MONEY Markets

Here’s How Anyone Can Beat Professional Investors

141110_INV_PassiveInvesting
With cheap index funds, you can diversify without paying a premium. Herbert Gehr—Getty Images/Time & Life Picture

Statistically speaking, financial experts still can't match the "wisdom of the crowd."

Another day, another piece of evidence that active fund managers are no better at investing than lab rats.

This time, researchers at Bank of America found that more than 4 out of 5 managers have failed to beat the Russell 1000 index of large-company stocks so far this year. In fact, there’s been only one year in the last decade (2007) when a majority of active managers beat the market.

“It’s an incredibly competitive environment, with so many active managers looking for the next great investment, and it’s just not there,” says Alexander Dyck, a finance professor at University of Toronto’s Rotman School of Management, who has co-authored an international comparison of active and passive strategies.

Dyck’s research found that in the United States, passive strategies work better than active management. That is, mutual funds that simply mimic an index actually return more money, post-fees, than funds managed by professionals making hands-on choices about what stocks, bonds, and other assets to hold.

That finding is a big deal because people who invest in active funds—say, in their 401(k)s or other retirement accounts—typically pay much higher fees than those who invest in passive funds. Thanks to active management, stock fund investors on average end up paying more than five times as much in expenses than they would with index funds; that can amount to tens of thousands of dollars, as the chart below shows.

Screen Shot 2014-11-11 at 4.54.47 PM (2)
Source: https://personal.vanguard.com/us/insights/investingtruths/investing-truth-about-cost

When active funds do beat their benchmarks, that can make up for high fees (though evidence suggests even that scenario is rare). But with most returns so uninspiring, there doesn’t seem to be much remaining justification for active management, at least for the average investor. Better to stick with cheap index funds.

Of course, there are exceptions to this rule. Dyck’s research, for example, found that active managers can still beat their benchmarks when they invest overseas—particularly in emerging markets like China, where investing in companies hand-picked by a professional tends to be a better bet than investing in a basket of stocks representing every company out there.

“In countries with significant governance risks, a plain old index gives you exposure to everything, including the good, the bad, and the ugly,” says Dyck.

But even though active investing outside of the U.S. seems to work for institutional investors who generally pay lower fees, Dyck says, it doesn’t mean it’ll be worth it for you. As a retail investor, you’ll almost always pay more than the professionals.

MONEY fix my mix

Get Free Help with Your Investing Challenges

Pile of money
B.A.E. Inc.—Alamy

MONEY is looking for people who are willing to share the details of their portfolio in exchange for a free workup with a financial planner.

Has the volatile market caused you to flee stocks for the security of cash and bonds?

Are you close to 100% in stocks but thinking now it might be time to dial back?

Would you like to rework your investments to generate more income from dividends and bonds?

If so, we’d like to help.

For an upcoming issue, MONEY is looking for people who’d be willing to share their portfolio and financial situation in the magazine, in exchange for having a top-shelf financial planner examine their investments from top to bottom and come up with a full and personalized financial plan.

You must be comfortable sharing details of your personal and financial life (including your real names) and being photographed for the story.

If interested, please fill out the form below. Please tell us a little about your investment challenges, and also include a few details about your family’s finances, including income, approximate savings, and debts. All of this information will be kept confidential until we talk and you agree to appear in the story.

Everybody has an investment challenge, so let’s hear yours!

MONEY financial advisers

What Is a Fiduciary, and Why Should You Care?

Your investments are at stake, explains Ritholtz Wealth Management CEO Josh Brown (a.k.a. The Reformed Broker).

MONEY stocks

Why Would Someone Start a New Stock Exchange?

Brad Katsuyama, CEO of IEX, talks about why he helped to build a startup stock exchange.

MONEY investing strategy

5 Mental Habits That Make Investors Rich

141106_INV_DreamInvestor
PeopleImages.com—Getty Images

Don't take yourself so seriously.

If I could build a dream investor from scratch, his name would be Paul.

Paul is an optimistic a-political sociopathic history buff with lots of hobbies who takes others’ opinions more seriously than his own.

