The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals

Citation preview

The

Smartest

Investment Book

You'll Ever Read The Simple, Stress-Free 'Nay to each Your Investment Goals

Daniel R. Solin

VIKING CANADA

VIKING CANADA

Published by the Penguin Group Penguin Group (Canada), 90 Eglinton Avenue East, Suite 700, Toronto, Ontario, Canada (a division of Pearson Canada Inc.)

M4P 2Y3

Penguin Group (USA) Inc., 375 Hudson Street, New York, New York 10014, U.S.A. Penguin Books Ltd, 80 Strand, London WC2R ORL, England Penguin Ireland, 25 St Stephen's Green, Dublin 2, Ireland (a division of Penguin Books Ltd) Penguin Group (Australia), 250 Carnberwell Road, Carnberwell, Victoria 3124, Australia (a division of Pearson Australia Group Pty Ltd) Penguin Books India Pvt Ltd, 11 Community Centre, Panchsheel Park, New Delhi - 110 017, India Penguin Group (NZ), cur Airborne and Rosedale Roads, Albany, Auckland 1310, New Zealand (a division of Pearson New Zealand Ltd) Penguin Books (South Africa) (Pty) Ltd, 24 Srurdee Avenue, Rosebank, Johannesburg 2196, South Africa Penguin Books Ltd, Registered Offices: 80 Strand, London WC2R ORL, England Published in Canada by Viking Canada, a division of Pearson Canada Inc., 2006 Published in the United States by Perigee Books, a division of Penguin Group (U.S.A) Inc., 2006 While the author has made every effort to provide accurate telephone numbers and internet addresses at the time of publication, neither the publisher nor the author assumes any responsibility for errors, or for changes that occur after publication. Further, the publisher does not have any control over and does not assume any responsibility for author or third-party websites or their content. This publication contains the opinions and ideas of its author and is designed to provide useful advice in regard to the subject matrer covered. The author and publisher are not engaged in rendering legal, accounting, or other professional services in this publication. This publication is not intended to provide a basis for action in particular circumstances without consideration by a competent professional. The author and publisher expressly disclaim any responsibility for any liability, loss, or risk, personal or otherwise, which is incurred as a consequence, direcdy or indirecdy, of the use and application of any of the contents of this book. 2

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Copyright © Daniel R. Solin, 2006 All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted in any form or by any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of both the copyright owner and the above publisher of this book. Manufactured in the U.S.A. ISBN-IO: 0-670-06626-5 ISBN-13: 978-0-670-06626-1 Library and Archives Canada Cataloguing in Publication data available upon request American Library of Congress Cataloging in Publication data available Visit the Penguin Group (Canada) website at www.penguin.ca Special and corporate bulk purchase rates available; please see www.penguin.ca/corporatesales or call 1-800-810-3104, ext. 477 or 474

To hard-working Canadian investors: There is a better, easier, less stressful way to achieve your financial goals. I hope that the time you spend reading this book will be the best investment you will ever make.

Contents Introduction: We Me Different but We Are the Same

XIII

Part One Become a Smart Investor: Change Your Investment Life Forever

I

I. An Unbelievable Chimp Story

3

2. An Unbelievable True Story

5

3. Smart Investing Takes Less Time Than Brunch

II

4. Drop Me

13

[Q

the Bottom Line!

5. Smart Investing Simply Makes Sense

l7

Part Two Your Broker or Advisor Is Keeping You

from Being a Smart Investor

21

6. Brokers Make Money When T hey Are Hyperactive

7. 8. 9. 10.

A Loser's Game Why Investors Pursue Hyperactive Investi ng T he "Activity" Myth What's Wrong with Hyperactive Investing?

II. Brokers Aren't on Your Side

12. Hyperactive Brokers, Underachieving Students 13. What Do You Think of T hese O dds?

23 26 29 34 36 39 42 44

Contents ix

14. Nobody Can Time the Market

48

15. Nobody Can Consistently Beat the Market

51

16. Nobody Can Pick "Hot" Fund Managers

55

17. Why Recommend This Mutual Fund? 18. Hyperactive Investing Is Expensive

58 62

19. If It Walks like a Duck and Quacks like a Duck. ..

65

20. Brokers Understand Fees but Not Risk

67

21. Too Many Stocks, Too Few Bonds

70

22. Risk and Reward

73

23. Beware of House Funds!

29. "Financial Pornography"

77 79 81 84 88 91 94

30. Should Your Broker Act Only in Your Best Interest and Be Careful with Your Money?

98

24. Beware of Margin! 25. Beware of Hedge Funds! 26. Value Stocks-Reward Without Risk? 27. Why Hasn't Anyone Told You? 28. The Financial Media Are Part of the Problem

