Most stocks end up losing you money. So what’s a stock-market investor to do?

Most stocks end up losing you money. So what’s a stock-market investor to do?

May 21, 2023 

By Brett Arends

If you’re going to try to retire early and rich by picking the right stocks, there’s something you should know first: Most stocks end up losing you money. 

Over the long term, a majority of stocks on the U.S. stock market have actually ended up as worse investments than keeping your money in low-risk 1-month Treasury bills. (Or savings accounts, or certificates of deposit.)

It’s easy to look at the fabulous wealth created by those who picked the big winners. We ignore at our peril all the losers.

Going all the way back to 1926, it turns out that a stunning 59% — roughly three out of five — of all the stocks ever quoted on the U.S. stock market have made their investors poorer. Yes, the stock market overall has gone up phenomenally since then. But all of the gains have come from those other 40%, or two out of five. And even among those “winners” most of the gains have come from a very few.

So reports Hendrik Bessembinder, a professor at Arizona State University’s W.P. Carey School of Business, in another of his landmark studies into stockholders’ returns. 

He’s crunched the numbers on 28,114 stocks ever traded on U.S. markets and tracked by the authoritative Center for Research in Security Prices, an affiliate of the University of Chicago.

Total wealth for stockholders over the entire period sums to $55 trillion, he calculates. But the winners, fewer than 12,000, accounted for … er … $64 trillion of that.

The other 16,000 stocks lost you $9 trillion, that means.

When you look closer at the numbers, it gets even crazier. Out of those 12,000 or so stocks that made you any money at all, nearly half — about 45% — of all the money created came from just 50 stocks.

Put another way, this means that the majority of stocks lost you money, and most of the rest made you bupkis. Just 0.17% of all stocks, or one in 562, accounted for about half of all the wealth ever created on the U.S. stock market.

How do you like those odds?

Naturally this has been distorted by inflation, which ignores the devaluation of the dollar over that period. 

Nonetheless, from Bessembinder’s data, 5% of all the wealth created on the U.S. stock market was created by one company: Apple AAPL. And 20% of all the wealth was created by 10 companies: Apple, Microsoft MSFT, Exxon Mobil XOM, Google parent Alphabet GOOG GOOGL, Amazon AMZN, Berkshire Hathaway BRK BRK, Johnson & Johnson JNJ, Walmart, WMT Chevron CVX and Procter & Gamble PG.  

It’s something to bear in mind — especially now that investors are getting thrilled about artificial intelligence and are trying to pick the likely winners from this next technological advance.

It reminds me of Warren Buffett’s comment that the only way for most investors to win from the invention of the automobile was to bet against the companies — like buggy-whip manufacturers — whose industries would be put out of business. Picking the winning car companies in advance was almost impossible: In the early days there were hundreds. Almost all of them went bust.

I remember a wise investor telling me something similar during the dot-com mania of 1999-2000. Even if the dot-com revolution really did end up transforming the world, he said, there was no way to know in advance who would be the big winners. And, he added, many of the likely winners probably weren’t even on the market.

How right he was. Of the top tech stocks back then, only Amazon and Microsoft have ended up big winners. In 1999 nobody was talking about Apple as the likely winner. Alphabet, né Google, wasn’t a public company and Meta, né Facebook, didn’t even exist.

Meanwhile, Bessembinder’s list of the companies that have destroyed the most stockholder value is littered with the big tech hopes of yesterday (or, actually, today). WorldCom is the all-time champ, alone leaving stockholders $100 billion poorer. Lucent, Palm and Sycamore Networks are also near the top of the list. 

So, too, are a lot of newer hot names, although it is surely far too early to draw firm conclusions about the ultimate fortunes of Uber UBER, DoorDash DASH and Airbnb ABNB, among others. (We should note that Bessembinder tracked the data through the end of last year, and many of these stocks have rallied in 2023.)

The latest research is yet another strong argument in favor of investing in broadly diversified, low-cost mutual funds. Actually, as we don’t know who will create the most wealth out of the stocks on the market today, it’s really a strong argument in favor of a fund that invests them equally, such as the iShares MSCI U.S.A. Equal Weighted ETF EUSA.