Let me tell you why he is going to kick your butt at investing.

The sociopath

Psychologist Essi Vidling once interviewed a serial killer. Vidling showed the killer pictures of different facial expressions, and asked him to describe what the people were feeling. The murderer got most right, except pictures of people making fearful faces. “I don’t know what that expression is called, but it’s what people look like right before I stab them,” he said.

Paul couldn’t harm a fly. But a key trait of sociopaths is the ability to remain calm when others are terrified, so much that they don’t even understand why other people get scared. It’s also a necessity to becoming a good investor. In her book Confessions of a Sociopath, M.E Thomas writes:

The thing with sociopaths is that we are largely unaffected by fear … I am also blessed with a complete lack of sentiment … My lack of empathy means I don’t get caught up in other people’s panic.

Paul is like this, too. He doesn’t understand why people investing for 10 years get fearful when stocks have a bad 10 days. Recessions don’t bother him. Pullbacks entertain him. He thought the flash crash was kind of funny. He doesn’t care when his companies miss earnings by a penny. He’s immune to that stuff, which is a big advantage over most investors.

The a-political investor

Paul has political beliefs — who doesn’t?

But he knows that millions of equally smart people have opposite beliefs they are just as sure in. Since markets reflect the combined beliefs of millions of people, Paul knows that there is no reason to expect markets to converge on his personal beliefs, even if he is dead sure it is the truth. So he never lets his politics guide his investment decisions.

Paul knows that political moralizing is one of the most dangerous poisons your brain can come across, causing countless smart people to make dumb decisions. Even when he is bothered by political events, Paul repeats to himself in the mirror: “The market doesn’t care what I think. The market doesn’t care what I think.”

The history buff

Paul loves history. He loves it for a specific reason: It teaches him that anything is possible at any time, no matter how farfetched it sounds. “One damned thing after another,” a historian once described his field.

Paul knows that some people read history for clues on what might happen next, but history’s biggest lesson is that nobody has any idea, ever.

When people say oil prices can only go up, or have to fall, Paul knows history isn’t on their side — either could occur. He knows that when people say China owns the next century, or that America’s best days are behind it, history says either could be wrong.

History makes Paul humble, and prevents him from taking forecasts too seriously.

The hobbyist

Paul likes golf. He enjoys cooking. He reads on the beach. He has a day job that takes up most of his time.

Paul loves investing, but he doesn’t have time to worry about whether Apple is going to miss earnings, or if fourth-quarter GDP will come in lower than expected. He’s too busy for that stuff.

And he likes it that way. He knows investing is mostly a waiting game, and he has plenty of hobbies to keep him busy while he waits. His ignorance of trivial stuff has saved him thousands of dollars and countless time.

The open-minded thinker

Paul knows he’s just one of seven billion people in the world, and that his own life experiences are a tiny fraction of what’s to be learned out there.

He knows that everyone wants to think they are right, and that people will jump through hoops to defend their beliefs. He also knows this is dangerous, because it prevents people from learning. Paul knows that everyone has at least one firm, diehard belief that is totally wrong, and this scares him.

Paul is insanely curious about what other people think. He’s more interested in what other people think than he is in sharing his own views. He doesn’t take everyone seriously — he knows the world is full of idiots — but he knows the only way he can improve is if he questions what he knows and opens his mind to what others think.

The realistic optimist

Paul knows there’s a lot of bad stuff in this world. Crime. War. Hunger. Poverty. Injustice. Disease. Politicians.

All of these things bother Paul. But only to a point. Because he knows that despite the wrongs of the world, more people wake up every morning wanting to do good than try to do harm. And he knows that despite a constant barrage of problems, the good group will eventually win out in the long run. That’s why things tend to get better for almost everyone.

Paul doesn’t get caught up in doom loops, refusing to invest today because he’s worried about future budget deficits, or future inflation, or how his grandkids will pay for Social Security. Optimists get heckled as oblivious goofs from time to time, but Paul knows the odds are overwhelmingly in their favor of the long haul.

I’m trying to be more like Paul.

Related:

Check back every Tuesday and Friday for Morgan Housel’s columns.

