You've seen the ads on TV. You know: those ads that trumpet the quiet wisdom of a professional money manager by coyly showcasing the ignorance of the common man.
(Frazzled middle-class man scampers frantically into investment advisor's office, waving piles of mutual fund brochures.)
"Should I invest in stocks? Bonds? Tech? Growth? Long term? Short term? Foreign, domestic, tax-advantaged? Small cap? Blue chip, value chip, cow chip?"
(Advisor gives well-meaning, confident smile.)
"We can help. We have portfolio funds that take the pain out of investment decisions."
Every time I see one of these ads, I scream. It's really starting to annoy my neighbors -- not to mention my wife -- so I wish the stations would stop running them. But hundreds of variants of these ads seem to be a constant in the money management business.
Why they're nasty
These ads are evil for several reasons. For starters, the message is incredibly negative. The implication is that investing is complicated and that no individual investor can reasonably expect to manage his or her own investments. It's Serious Business, much better left to professionals who really know what they're doing. The ads are not meant to raise people up, help them learn, and bolster their confidence. Instead, they are meant to find the people lying on the ground, those with the least confidence, so that the money manager can give them a good kick.
And the money manager really is intending to kick them. When you examine the product that the money manager's pitching, you find that a portfolio fund is simply a mutual fund that invests in other mutual funds. It's essentially bundling together a bunch of mutual funds into a single mutual fund, which is sold to investors.
So where's the kicking? Well, it's in the fees. Each mutual fund in the bundle has its own management fees, which, in these funds, are generally in excess of 2%. But the portfolio fund also has its own fees, which are up to 2.35%. So you're probably paying about 4.5% to invest in a fund of funds that, in aggregate, likely owns nearly every stock in the entire market.
That 4.5% difference is huge. The compounded average return of the S&P 500 over the past 50 years has been 10.94%. A $10,000 investment at 10.94% grows to $134,000 in 25 years. However, if you subtract a 4.5% fee from the 10.94% return, then that money only grows to $48,000 -- about a third as much. After taxes and inflation, the poor investor would be lucky to break even.
That makes it clear why these advertisements target those without much confidence in their investment abilities. These money managers really want to find and exploit individuals who don't know anything about investing, or the importance of fees. A more honest message would be: "Completely ignorant about investing? Perfect! Come here, and we'll steal your retirement from you, one dollar at a time."
It is simple
The irony of the whole situation is that investing is easily within reach of anyone who has basic reasoning abilities. Even the world's richest investor, Berkshire Hathaway CEO Warren Buffett, has said, "You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ." It's not even really that difficult once you get past trying to pronounce "EBITDA." Investing really isn't about buzzwords and complexity. It's simply finding a good strategy and patiently sticking with it.
The strategy at Motley Fool Inside Value is quite easy to understand. When investors buy shares, they're actually purchasing a fraction of a company. Our aim is to simply buy dominant companies that make piles of money and are likely to continue to make piles of money. When the businesses continue to prosper and grow, the benefits accrue to the shareholders in the form of increasing share prices and dividend payouts.
The implementation
Identifying dominating companies is easily within the reach of average investors. In fact, many of the companies are dominant because they are so well-known by consumers. Take Colgate-Palmolive (NYSE:CL). It makes toothpaste, soap, dog food -- and it makes investors money. It's up more than 15% since it was recommended in the December issue of Inside Value.
And there are dominant companies like this everywhere you look. Do you use Band-Aids or Tylenol? Take a peek at Johnson & Johnson (NYSE:JNJ). Do you blow your nose? Check out Kimberly-Clark (NYSE:KMB)? Do you regularly wear clothes? TheGap (NYSE:GPS) is more than just the area between David Letterman's teeth. Even the computer from which you're reading this has a good chance of using an Intel (NASDAQ:INTC) processor and connecting to the Internet with hardware sold by Cisco (NASDAQ:CSCO). Once you start playing the game, it's hard to look somewhere and not see a product created by a dominant company.
After identifying a dominant company, our strategy is to determine whether it's making boatloads of money now and in the future. "Boatloads" is a relative term, and in this case, we mean relative to the price that we're paying for our share of the company. We want to pay less than the company is actually worth.
It's not simply because we're cheap. Rather, it's because we want to make large amounts of money. Why would we expect to earn disproportionately large returns if we're paying more for a company than it is actually worth? We wouldn't, so we buy cheap stocks and wait for them to become expensive stocks.
Conclusion
Thus, there's no need to accept the near-certain underperformance touted by these ghastly advertisements. The techniques for identifying and evaluating dominant companies are easily within the reach of the average person and can lead to superior performance. You can learn what you need to by reading a book, talking with other investors, or checking out the rest of our content.
If you're interested in finding out what we see as the amazing opportunities to pick up undervalued stocks right now -- complete with full analysis of why we think these stocks will outperform and alerts when important news happens -- then check out our Inside Value newsletter. Free trial subscriptions are available, or for a limited time, you can purchase a subscription at a 25% discount to our regular price.
Richard Gibbons, a member of the Inside Value team, might seem like he angers easily, but really he just likes to rant. He owns Cisco LEAP calls, but none of the other stocks discussed in this article. The Motley Fool has a disclosure policy.