Meanwhile, if you are going to try to pick stocks, remember the odds are stacked against you. 

https://www.marketwatch.com/story/most-stocks-end-up-losing-you-money-whats-an-investor-to-do-996e8326?link=sfmw_fb

Concentrated portfolio of stocks or Index funds or Mutual/Hedge funds

How should I invest in the stock market?

Should I invest in my own selected stocks and manage my own portfolio?

Should I entrust my money to the fund managers in mutual funds or hedge funds?

Or, should I just buy an index-linked fund or an ETF?

Investing in mutual funds and hedge funds

The problem here is, as an aggregate, these funds underperform the market, after taking into consideration the costs incurred.  

Over a one year period, these costs maybe small, but over a long period, these costs compounded into a huge amount that is leaked out of your portfolio, not available to you to reinvest into your portfolio.

It is generally sound to avoid these funds, since there are better alternatives.

Investing in index linked funds or ETF

Index linked mutual funds have on the aggregate given you the chance to capture the returns of the market at low costs.    

They have in general outperformed the mutual funds and hedge funds, as a group over the long term.

Due to recent awareness of the performances of the mutual funds and hedge funds due to the higher costs involved, more and more money are flooding into index linked funds or ETFs.

Investing in a concentrated portfolio of  a selected group of stocks

I believe this is possible for those with a good and sound philosophy and method; who are hardworking, knowledgeable and disciplined.

These constitute less than 5% of the investors in the market.

An example of a sound philosophy:

• Know the business you are investing.
• The business has durable competitive advantage.
• The management has integrity and are capable.
• The company is available at a fair or bargain price.
• The investing time horizon is long term (> 5 years or more).
• Dividends are reinvested.

The stock markets have returned averagely about 10.5% per year for a long period.  The returns of the stock market over the short term is extremely volatile; inflation over this short period is small.   On the other hand, the returns of the stock market for any 5 years or more rolling period have always been positive.   Those who choose the "good quality stocks" bought at "bargain prices" can expect to perform better than the average and should have returns better than the 10.5% per year.

In summary:

1.   If you are knowledgeable, do invest on your own.

Own a concentrated portfolio of good quality stocks (those with durable competitive advantage).

Do not overpay to own them.

Keep them for the long term, reinvest the dividends, and allowing compounding to give you the higher returns.

2.   If you are not so knowledgeable, but still intelligent in your investing.

Go for index linked funds.

Do you have the uncanny ability to pick out the best mutual or hedge fund managers?  If you have, you may wish to park your money with them.  If not, avoid these products altogether and go for index linked funds or ETF.

Index funds and active management - Warren Buffett is a vocal critic of active management.

Towards his later life, particularly following the global financial crisis of 2007-8, Buffett became an increasingly vocal critic of active management, i.e., mutual funds and hedge funds. 

Buffett is skeptical that active management and stock-picking can outperform the market in the long run, and has advised both individual and institutional investors to move their money to low-cost index funds that track broad, diversified stock market indices. 

Buffett said in one of his letters to shareholders that "when trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients."

In 2007, Buffett made a bet with numerous managers that a simple S&P 500 index fund will outperform hedge funds that charge exorbitant fees. By 2017, the index fund was outperforming every hedge fund that had made the bet against Buffett by a significant margin.

Buffett slams Wall Street 'monkeys', says hedge funds, advisors have cost clients $100 billion

Andrew Harrer | Bloomberg | Getty Images

Warren Buffett, chairman and chief executive officer of Berkshire Hathaway Inc.

Warren Buffett on Saturday devoted more than four pages of his 29-page annual shareholder letter to criticism of active managers on Wall Street, excoriating what he perceived as exorbitant fees they charge for returns that fail to live up to lofty assumptions.

Meanwhile the legendary stock picker extolled the virtues of passive investing and its advantages for regular investors. The 'Oracle of Omaha' even compared active managers to monkeys, and estimated that financial advisors, in their futile search for ways to beat the market, had cost clients $100 billion in wasted fees in the last 10 years.

"When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients," stated the widely-read letter released on Saturday morning. "Both large and small investors should stick with low-cost index funds."