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MONEY retirement income

The Creepy Truth About Life Settlements

Actress Betty White presents the late producer Bob Stewart with a posthumous Lifetime Achievement Award during the 40th annual Daytime Emmy Awards in Beverly Hills, California June 16, 2013.
Actress Betty White has pitched life settlements to seniors. Danny Moloshok—Reuters

A new novel revolves around a murderous life settlements investor. That's fiction. But these products have very real risks for buyers and sellers.

Selling your life insurance policy is right up there with taking out a reverse mortgage when it comes to retirement income sources that most people would be better off not tapping. But folks do it anyway, while paying little attention to the costs and, as a new novel points out, the risks of a policy landing in the wrong hands.

Selling a life policy for a relatively large sum—known as a life settlement—has gotten easier over the last decade. Hedge funds, private equity funds, insurers and pension funds dominate the market, which totals around $35 billion, up from $2 billion in 2002. Individuals are investing in them too, through securities that represent a fraction of a bundle of life settlements, sometimes called death bonds.

How Life Settlements Work

Those most likely to be offered a life settlement, formerly known as a viatical, are individuals with a universal life insurance policy they no longer need or can’t afford—or who simply don’t want to pay the premiums. A term life policy that converts to a universal policy may also have value. Policyholders sell their insurance for more than they’d get by surrendering the policy to their insurer. If you have a death benefit of $1 million, you might have $100,000 cash surrender value but manage to get $250,000 from a third-party investor. The investor assumes future premium payments and collects $1 million at your death.

Not a bad deal, assuming you’re comfortable with the fact that someone out there has a financial interest in your demise. You get a bigger payout for a policy you were going to give up anyway. Life policies with total face value in the tens of billions of dollars lapse every year, according to industry estimates. Many of those policies have value in the secondary market.

As part of their ad campaign, the life settlement industry has enlisted actress Betty White, who pitches these deals for “savvy senior citizens needing cash.” Heck, she’s more persuasive than Fred Thompson is about reverse mortgages. But don’t be easily swayed. Aging celebrities from Henry Winkler to Sally Field are pitching all sorts of elder products these days in what amounts to an encore career—not a genuine endorsement.

The Privacy Risk

Okay, so what are the downsides to life settlements? For policyholders seeking to raise money, the creepiest risk by far is that you sell your policy to Tony Soprano, who understands that the quicker you die, the greater his rate of return. This is the extreme case explored in a new novel by Ben Lieberman, The Carnage Account. The lead character is a Wall Street high roller who buys up life settlements and dispatches the people with the biggest policies. “Very few products on Wall Street have been immune to exploitation,” says Lieberman, noting the wave of subprime mortgages that blew up in the financial crisis. “The abuse can now hurt more than your property. Instead of losing your house you can lose your life.”

Of course, Lieberman is a novelist with an active imagination. Life settlements have been around since the AIDS crisis, and there has never been a known case of murder for quick payoff, says Darwin Bayston, CEO and president of the Life Insurance Settlement Association. There have been only three formal complaints of any kind about life settlements to national regulators in the last three years, he says.

Yet Lieberman, who has a long Wall Street background, finds the entry of cutthroat hedge fund managers more than a little unsettling. Policies with insurers or held by pension funds remain largely anonymous inside huge portfolios. Institutions base their settlement offers on average life expectancies, knowing some policies will pay early and some will pay late.

But in smaller and more actively managed pools investors may pick and choose life policies that promise a quicker payoff, based on things like depression and mental illness, or clues from medical staff as to the most “valuable” policies. Life settlement investors are also targeting an estimated $40 billion of death benefits that policyholders might sell to fund long-term care needs, spinning it as socially conscious investing. How else will these seniors pay for end-of-life care? “Instead of credit risk or prepayment risk we now evaluate longevity risk,” Lieberman says. “This began as a way to help terminally ill patients. Now it incorporates perfectly healthy people and presents a way to bet against human life.”

