's sworn off individual stocks. Makes sense to us. Investors were right to distrust the optimists at CIT Group (NYSE: CIT ) and Wynn Resorts (Nasdaq: WYNN ) , among others.
So, what should you do?
Adams gave us nine steps that he says can help you to generate (and protect) wealth when performed in order. We think his suggestions are pretty Foolish, and thus, with his permission (thanks, Scott), we publish them here:
- Make a will.
- Pay off your credit cards.
- Get term life insurance if you have a family to support.
- Fund your 401(k) to the maximum.
- Fund your IRA to the maximum.
- Buy a house if you want to live in a house and can afford it.
- Put six months' worth of expenses in a money market account.
- Take whatever money is left over, and invest 70% in a stock index fund and 30% in a bond fund through any discount broker, and never touch it until retirement.
- If any of this confuses you, or you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner.
You're not in Elbonia any more, Dilbert
Adams' nine steps look pretty familiar to us Fools; we've always advocated paying off debt, saving for retirement, and having a substantial emergency fund. But avoiding individual stocks altogether? We respectfully disagree.
However, we do agree that if you're going to try to beat the market with stocks, you need to know what you're buying -- and you need to be able to trust the management of the companies you own.
That's why our Rule Breakers team does whatever it takes to stay on top of the companies we recommend -- like travel across the country to meet with top management.
And because these research trips don't pay for themselves, we invite you to take a free, 30-day trial of Motley Fool Rule Breakers.
You'll get full access to our members-only website, including full research and write-ups on every stock on our scorecard. Stay with us if you think it will make you money, pay nothing if you don't.
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This article was originally published Oct. 23, 2008. It has been updated.
Austin Edwards owns shares of Google. Tim Beyers is a member of the market-beating Rule Breakers team and owns both Google shares and options. Google and VMWare are Motley Fool Rule Breakers selections. The Motley Fool's disclosure policy is thinking up new torture devices for Catbert, evil HR director, who just took a gig consulting for some of Wall Street's biggest firms.