Wealth Without Wall Street

The following is a guest post from The Insider's Guides.

“Wall Street's world turned upside down”

These were the headlines in 2009.

Wall Street financial management has proven itself worthless. Bill Gross was right. “Professional money management is a gigantic rip-off.” Only 2 advisors provided their clients with the correct advice about the total collapse of the market in 2008-9. In one year, most money management clients have seen their accounts plunge 40%, 50% even 70%. No advisor has fired him/herself. No advisor has returned their advisory fees and commissions. In fact, most advisors hid from their clients during the worst of the storm, as acknowledged by Fidelity executives in May 2009.

The naked truth—YOU must build wealth without Wall Street.

What to do?

Look at Wall Street “turned upside down.”

• First, when money managers buy and sell securities in their mutual and hedge funds, they are trying to predict the future of the market. There is no proof this can be done over time. Yesterday’s winners are usually tomorrow’s losers. The AVERAGE market return has been 12%, so a few managers will beat the average by luck—Just not the same ones every year.

• Second, you must pay the costs of the manager, her/his marketing group and operations, whether or not s/he makes you a dime. It is always better to pay as little as possible for the same performance over the long term. Costs can take up to 33% of your returns, over time. Investors averaged only 2.57% annually from 1984 through 2002 despite buying the ‘winners’ at the top.

• Third, managers are paid for increasing “ASSETS under management,” not for making you rich. Bringing in more assets is a full-time job. It is expensive to market the funds given that there are now thousands available. It is inevitable that popular funds will grow until they produce average returns with high expenses. Managers want to be rich, not right.  It takes luck to pick successful stocks. You do not benefit from economies of scale. As assets grow, fees do NOT shrink.

• Fourth, there is much less chance of you being treated poorly by fund management if the structure and governance are customer-oriented like Vanguard’s and TIAA-CREF’s are.

• Fifth, many professional managers and Wall Street “insiders” place their core assets in index funds. As bond guru, Bill Gross, said, “professional money management is a gigantic rip-off.”

• Sixth, since no manager can consistently beat the market, a mutual fund or hedge fund for that matter, must be evaluated as a commodity. Commodities are usually judged on price. As Benjamin Graham, legendary value investor, said, “Investors should purchase stocks like they purchase groceries—not like they purchase perfume.” Actually, all financial services should be purchased this way—insurance, mortgage, credit, banking.

• Seventh, due to changes in access and technology, some manufacturers of financial services and products have decided to enhance their direct to customer channel. Even though Vanguard funds have not been sold by personal selling, it has grown to rival most fund complexes. Discount brokers are now considered to have better customer service than brokerage firm services, according to Consumer Reports. Even though Progressive Insurance is sold by agents, their success in the direct channel has been impressive. 

• Eighth, Wall Street cannot reduce the risk of investing. Most individual investors have lost 30% to 50% of their life savings in the last Wall Street bubble. Many investors now realize that Wall Street is selling snake oil. Even the promise of diversification has left many realizing that “experts” can’t control risk.

• Ninth, Wall Street used to control price—raising the price of investing to grow revenue directly lowers investor returns. The advisor or fund with the highest price does NOT guarantee success: only expenses to investors. 

Investors can now control the price. We can use low-cost mutual funds and brokers. Since Wall Street cannot predict the markets and we don’t know if stocks will outperform all other assets over time, we must take the Pascal wager:

Pascal’s wager: The consequences of not being in the markets are worse than being in it for the long haul. Buying the market returns at the lowest price is the best solution for long-term wealth-building. You are better off without “professional” advice.

Example: Member Ron Delaney of New York will gain $400,000 because he asked about his 401k plan. Mutual fund fees are the largest source of overcharges—$400,000—over time. Ron did not believe pension costs were as high as we said. He asked his HR person about the costs of his 401K plan. He received a packet of materials. Finally, he calculated that his annual expenses were 2.1% and his annual fee was $50. His plan offered index funds for just 0.70%. He picked which funds he needed and saved $2,800 ($4200-$1400) every year. By the time Ron retires, he may have added an extra $400,000 to his 401k.