One former life settlements investor told me he has seen third-party portfolios of life policies fully disclosing the names of the insured parties, which is the basis for the success of Lieberman’s fictional Carnage Account. In his novel, a murderous hedge fund manager gets this information and speeds up the whole process. Again, that’s fiction. But even Bayston concedes that a determined life settlements investor could get the identities of the insured people whose long lives are bad for investment returns.

The Financial Risks

Now, let’s look at the non-fiction risks with life settlements. For sellers, they are considerable, and include giving up your policy too cheaply and paying dearly for the transaction, and possibly becoming ineligible to buy another policy. Always check the cash surrender value first. Do not be swayed by brokers putting on a hard sale. They stand to collect commissions of up to 30% of the settlement. If you are determined to quit paying premiums, rather than sell the policy consider letting the cash value fund future premiums until the cash is exhausted. That’s a much better deal for heirs if you pass away in the interim. You can sell the policy when the cash value has been depleted—and get more for it then.

For buyers, settlements are complex and illiquid, and they may not pay out for many years. Given these hidden risks, they generally do not make sense for individual investors. Wall Street, meanwhile, benefits from their huge fees and expected long-run annual returns of 12% or more. Perhaps more important, settlements offer returns with no correlation to the financial market, which can be attractive to sophisticated investors and institutions, such as pension funds.

The life settlements industry has leveled off since the financial crisis, in large part because policies are taking longer to pay, thanks to increasing longevity. That drives down returns. Underscoring this risk to investors: the Society of Actuaries recently published revised mortality rates showing that a 65-year-old can now expect to live two years longer than someone that age just 14 years ago. But investors have been edging back into the market the last couple years, drawn by more realistic return assumptions and an anticipated flood of life policies held by boomers who will need cash to pay for assisted living.

Only in a novel do life settlements investors manage longevity risk with a hit man. But there are good reasons to be careful nonetheless.

MONEY General Electric

The Untold Story Behind GE’s Most Lucrative Business

A General Electric Co. employee examines a component for a gas turbine at the company's factory.
Fabrice Dimier—Bloomberg via Getty Images

GE’s services business should be a big story for investors.

The financial media these days has two stories when it comes to General Electric GENERAL ELECTRIC CO. GE 1.9093% the one that says GE is downplaying its banking business and the one that shows how GE is returning to its roots by “making stuff” again.

While both storylines are important to GE investors, a separate transformation taking shape inside the world’s seventh-largest company will steal the spotlight in the years to come. The seeds of GE’s next big breakthrough were planted nearly two decades ago, but they’re just now taking root as manufacturing enters a technology- and data-fueled era.

Read on to learn the untold story of GE’s most lucrative business and discover why it’s so important for shareholders to understand.

The one that (almost) got away

The origin of this story dates back to the early 1990s. Jack Welch, also known as “Neutron Jack,” was GE’s CEO, and he was busy making his mark on corporate America.

Quadrupling GE’s market value in roughly 14 years made Welch a superstar in the eyes of everyone from the media to stockholders. To business students around the country, he was the Michael Jordan of their future profession.

Like Jordan, Welch was a fierce competitor, and his unorthodox, assertive style of management took his team to the top: GE became the largest company in the world.

By the mid-1990s, however, this titan of industry faced a dilemma within GE’s walls.

His success to date had rested on strategies that boosted manufacturing efficiency, heightened competition among his managers, and focused strictly on markets in which GE could steamroll the competition. Each had its pros and cons, but the latter strategy specifically began to show signs of obsolescence in the mid-1990s.

This strategy had become known as the “No. 1 or No. 2″ policy at GE. It meant General Electric aimed to dominate the industries in which it operated, or else it would abandon the cause. Anything less than first or second place in market share was simply unacceptable.

As GE grew in size, this all-or-nothing style of thinking caused some serious problems. First off, the incentives were misaligned for GE’s managers. Its own leaders became hyperfocused on maintaining their market position in a given industry instead of thinking about how to expand into a new one. Expansion would mean growing their addressable market, of course, which could bump GE’s rank down a notch or two.