Chris Kleponis | Bloomberg | Getty Images

'The results were dismal'

Buffett started this critical section of the letter with an update on a 10-year wager against Wall Street's active management he made nine years ago, with the proceeds going to a charity. This is how the billionaire described his original challenge:

"I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?"

To his surprise, only one person stepped up to take the other side of the bet: Protégé Partners' Ted Seides, a 'fund of funds' manager. According to the bet, Seides selected five funds of hedge funds, whose results after fees would be averaged and compared to Buffett's selection, a Vanguard S&P index fund.

Here's what happened, according to the letter: 

"The compounded annual increase to date for the index fund is 7.1%, which is a return that could easily prove typical for the stock market over time...The five funds-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000."

In fact, none of the basket of funds came even close, according to Buffett:

Source: Berkshire Hathaway 2016 shareholder letter

"The results for their investors were dismal – really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed," Buffett wrote. "As Gordon Gekko might have put it: 'Fees never sleep.'"

Investors seem to be heeding Buffett's anti-active advice, as more than $20 billion flowed out of U.S. active equity funds in January despite a rising stock market, according to Morningstar. In the last 12 months, more than half a trillion dollars have flowed into passive funds, while active funds have experienced outflows, Morningstar's data showed. 

In his letter, Buffett criticized how the whole Wall Street complex is still set up to send pension funds, endowments and other investor types into under-performing active vehicles. He claimed that the wealthy investor classes are getting ripped off the most:

"In many aspects of life, indeed, wealth does command top-grade products or services. For that reason, the financial 'elites' – wealthy individuals, pension funds, college endowments and the like – have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. This reluctance of the rich normally prevails even though the product at issue is –on an expectancy basis – clearly the best choice. My calculation, admittedly very rough, is that the search by the elite for superior investment advice has caused it, in aggregate, to waste more than $100 billion over the past decade. Figure it out: Even a 1% fee on a few trillion dollars adds up. Of course, not every investor who put money in hedge funds ten years ago lagged S&P returns. But I believe my calculation of the aggregate shortfall is conservative."

Buffett stated that he knows of only 10 managers that he spotted early on who could outperform the S&P 500 over the long term, and they did so. He acknowledged there are more out there who may be able to beat the market, but they are the clear exception. 

"Further complicating the search for the rare high-fee manager who is worth his or her pay is the fact that some investment professionals, just as some amateurs, will be lucky over short periods," Buffett wrote.

"If 1,000 managers make a market prediction at the beginning of a year, it's very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him."

The billionaire heaped praise on Jack Bogle, the founder of the Vanguard Group who started the first index fund 40 years ago.

"If a statue is ever erected to honor the person who has done the most for American investors, the hands down choice should be Jack Bogle," the letter stated. "In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned."

"He is a hero to them and to me," Buffett added.


John Melloy | @johnmelloy
Saturday, 25 Feb 2017
CNBC.com

http://www.cnbc.com/2017/02/25/buffett-slams-wall-street-monkeys-says-hedge-funds-cost-100-billion.html

How Many Mutual Funds Routinely Rout the Market? Zero

The bull market in stocks turned six last Monday, and despite some rocky stretches — like last week, when the market fell — it has generally been a very pleasant time for money managers, who have often posted good numbers.

Look more closely at those gaudy returns, however, and you may see something startling. The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years.

In fact, based on the updated findings and definitions of a particular study, it appears that no mutual fund managers have.

I wrote about the initial findings of that study last summer. It is called “Does Past Performance Matter? The Persistence Scorecard,” and it is conducted by S.&P. Dow Jones Indices twice a year. The edition of the study that I focused on began in March 2009, the start of the bull market.

It included 2,862 broad, actively managed domestic stock mutual funds that were in operation for the 12 months through 2010. The S.&P. Dow Jones team winnowed the funds based on performance. It selected the 25 percent of funds with the best returns over those 12 months — and then asked how many of those funds actually remained in the top quarter in each of the four succeeding 12-month periods through March 2014.

The answer was remarkably low: two.

Just two funds — the Hodges Small Cap fund and the AMG SouthernSun Small Cap fund — managed to hold on to their berths in the top quarter every year for five years running. And for the 2,862 funds as a whole, that record is even a little worse than you would have expected from random chance alone.