Part Three Smart Investors Know Better

103

31. Who Believes Me?

105

32. When Do Smart Investors Need an Advisor?

111

Part Four The Real Way Smart Investors Beat 95% of the "Pros"

117

33. The Four-Step Process

119

34. Step 1: Determine Your Asset Allocation

121

x Contents

35. Step 2: Open a Brokerage Account and Purchase ETFs 37. Step 4: Rebalance Your Portfolio

127 129 132

38. What About Income Trusts?

134

39. Don't Back Down

136

40. Where Are the Pension Plans for Smart Investors?

139

4 1. Have the Inmates Taken Over the Asylum?

141

42. The Smartest Investor Who Ever Read an Investment Book

143

43. Too Good to Be True?

145

36. Step 3: Select Your Investments

Appendix B: Risk and Return Summary

171 179

Additional Resources

181

Acknowledgments

183

Index

185

Appendix A: Asset Allocation Questionnaire

Introduction: We Are Different, but We Are the Same With understandable pride, Canadians celebrate their differences from their American neighbours. However, when it comes to investing, the two countries are remarkably the same. • Actively managed mutual funds in both countries are aggressively marketed. • Active managers in Canada have the same dismal record as their American counterparts at beating an unmanaged index of stocks, while charging higher fees for this underperformance. • Hedge funds and other "alternative" investments are poorly understood in both countries, leading investors to assume risks that they neither understand nor can afford to take. • Investors in both countries are under the mistaken belief that investing is extremely complex and difficult, requiring the services of brokers and advisors to provide the necessary guidance. • The brokers and advisors to whom investors turn for advice in both countries are conflicted and often poorly trained in basic principles of finance. As a consequence, they often do more harm than good.

xU

Introduction

The reality is thar investing is quite simple and easy. The vaSt majority of investors do not need any advice or guidance from so-called investment professionals. Instead, in less than 90 minutes a year, most investors can select one of four basic ponfolios and, based. on historical returns, are likely to beat the returns achieved by 95% or more of professional money managers. Let me state it very bluntly: The road to financial perdition begins with the call to your broker or financial advisor who tells you he or she can "beat the markets." Canadians would be far better off if they took control of their own finan ces and never dealt with any broker or advisor.

PART ONE

Become a Smart Investor: Change Your Investment Life Forever

Chapter 1

An Unbelievable Chimp Story The investor's chiefproblem-and even his worst enemyis likely to be himself -Benjamin Graham, The Intelligent Investor

There is a chimpanzee in a remote region of Sierra Leone that routinely performs open-heart surgery. His success rate is higher-and his mortality rate lower-than many of the finest heart surgeons in the world. Okay, I made that up. But, if you read that report in the newspaper, you would think that either 1. that chimp is really extraordinary; or 2. those heart surgeons are not very good. If the story were true, and you needed a heart operation, you might seek out the chimp and avoid the heart surgeons. The Financial Times of London annually runs a contest, pitting a neophyte investor against market analysts. In 2002,

4 Become a Smart Investor

a five-year-old London girl chose stocks randomly from 100 pieces of paper listing companies on the Financial Times Stock Exchange. Her results were compared with those of a top financial analyst and those of a woman who used the "movement of the planets" to choose her portfolio. Over a period of one year, the little girl won handily. Very handily, as a matter of fact. Her stocks gained 5.8%. In stark contrast, the portfolio of the professional analyst lost 46.2%. The analyst was also bested by the financial astrologer, whose stocks lost only 6.2%. The little girl celebrated by going to McDonald's. I suspect the analyst continued to dine at more expensive establishments. There are some excellent peer-reviewed studies that demonstrate that the stocks most highly rated by financial analysts consistently underperform the market. Those reports are fact. Either the little girl is very good, the analysts are very bad or the much-touted skill of stock picking is not something that any smart investor would want to bet the farm on. And the chimp? Well, he still doesn't perform open-heart surgery.

Chapter 2

An Unbelievable True Story Most individual investors would be better off in an index mutualfund -Peter Lynch, former manager of the Fidelity Magellan Fund, Barron's, April 2, 1990, p. 15

More than 50 million Canadian investors hold a total of more than $550 billion in mutual funds. Most of this money, and virtually all money held in individual stocks or in income trusts, is invested the wrong way-by money managers who engage in what I call "hyperactive management." Hyperactive management is characterized by efforts to beat the market by picking winners and timing the market. This is dumb money.

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