There was absolutely no incentive to grow outside of the box, per se, even if it made sense from a product or customer perspective. To use an analogy, it’s as if a traditional motorcycle manufacturer refused to enter the growing market for off-road dirt bikes because this would grow the arena in which it competed and would mean relinquishing its “No. 1 or No. 2″ position. While this might sound ridiculous, it was a prime example of how GE’s bureaucracy was creating perverse incentives.

And, in the worst-case scenarios, GE managers were given leeway to define their own markets. When this happened, they would often manipulate (read: shrink) their “industry size” in an attempt to look like they had a dominant market presence. Since GE’s underperformers could be shown the door at any moment, this move was a self-preservation no-brainer. But it was highly counterproductive for the company.

At the end of the day, the overriding focus on being first or second prevented managers from tackling new, promising opportunities in which GE might be the underdog at the outset. And the services business was one of these markets.

A “punch in the nose”

At the time, the business of maintaining and servicing heavy industrial equipment was loaded with entrenched players dispersed across the globe. In fact, GE’s potential competitors in this arena numbered in the thousands. One could compare the scenario to a major car manufacturer trying to nudge its way into an auto maintenance industry overpopulated with established, local mechanics.

Taking a backseat to entrenched players — even if it was in the best interests of GE’s customers — was simply unacceptable. It also seemed like small potatoes for a company of GE’s size.

But here was GE selling hundreds of proprietary products like gas turbines that would inevitably need regular maintenance and upgrades. Services might not have seemed glamorous, but it was an area in which GE had a unique and potentially durable advantage.

By 1995, Welch relented; ironically, it was his middle managers who convinced him that this market was too crucial to be overlooked. Welch did an about-face on his long-standing management mantra, and GE began to aggressively pursue services.

In 2000, Welch recalled how the light bulb went off and why he reversed course on services:

Rather than the increasingly limited market opportunity that had come from this number-one or number-two definition that had once served us so well, we now had our eyes widened to the vast opportunity that lay ahead for our product and service offerings. This simple but very big change, this punch in the nose, and our willingness to see it as “the better idea,” was a major factor in our acceleration to double-digit revenue growth rates in the latter half of the ’90s.

Welch’s refusal to set foot in industries in which he couldn’t dominate would be like Michael Jordan refusing to take some lower-percentage perimeter shots. It might make sense for a short stretch of time, but ultimately it underutilized the company’s talent and limited its ability to attack areas where the competition could be outmaneuvered.

The rise of services

Welch called his realization a “punch in the nose,” but he took it in stride. Within three years time, revenue from GE services reached $10 billion, and Welch was singing its praises in his annual letter to shareholders:

The opportunity for growth in product services is unlimited. We have the ability, using high-technology services, to make our customers’ existing assets (e.g., power plants, locomotives, airplanes, factories, hospital equipment and the like) more productive, and by doing so reduce their capital outlays. This growing capability, much of it information technology-based, will enable us to increase our revenues from product services by more than 30% in 1998 — to $13 billion.

What began as a maintenance-focused exercise was unfolding as a productivity-enhancing opportunity for GE customers. And that has continued behind the scenes for the last 15 years. Welch’s successor, Jeff Immelt, has carried the torch.

Under Immelt’s leadership, GE’s services capabilities have evolved and multiplied. Today, GE can actually diagnose problems in the company’s products in advance of a breakdown. For gas turbines and rail locomotives, it’s like a “check engine” light flashing on in your car, but with a real-time response from one of GE’s engineers connected via the industrial Internet.

The probability that a customer will actually have to visit the repair shop is greatly reduced — a big win for around-the-clock energy, airline, or rail operations.

For GE, it’s also a win. Long-term contractual service agreements deepen GE’s relationship with major clients. They enable engineers to better understand how their products are being used in the field, which can, in turn, influence the design process.

It’s also a highly lucrative business.

I’ve compared the equipment-and-services relationship to a razor-and-blade business model. This means the initial sale of GE equipment (the razor) is often accompanied by an even more profitable service relationship (the blade).

The following chart shows how much more profitable services are for General Electric relative to the operating margins of the company as a whole:

Services as reported in third-quarter 2014. Overall business as of 2013 year-end. Source: GE 10-Q, 10-K.