In other words, if all of the managers of the 2,862 funds hadn’t bothered to try to pick stocks at all — if they had merely flipped coins — they would, as a group, probably have produced better numbers. Instead of two funds at the end of five years, basic probability theory tells us there should have been three. (If you’re curious, I explained how the math works in a subsequent column, “Heads or Tails? Either Way, You Might Beat a Stock Picker.”

The study seemed to support the considerable body of evidence suggesting that most people shouldn’t even try to beat the market: Just pick low-cost index funds, assemble a balanced and appropriate portfolio for your specific needs, and give up on active fund management.

The data in the study didn’t prove that the mutual fund managers lacked talent or that you couldn’t beat the market. But, as Keith Loggie, the senior director of global research and design at S.&P. Dow Jones Indices, said in an interview last week, the evidence certainly didn’t bolster the case for investing with active fund managers.

“Looking at the numbers, you can’t tell whether there is skill involved in what they do or whether their performance is just a matter of luck,” Mr. Loggie said. “I believe that many of them do have skill. But even if they do have it, based on how they’ve done in the past you really can’t predict how they will perform in the future.”

Still, those two funds did manage to perform splendidly in that study. Their stubborn persistence at the top of the heap over that five-year period suggested that there was some hope for active fund managers. If they could do it, after all, others could, too.

But we’re now about two weeks away from the completion of another 12 months since the end of that study, and it’s been a mediocre stretch, at best, for those two mutual funds. When the month is over, to borrow from Agatha Christie, it looks as though we’ll be saying: And then there were none.

Here are the dismal statistics: The SouthernSun Small Cap fund has actually lost money for investors over the 12 months through Thursday. It was down 3.2 percent, according to Morningstar, and for the nine months through December, it was in the bottom quartile of funds in the S.&P. Dow Jones study. The Hodges Small Cap fund has done better, gaining almost 6 percent through Thursday. S.&.P. Dow Jones Indices says that put it in the third quartile — or second-to-worst one — through December. While it’s mathematically possible, it is highly unlikely that either will climb to the top quartile in the next few weeks, Mr. Loggie said.

Michael W. Cook, the lead manager of the SouthernSun Small Cap fund and the founder of the firm that runs it, was traveling last week and was unavailable to comment for this column. Craig Hodges, manager of the family-run Hodges Small Cap fund in Dallas, spoke to me on the telephone and told me that he wasn’t surprised that his fund had stumbled. “We’re not that good,” he said. “It was going to happen sooner or later. We’ve never expected to outperform all of the time.” And despite disappointing recent returns, both funds are still beating the market handily over the last five years.

Late last year, Mr. Hodges said, his fund was hurt by falling energy prices, which pulled down the returns of several of its holdings. “That kind of thing will happen,” he said. “You can expect that.” Last summer, he told me that over the long run — which he said is probably 50 years or more — he expects that his fund will do better than average. And he reiterated that view last week. “We’ll come out all right in the end,” he said. “I think if you pick a good manager, someone you believe in and you think you can trust, you’ve got to stick with him for a long time, and if he’s good, he’ll perform for you.”

Mr. Loggie and his crew are continuing their regular monitoring of mutual fund performance. Right on schedule, they did another winnowing of mutual funds through the five years that ended in September — and they will do another one for the five years ending this month.

The September performance derby produced more funds that ended up consistently in the top quartile — nine of them, Mr. Loggie said. “That’s not surprising,” he said. “Some periods you have more funds, some periods you have less.”

But what you never have, he said, is any indication that past performance predicts future returns. “It’s possible that any one of these funds will beat the market over the long term,” he said. “Some of them will do that. But the problem is that we don’t know which of them will do that in advance.” And that, in a nutshell, is the kernel of the argument for buying index funds.


http://www.nytimes.com/2015/03/15/your-money/how-many-mutual-funds-routinely-rout-the-market-zero.html?rref=collection%2Fcolumn%2Fbusiness-strategies

A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability.

One thing badly needed by investors - and a quality they rarely seem to have - is a sense of financial history.  In nine companies out of ten the factor of fluctuation has been a more dominant and important consideration in the matter of investment than has the factor of long-term growth or decline.