Your choice is clear—avoid Wall Street. Their “advice” is just marketing hype. Their research exists to sell their products. Take the advice of unbiased advisors like master investor Warren Buffett,

By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals.  Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb.

Comments

[texashaze]

This is a very timely article for an issue I've been struggling. I hired a financial advisor 3 years ago. We bought stocks then and have never sold or bought again yet my value dropped by 40%. All these guys preach is buy and hold. I'm sorry if you have a loser you need to get rid of it, or if you see a stock that will appreciate faster than your existing portfolio then you should buy it. This is a huge financial advisor company that seems to have taken my commissions and monthly fees and forgotten me. I really think I would have done better on my own. The only thing is that my advisor is a nice guy and I can't bring myself to fire him. I know its foolish but it is what it is. However I will likely do it in the next few months and do my own.

Anyone else struggling with this issue?

[Ron]

Although I've never had a financial adviser, I think I can understand the allure of hiring an "expert" to handle your money. Marketing and titles, "financial adviser" can be powerful inducements to act. A long time friend has recently left our company and became a financial adviser,he then convinced a number of our friends to allow him to handle their investments. He had been a top salesman for our company and definitely a "nice guy" but 6monthsof company paid training does not an expert make. Remember, Bernie Madoff is reputed to be a nice guy also

[Eugene Krabs]

Buy-and-hold isn't really an issue. The real issue is expense ratios and fees. Regardless of market performance, you're always guaranteed to pay that amount into the pockets of professional managers.

Good entry overall.

[Rajeev Singh]

This is a nice article exposing the myth about so called expert money management by professional fund managers, but, I think one can not stay away from equities as an investment tool. Best option is to go for index fund, Buy and hold strategy has worked so far and should do so going forward. With the knowledge that every boom is followed by bust and every bust is the precursor of next boom , one can use this knowledge to cash out of equities at the top of boom and reinvest in bust. Easier said than done though.

[Old Limey]

Allow me to tell you what worked for me. I retired in September 1992 after a 32 year career as an engineer performing structural analysis on ICBM components such as rocket motors, reentry vehicles and various related components, so I obviously have a good background in mathematics, science and computers.
Two or three months later I took over managing my 401K by moving it into a self directed IRA at Fidelity investments. I also moved our taxable investment money to the same institution and started managing it using only no load mutual funds. I had also recently subscribed to Investor's Business Daily (IBD) where I became a convert to its editor William O'Neil's philosophy of 'Momentum Investing' which he categorizes as "Buy High, Sell Higher".

The crux of this method is to buy a fund that has broken out and has started trending higher, you hold this fund as long as it remains in an uptrend. When you become convinced that its uptrend has failed you switch horses, i.e. you sell the fund and conduct a search for a new uptrending fund. If you cannot find a good fund that meets your requirements then, by default, you are out of the market and in a money market fund. In a nutshell, Buy and Hope doesn't work, but market timing and fund selection can work very well but they require skill, judgment, and a lot of time and effort.

Obviously for this to work you either need to follow someone else's advice as what to buy and when to exchange into something else, or, as in my case, you educate yourself in the technical analysis of stock and fund trends, and make all of your own decisions. For this, the first requirement is to have your own mutual fund database on your own computer, and have it updated every day. Fortunately at that time there was an ad in IBD advertising just such a database of mutual funds. The database also came with some very good charting and analysis software that contained the tools that I needed so I became a charter subscriber and still am today.

The database structure was also made public to selected subscribers so I was also able to construct my own software that used this database to perform a wide variety of statistical analyses on mutual funds.
I used this approach, with frequent refinement, from 12/28/92 until when on 11/1/07 I made the important decision to stop trading and to move into the slow lane, holding just CDs in our IRA accounts and individual municipal bonds in our trust account, all to be held until maturity. This minimized our income taxes which by this time were getting quite onerous, avoided the stress and anxiety of worrying about the market every day, eliminated management fees paid to mutual funds, while still providing far more income than we need.