What’s more, services are growing. Once again, this segment is outpacing the rest of GE’s business, making up ground at a company that was hit hard by the financial crisis:

Source: GE's Services and Industrial Internet Presentation on Oct. 9, 2014 and SEC 10-K filings.
Source: GE’s Services and Industrial Internet Presentation on Oct. 9, 2014 and SEC 10-K filings.

Finally, services are scaling across the business. This means it’s starting to make a significant impact on the revenue and earnings of this massive conglomerate.

For instance, from 2011 to 2013, services accounted for 28% of revenue but 40% of earnings on average. Investors can expect services to be an even larger piece of the revenue and earnings pie going forward due to a huge pipeline of work.

Right now, the most important chart for GE investors is one of its $250 billion order backlog. Look at how GE’s backlog has ballooned and transformed from services-light to services-heavy over the past 13 years:

As of 2000 year-end and third-quarter of 2014. Source: GE's 2000 10-K and 2014 Q3 10-Q filing.
As of 2000 year-end and third-quarter of 2014. Source: GE’s 2000 10-K and 2014 Q3 10-Q filing.

What you need to know about the new GE

For investors, it’s important to recognize GE for what it is today.

It’s no longer a bank. In fact, GE expects to derive only 25% of operating earnings from lending by 2016. Lending, too, will be a services-driven business, with GE providing financial expertise — as well as money — to clients in a variety of industries.

It’s no longer an old-school manufacturer, either. Gone are the days of trying to win based on having the absolute lowest costs in the business.

Today, it’s all about enhancing products through services. How can customers reduce downtime? How can real-time data, robots, and connectivity make machines more efficient? Here’s how Immelt put it in a recent presentation on services and GE’s industrial Internet:

[T]his is the new battlefield. This is the new basis for competition. No matter who you invest in, if you are in the industrial space … this is the game of the future.

After two decades in the making, the future has arrived in the form of high-tech services at GE. Although it has generally flown under the radar in the mainstream financial press, the story of services is one that long-term GE investors simply can’t afford to ignore.

MONEY stocks

How to See the Stock Market Like Warren Buffett Does

Warren Buffett, chief executive officer of Berkshire Hathaway Inc.
Jeff Kowalsky—Bloomberg via Getty Images

Ultimately, intelligent investors mustn't view stocks as numbers on screens or charts moving up and down, but as businesses.

When I say “stock,” what comes to mind?

If it’s one that you own, do you think of a chart that is hopefully moving upwards? If it’s one you’re thinking about owning, do you think about how a few important numbers and metrics stack up against those of its peers?

One of the greatest investors of all time — the one and only Warren Buffett — looks at stocks in a way that is easy to understand yet incredibly hard to manage. But his strategy is one we should all remember when we think about the stocks we own and the ones we’re thinking about investing in.

The simple wisdom

When Buffett discusses the progress of Berkshire Hathaway’s four biggest individual stock holdings — Wells Fargo, Coca-Cola, American Express, and IBM — in his latest annual letter to shareholders, at no point does he mention their price.

Instead, he speaks of two critical things: Berkshire’s ownership stake in the companies themselves and how much of their bottom-line earnings are actually available to Berkshire because of that stake.

Berkshire Hathaway’s ownership of each of the big four has grown over the last few years thanks to its purchase of larger positions in Wells Fargo and IBM plus the share repurchase efforts of the management teams at Coca-Cola and American Express.

youll-never-see-your-stocks-the-same-way-again-1_large

Although those slight increases in ownership may not raise any eyebrows, dominate headlines, or even inspire a Tweet, consider Buffett’s own words:

If you think tenths of a percent aren’t important, ponder this math: For the four companies in aggregate, each increase of one-tenth of a percent in our share of their equity raises Berkshire’s share of their annual earnings by $50 million.

And that brings us to our second point: It isn’t just the ownership stake that matters, but the actual results of the company that is owned. Buffett went on to say:

The four companies possess excellent businesses and are run by managers who are both talented and shareholder-oriented. At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business; it’s better to have a partial interest in the Hope diamond than to own all of a rhinestone.