Yet the market tends to greet each upsurge as if it were the beginning of an endless growth and each decline in earnings as if it presaged ultimate extinction.

Investments may be soundly made with either of two alternative intentions:

(a)  to carry them determinedly through the fluctuations that are reasonably to be expected in the future, or
(b) to take advantage of such fluctuations by buying when confidence and prices are low and by selling when both are high.

Neither policy can be followed with intelligence unless the investor, or his adviser, has a broad comprehension of the effects of the economic alternations of the past, and unless he takes them fully into account in planning to meet the future.

The art of investment has one characteristic which is not generally appreciated.  A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability, but to improve this easily attainable standard requires much application and more than a trace of wisdom.  If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse.

Since anyone - by just buying and holding a representative list - can equal the performance of the market averages, it would seem a comparatively simple matter to "beat the averages"' but as a matter of fact the proportion of smart people who try this and fail is surprisingly large.

Even many of the investment funds, with all their experienced personnel, have not performed as well over the years as has the general market.

Allied to the foregoing is the record of the published stock-market predictions of the brokerage houses, for there is strong evidence that their calculated forecasts have been somewhat less reliable than the simple tossing of a coin.


Benjamin Graham
Intelligent Investor

Asset Management Accounting 101 (A Conceptual Overview)

The single biggest metric to watch for any company in this industry is assets under management (AUM), the sum of all the money that customers have entrusted to the firm.

An asset manager derives its revenue as a percentage of assets under management, AUM is a good indication of how well -or how badly - a firm is doing.

Unlike a bank or insurer, where big losses can cause the firm to become insolvent, big losses in asset management portfolios are borne by customers.

Big losses will affect fee income by reducing AUM, but an asset manager could lose well over half the value of its assets under management and still remain in business.

In a worst-case scenario, customers could withdraw their remaining dollars and the firm could fold if its fee income became inadequate to support its operations.

But because asset management requires almost no capital investment, these companies can pare back to the bone to remain in business.



Additional notes:
Asset management firms run money for their customers and demand a small chunk of the assets as a fee in return.

This is lucrative work and requires very little capital investment.

The real assets of the firm are its investment managers, so typically compensation is the firm's main expense.

Even better, it doesn't take twice as many people to run twice as much money so economies of scale are excellent.

This means that increases in assets under management - and therefore, in advisory fees - will drop almost completely to the bottom line.

All this adds up to stellar operating margins, which are usually in the 30% to 40% range - something you won't see in many industries.

Be a Buffett, don't back the benchmark

Be a Buffett, don't back the benchmark
Warren Buffett’s latest letter to Berkshire Hathaway shareholders is the usual mixture of folksy charm and investment wisdom.

A playing card featuring a picture of Warren Buffett. The investor has beaten the S&P 500 index 39 years out of 47 Photo: Reuters

By Tom Stevenson

9:15PM GMT 03 Mar 2012

33 Comments

The part that grabbed the headlines this year was a comparison of equity investing against bonds and gold, which unsurprisingly came down on the side of shares. Having achieved a 19.8pc annual growth rate from stocks over 47 years, it is not hard to see why they should be Buffett’s first love.

For me, there was a more interesting lesson in this year’s letter. It was a thought prompted by its first page on which Buffett compares his performance year by year since 1965 against the S&P 500 index. Last year, the 4.6pc rise in the value of Berkshire Hathaway’s book value compared with 2.1pc growth in the main US benchmark.

It was the 39th year out of 47 in which he has beaten the market, a fantastically consistent performance. But then, as Buffett says, “if our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price.”

So once a year, and cumulatively over the half century he has run Berkshire Hathaway, Buffett compares his progress against the S&P 500. It is a convenient benchmark to see if he is earning his corn and, in that regard, he is no different from any other fund manager.

In another important way, however, Buffett is quite different from the majority of professional investors. This is because, although he cares about his overall performance compared with the benchmark, he is indifferent to how his portfolio of investments compares with the make-up of the S&P 500. He is, to use the jargon, unconstrained by the benchmark.

