Forget Stocks

We Fool contributors are a lucky lot. We have the freedom to write pretty much whatever we want as long as it involves an investing topic that will add to our readers' collective knowledge. So, since nothing is taboo, I'm going to tell you something you might never read again at The Motley Fool: Our stock-picking services may be a complete waste of your time.

The problem with stocks
According to modern portfolio theory, rational investors will choose to diversify holdings in their portfolios to reduce risk while maximizing returns. Numbers back up the idea, but it's only half true. You can't really maximize your returns by diversifying, but you can reduce the risk that your portfolio's value will bounce around like a rubber ball from year to year -- otherwise known as volatility.

But diversification is completely overrated as far as some superior investors are concerned. Take Charlie Munger, Warren Buffett's business partner, for example. Regarding diversification, Munger has famously said that he and Buffett "... don't believe that widespread diversification will yield a good result. We believe almost all good investments will involve relatively low diversification." Not surprisingly, Berkshire Hathaway's portfolio has provided ample support for this belief in recent years.

And therein, Fool, lies the fundamental problem with investing in individual stocks: Buy a lot of stocks and, as Munger says, you'll probably limit your upside. Buy only a few and you'll be subject to higher volatility. Well, that, and you'll dramatically increase your risk of substantial capital loss.

No matter how good the stock-pickers here at the Fool are -- and, boy, do we ever have some good ones -- we'll never, ever be able to help you avoid those problems if stock investing is your game. You'll either simply have to deal with it or forsake stocks altogether. Sorry, pal.

Would that really be so bad?
That's why I have to ask: Why own stocks? Is it really worth the hassle? Not unless you're willing to spend some time on the endeavor, and you enjoy the idea of finding and buying what others won't, earning just rewards when you're right. That might sound good to many, and maybe even to you. But I'll bet most would rather eat a scoop of spinach-flavored ice cream than suffer through the wild gyrations of a high-risk portfolio.

Besides, you don't have to own individual stocks to generate superior returns. We've run the numbers and the newsletter with the highest percentage of market-beating picks is ... Motley Fool Champion Funds. Yeah, that's right, mutual funds are beating stocks. Well, actually, they're not just beating stocks. They're trouncing stocks. Have a look:

Newsletter

Total
Picks

Ahead of
the Index

% of
Winners

Stock Advisor

86

54

62.8%

Hidden Gems

56

30

53.6%

Income Investor

52

34

65.4%

Inside Value

28

13

46.4%

Champion Funds

31

25

80.6%

Rule Breakers

26

14

53.8%

To be fair, every newsletter is beating its comparable index by several percentage points. It's just that Champion Funds is performing as well as or better in terms of total return than the other Fool services born around the same time (Rule Breakers and Inside Value), yet it has many more picks in the black.

Good managers make all the difference
How could that be? Managers, says Champion Funds lead analyst Shannon Zimmerman. His picks are being run by some of the world's best stock-pickers. And they've been at it for, on average, close to a decade. No wonder he's beating the other Fool advisors. Heck, with that much help, how could he lose?

Shannon's secret sauce comes from trimming the fat from the mutual fund market to find the best. That's not easy. For example, researcher Morningstar (Nasdaq: MORN  ) tracks 14,000 mutual funds. But certain key attributes lend clues. Among them: long-term manager tenure, managers who are invested in their own funds, a record of high performance, and a relatively cheap expense ratio. Have a look at the comparison between the average champ and the average domestic stock fund:

Key Metrics

Domestic Stock
Fund Average

Champion
Funds Average

Manager Tenure

4.5 yrs.

9.5 yrs.

Expense Ratio

1.45%

0.95%

12b-1 Fee

0.41%

0.01%

+/- S&P (3 yrs.)

1.78%

5.33%

+/- S&P (5 yrs.)

2.82%

11.07%

Turnover

96%

51%

*Data through July 2005

Invest with the next Peter Lynch
The irony of the stock market is that you can invest in solid companies and still lose money. Just ask those who've had money in Microsoft (Nasdaq: MSFT  ) over the past five years. Or Nokia (NYSE: NOK  ) . Or Priceline (Nasdaq: PCLN  ) . That's why diversification is still all the rage and will be for some time to come.

Great funds, on the other hand, don't have this problem. Diversification is built in, and the picks are combined into balanced portfolios assembled by world-class managers. Take Peter Lynch of the Fidelity Magellan Fund (FUND: FMAGX  ) , for example. He bought and sold thousands of stocks during his tenure, and those who invested with him saw 29% annual returns.

Is the next Peter Lynch out there? Absolutely. You might want to join the search if your goal is the highest possible returns from your fund portfolio. Fortunately, it's easy to do. Just take a risk-free trial to Champion Funds today. You'll get access to every one of Shannon's 31 picks, numerous interviews with top fund managers, and three specific model portfolios, all of which are beating their comparative indexes.

The Foolish bottom line
Individual stocks are always a great option for the business-focused investor. But what if your only goal is the highest possible returns? What if you don't give a lick about business? Then you're like the homeowner who has never learned a thing about maintenance. And just as you should forget trying to fix the plumbing yourself, you should forgo individual stocks in favor of funds. Your house, and your portfolio, will be better off for it.

Fool contributorTim Beyersstill considers himself a stock jock, but Shannon's performance leaves him wondering if he should be. Tim owns shares of Nokia. You can find out what else is in his portfolio by checking Tim's Fool profile, which ishere. Priceline is a Motley Fool Stock Advisor pick. The Motley Fool has an ironcladdisclosure policy.


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