As a result of both increased ownership and the continued success of Buffett’s “Big Four,” the portion of earnings available to Berkshire — although only the dividends paid out show up on its financial statements — has grown dramatically since 2011:

youll-never-see-your-stocks-the-same-way-again-2_large

But this growth is nothing new. In his 2011 letter to shareholders, Buffett said:

We expect the combined earnings of the four — and their dividends as well — to increase in 2012 and, for that matter, almost every year for a long time to come. A decade from now, our current holdings of the four companies might well account for earnings of $7 billion, of which $2 billion in dividends would come to us.

And while the earnings growth of the Big Four may not continue at its recent pace of more than 15% annually, $7 billion may even be a dramatic understatement.

The key takeaway

As Buffett’s famed mentor Benjamin Graham said in his seminal book The Intelligent Investor: “Investment is most intelligent when it is most businesslike.”

Ultimately, intelligent investors mustn’t view stocks as numbers on screens or charts moving up and down, but as businesses. We must largely ignore movements in stock prices and evaluate the fundamental business dynamics, knowing that over time stock prices will reflect changes in underlying fundamentals and the results of the business.

For example, since Chipotle CHIPOTLE MEXICAN GRILL INC. CMG -0.6376% went public on Jan. 26, 2006, its stock has moved up or down by 5% roughly once every four weeks, or 132 times. But those investors who have patiently waited, ignoring the price gyrations and trusting in the company’s hugely successful business, would have seen a $1,000 investment grow to nearly $14,000 at the time of writing.

Examples like this show why Buffett once remarked, “The stock market is designed to transfer money from the active to the patient.”

Does this mean you should simply pour money into great businesses? No, because, as Buffett has also said, “A business with terrific economics can be a bad investment if the price paid is excessive.”

But we must see that whenever we make an investment, we must always consider it part-ownership in a company, not simply a stock. Buffett does, and so should you and I.

MONEY Gold

What I Tell Clients Who Want to Buy Gold

Stacks of gold bars
Mike Groll—AP

Sometimes people want gold because of greed, sometimes because of fear. Here's what you should know before you buy it.

“Okay,” the client said at the end of our meeting, after I had recommended my investment strategy, “I’ve just got one more question.”

“Go ahead,” I said.

“What about gold?”

“Why gold?” I asked. I’ve found that the reasons people give me really vary. When they say they want to buy gold, there’s some deeper issue we need to get at. “What is it about gold that appeals to you?”

“It’s low right now. You believe in buy low, sell high, right? I want to earn more than I can from bonds. There’s always a market for gold, no matter what happens.”

Hmmm. The client is expressing both greed and fear. It’s usually one or the other.

So I tried to explain:

You don’t invest in gold; you speculate on gold. Gold grows in value when someone else will speculate more than you did when you bought it. Perhaps it rises and falls with inflation. An exhaustive 2013 article in Financial Analysts Journal concluded that’s not really true. The authors found that the price of gold rises…when it rises. The price of gold fall…when it falls.

There’s some evidence that gold has kept its value in relation to a loaf of bread. The problem is that this comparison goes back the reign of the Babylonian king Nebuchadnezzar in 562 BC. For most investors, that time frame is way too long.

Some people want gold in case all hell breaks loose. It makes them feel safer than boring bonds. I can understand where they’re coming from. Bonds are almost purely conceptual because most people don’t ever even get a piece of paper saying they own them. These people want gold so they can make a run for it if necessary. Like I said, I understand: I like feeling safe, too.

If you’re in this camp, you could use 1-2% of your portfolio to buy some gold. Take physical custody of it. Put it in your safe at home.

Remember the practicalities. Small coins will probably work best; you don’t want to be stuck trying to get change for $1,000 gold bars when the banks have closed. Gold weighs a lot so just buy enough to get you over the border. You don’t want your stash to slow you down when you’re sneaking away in the night.

Still not feeling secure? To take the next step down this road, add the following to your safe: guns, ammo, water, and copy of Mad Max or other favorite movie of this genre. The Book of Eli was okay and 2012 was even better.