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Buffett’s approach is simply to buy companies that he believes are undervalued compared with their intrinsic value and hold them for the very long term. If you think that most investors do something similar you may be disappointed. That is because the fund management industry has increasingly lashed itself to the mast of stock market indices. Its buy and sell decisions are to a greater or lesser extent determined not by the intrinsic merits of individual shares but by their weighting within a relevant price-derived benchmark.

It is an approach which more thoughtful investors believe may not necessarily be in the best interests of their customers. It has led to funds having heavy concentrations in small numbers of very large companies or in particular sectors that dominate and, as such, it may be seen as a significant contributor to the stock market’s booms and busts.

Investment approaches that measure their performance against price-related indices almost by definition encourage the purchase of overvalued shares that have been pushed above fair value. This is a particular problem with passive funds like index trackers but, to the extent that actively-managed funds have become “closet trackers”, it means they too risk being sucked in at the top of the market, contributing to moments of madness like the dot.com bubble a decade or so ago.

What is increasingly happening in the institutional investment world in response to these concerns is a move to alternative indices that try to take the price of a share out of the equation. These new indices focus on different measures such as a company’s sales, the value of its assets, even the size of its workforce. Alternatively, they simply measure themselves against an equally-weighted benchmark, one with a similar exposure to every company in an index. In both cases, there is evidence that these approaches outperform market value-based indices in the long run.

So why doesn’t everyone simply invest according to this new “fundamental” approach? The main reason is that the alternative methods have a tendency to solve one problem but create a new one. For example, equally weighting all the companies in an index gives a fund a relatively greater exposure to small companies. There will be times when this is an advantage and times when it leads to under-performance.

As a consequence of this, some active fund managers are testing a move back towards the unconstrained Buffett approach, freeing up their investors to back their best ideas regardless of a benchmark. Some might say that is what they are paid to do.

Tom Stevenson is an investment director at Fidelity Worldwide Investment. The views expressed are his own.
He tweets at @tomstevenson63.

http://www.telegraph.co.uk/finance/comment/tom-stevenson/9119808/Be-a-Buffett-dont-back-the-benchmark.html

QUICKIES: Seven investment myths you should not fall for

Text: Prerna Katiyar | ET Bureau

Pick this stock, it's trading at 52-week low.' 'That stock is a multi-bagger, trading at such a low PE.' 'Penny stocks make fortunes while stocks trading below book value are a sure pick for making quick bucks.'

Haven't we all heard such statements at some point in our lives? If you are one of those who believe in such assertions, read on. For, these are among the many myths in investing.



Here we list seven of them


Myth No 1: Stocks trading below book value are cheap

Book value (BV) is the actual worth of a stock as in a company's books/balance sheet, or the cost of an asset minus accumulated depreciation.

BV depends more on historical cost and depreciation and often has little correlation to the current share price.

Shares of industries that are capital intensive trade at lower price/ book ratios, as they generate lower earnings. On the other hand, those business models that have more human capital will fetch higher earnings and will trade at higher price/book ratios.

"Price/book (ratio) of below 1 may be cheap but one should see other aspects such as earnings forecast, guidance, management and debt on the books of the company ," says Angel Broking's equity derivatives head Siddarth Bhamre.


Myth No 2: Stocks trading at low P/E are under-valued

Price to earning ratio (P/E) is one of the most talked about ratios in the market. This is based on the theory that stocks with low P/Es are cheap.

However, P/E alone doesn't tell much about the stock price. P/E multiples may be a quick way to value a stock but one should look at this in correlation with expected growth earnings, the risk factors involved, company's performance and growth potential .

"This is surely a myth. It is also an indication of uncertain future earning of the stock concerned," says Birla Sunlife Mutual Fund CEO A Balasubramanian.

The idea behind dividing price with earnings is to create a levelplaying field where some kind of comparison can be made between high- and low-priced stocks.

Since P/E ratios vary across sectors, with growth stocks consistently trading at higher P/E, one can only compare the P/E ratio of a stock to the average P/E ratio of stocks in that sector.


Myth No. 3: Penny stocks make good fortunes

Penny stocks by nature are lowpriced , speculative and risky because of their limited liquidity, following and disclosure.

If it's easy to invest in penny stocks - as here you shell out much less money per share than you would require for a blue-chip firm - it's also easy to lose.