During this almost 15 year period that included the fabulous dot.com bubble, my annualized compound rate of return was 21.58% and my total gain was 1719.6%. I don't believe that my experience can be easily repeated given the dire state of the current world economy and also because investment bubbles like the dot.com bubble between 11/2/99 and 3/10/00, when the Nasdaq Composite hit 5048, probably only occur once in a lifetime if you are very fortunate, so like everything else in life, luck certainly has a large role to play.

[Mike Hunt]

Having an advisor was good during the steady boom of the late 90s and from 2002 - 2006, but I think buy and hold will be dead for some time. You are better off trading yourself (what I'm doing) or staying in safer assets until things shake out in the next few years. The gov't response of borrowing more to stabilize the system will just prolong the pain to years and decades instead of months and years.

But hey, keep talking about what Michelle Obama is wearing to keep you hopeful while the people in power keep borrowing money from our future and giving it to Goldman Sachs.

Cap and trade will be the next bubble, invest accordingly. And it will be another one that leaves us even worse off than now, if you can imagine this.

Sorry about the rant, figure it's appropriate for July 4th though.

-Mike

[Jim]

A few point to make in regards to this article.

Article: "Only 2 advisors provided their clients with the correct advice about the total collapse of the market in 2008-9."

This statement is not true. There are many (too many to count) Advisors who were completely out of the market before the downturn happened.

Article: "No advisor has fired him/herself. No advisor has returned their advisory fees and commissions."

This is a very deceptive statement. There are two advisors I can name off the top of my head who didn't charge a dime when their clients lost money. Mohnish Pabrai & Joe Ponzio. Both Advisors model their funds after Warren Buffett's early fund. If you don't make at least a 6% annual return, you don't pay them a dime in fee's. Since Mohnish Pabrai took a loss in 2008, he didn't charge any of his clients even one penny in fees of any kind therefore he had nothing to return. As for Joe Ponzio, he made a positive return for 2008, well above 6%.

Article: "The AVERAGE market return has been 12%, so a few managers will beat the average by luck—Just not the same ones every year."

The Average market return has been 7%, not even close to 12%. Not sure where you get your information but if its from an internet website, you're best to do it the hard way and get out a calculator. Furthermore, most value investor managers beat the market. Luck has very little to do with it in value investing. You simply don't know what you are speaking about.

Article: "you must pay the costs of the manager, her/his marketing group and operations, whether or not s/he makes you a dime."

Again, better research on your part is needed. There are many fantastic money managers that won't charge you a dime unless they can produce results. Finding them is the key and its obviously something that you haven't been able to find.

Article: "Third, managers are paid for increasing “ASSETS under management."

You are speaking of a "mutual fund" manager on these terms. Maybe the only thing we have in common is this: a mutual fund manager is not a manager of money in any sense of the word, they rarely know what they are doing.

Article: "It takes luck to pick successful stocks."

This is purely an uninformed statement. Countless books have been written by the best investors and investment advisors in the world of value investing who have all beat the markets year over year for periods of 20, 30, 40, & 50 years. Myself included in which out of the roughly 30 stocks I've owned in the last year, I lost money in 2 of them which equaled a whopping $100. I'm ranked #5 on covestor.com. That's not luck my friend. Its diligence.

Article: "many professional managers and Wall Street “insiders” place their core assets in index funds. As bond guru, Bill Gross, said, “professional money management is a gigantic rip-off."

Again, the author is getting confused between a "money manager" and a "mutual fund manager". Two completely different things. He is specifically talking about a mutual fund manager regardless if he knows it or not. Apparently, he doesn't know what he's talking about. That's very evident to a professional such as myself.

Article: "since no manager can consistently beat the market"

Countless people have beat the market. Warren Buffett has beat the market for the last 50 years, Charles Brandes, Joe Ponzio, Mohnish Pabrai, Edward Lampert, Bruce Greenwald, Seth Klarmen, Prem Watsa, Martin Whitman, Glenn Greenberg, Arnold Van Den Berg, Bill Ackman, myself, etc. All these people share the same investing principles. Everyone of them have beat the markets consistently for 20+ years. I could write a 50 page book of just names of people who have beat the markets since 1929. The notion that you can't beat the market is childish and blind. Completely incompetent.