However, none of these movies features a post-apocalyptic gold standard. According to them, if and when all hell breaks loose, you’ll want guns, ammo, gasoline, and perhaps a jet.

———-

Bridget Sullivan Mermel helps clients throughout the country with her comprehensive fee-only financial planning firm based in Chicago. She’s the author of the upcoming book More Money, More Meaning. Both a certified public accountant and a certified financial planner, she specializes in helping clients lower their tax burden with tax-smart investing.

Read next: Dubai’s Kids Now Worth Their Weight (Loss) in Gold

MONEY Investing

Pigs Fly: Millennials Finally Embrace Stocks

Jeans with cash in pocket
Laurence Dutton—Getty Images

Young adults have been the most conservative investors since the Great Recession. But now they are cozying up to stocks at three times the pace of boomers.

What a difference a bull market makes. The Dow Jones industrial average is up 160% from its financial crisis low, and the latest research shows that young people are beginning to think that stocks might not be so ill advised after all.

Nearly half of older millennials (ages 25-36) say they are more interested in owning stocks than they were five years ago, according to a Global Investor Pulse survey from asset manager BlackRock. This may signal an important turnaround. Earlier research has shown that millennials, while good savers, have tended to view stocks as too risky.

In July, Bankrate.com found that workers under 30 are more likely than any other age group to choose cash as their favorite long-term investment, and that 39% say cash is the best place to keep money they won’t need for at least 10 years. In January, the UBS Investor Watch report concluded that millennials are “the most fiscally conservative generation since the Great Depression,” with the typical investment portfolio holding 52% in cash—double the cash held by the average investor.

This conservative nature has raised alarms among financial planners and policymakers. Cash holdings, especially in such a low-rate environment, have no hope of growing into a suitable retirement nest egg. In fact, cash accounts have been yielding less, often far less, than 1% the past five years and have produced a negative rate of return after factoring in inflation.

Conservative millennials, with 40 years or more to weather the stock market’s ups and downs, have been losing money by playing it safe while the stock market has turned $10,000 into $26,000 in less than six years. Yes, the market plunged before that. But in the last century a diversified basket of stocks including dividends has never lost money over a 20-year period—and often the gains have been more than 10% or 12% a year.

Millennials are giving stocks a look for a number of reasons:

  • The market rebound. The market plunge was scary. Millennials may have seen their parents lose a third of their net worth or more. But with few assets at the time, the market drop didn’t really hurt their own portfolio, and stocks’ sharp and relentless rise the past six years is their new context.
  • Saver’s mentality. Millennials struggle with student loans and other debts, but they are dedicated savers. They have seen first-hand how little their savings grow in low-yielding investments and they better understand that they need higher returns to offset the long-term erosion of pension benefits.
  • Optimism still reigns. Millennials are easily our most optimistic generation. At some level, a rising stock market simply suits their worldview.

This last point shows up in many polls, including the BlackRock survey. Only 24% of Americans believe the economy is improving—a share that rises to 32% looking just at millennials, BlackRock found. Likewise, millennials are more confident in the job market: 32% say it is improving, vs. 27% of Americans overall. Millennials are also more likely to say saving enough to retire is possible: only 37% say that saving while paying bills is “very hard,” vs. 43% of the overall population.

Looking at the stock market, 45% of millennials say they are more interested than they were five years ago. That compares with just 16% of boomers. Millennials also seem more engaged: They spend about seven hours a month reviewing their investments, vs. about four hours for boomers.

This is all great news. Millennials will need the superior long-term return of stocks to reach retirement security. Yet many of them are just coming around to this idea now, having missed most of the bull market. In the near term, they risk being late to the party and buying just ahead of another market downdraft. If that happens, they need to keep in mind that the market will rebound again, as it did out of the mouth of the Great Recession. They have many decades to wait out any slumps. They just need to commit and stay with a regular investment regimen.

Read next:

Schwab’s Pitch to Millennials: Talk to (Robot) Chuck
Millennials Are Flocking to 401(k)s in Record Numbers
Millennials Should Love It When Stocks Dive

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