Says Bhamre, "Fortune can be made by high-denomination stocks also. Denomination has nothing to do with the rationale for picking a stock. Generally , retail investors are fond of stocks that are at sub- Rs 100 levels. But there may be stocks that may be trading in Rs 1,000-plus price but may well be cheap. Clarity on earnings is more important here. Anytime, I would be more comfortable buying an ICICI Bank (currently trading at Rs 1,038) than an IFCI at Rs 45. One should look at earnings visibility."


Myth No. 4: The worst is over in the stock market

Timing the market, a common strategy among investors, means forecasting and that should best be left to astrologers and tarot readers.

If one has done one's valuation studies, one shouldn't worry about timing the market. No one had predicted the bull run would take the Sensex from a level of 10,000 in February 2006 to over 21,000 in January 2008 - just as no one had any idea of the following crash, which saw the same index plummeting to 9,000 in March 2009.

"Timing the market is more of a gut feeling. It's more on the basis of perception, as there is no such thing (that the worst is over) when the future is uncertain. One can never surely time the market. The worst is over is more of a probability than a certainty. Timing the market is very difficult as market is driven not just by earnings but also by sentiments ," says Balasubramanian.


Myth No 5: Stocks that give high dividends are the best bet

This comes from the notion that regular dividends are extra income in the shareholder's hand. This may not always be true.

While a company may be making decent payouts every year, the share price appreciation may not be comparatively high. Before investing in companies paying high dividends, it's important to analyse if the company is reinvesting enough profit to grow its earnings consistently.

Says Brics Securities' research VP Sonam Udasi: "It's not dividend that matters but the yield. For eg, a company may pay a 100% or even a 300% dividend on a stock with face value of Rs 10.

So, the investor may receive Rs 10 or Rs 30 per share when the stock may be currently trading at Rs 800 or Rs 1000. This would translate into an yield of 1% or 3% only. Also, such companies may not necessarily be reinvesting their earnings in the business to generate future earnings and so there may be no stock movement. The dividend may be high but the EPS and growth per se may be constant."



Myth N0 6: Index stocks are the best stocks

If this was true, most investors would safely park their money in such stocks in anticipation of maximum profit without looking out for other value stocks.

Most indices are a collection of stocks with the highest market cap. Take, for eg, the Sensex.

Companies that make up the index are some of the largest, with stocks that are highly traded based on their free-float.

"Index stocks may not necessarily be the best stocks as they are mostly based on market-cap or free-float of the company and not earnings. This doesn't mean that all stocks of the Sensex are highearning stocks. One must take a stock-by-stock call," says Balasubramanian of Birla Sun Life Mutual Fund.

The stock price of a company depends on its earnings. One can find high-earning stocks outside the key indices as well, he says. The risk is certainly less with index stocks as they are well researched and leaders in their respective sectors, but, again, the margins may not be very high. So it's better to keep your eyes open to other stocks, too.



Myth No 7: Stocks trading at 52-week low are cheap

Says Udasi: "There may be a time in the economic cycle when a blue-chip stock may hit a 52-week low.

But the first thing that should come to one's mind is why did the stock hit the 52-week low.

There must be something fundamentally wrong with the stock if it has hit a 52-week low, and chances are they may hit a new 52-week low.

52-week low in itself guarantees nothing. If at all one is picking stocks at 52-week lows, they should have a long-term horizon so that when the economic cycle turns, the stock is able to recover."

Needless to say, quality matters most while buying any stock.


http://economictimes.indiatimes.com/seven-investment-myths-you-should-not-fall-for/quickiearticleshow/9438662.cms

Why are passive funds not more popular? The key to successful active investing – it is vital to monitor your portfolio. Yet many individual investors fail to do this.

Keep your investments on track


Funds that passively track the market are less popular than those with active managers, who try to beat the market. But some say they offer more certainty for lower charges. Which should you choose? Niki Chesworth investigates.

Published: 11:18AM GMT 01 Nov 2010

Active approach: whether you choose a tracker or a managed fund, the key is to keep an eye on their performance

Warren Buffett, the investment guru, has said the best way for most investors to own common stocks is through an index fund that charges minimal fees, saying they will "beat the net results delivered by the great majority of investment professionals".

Tracker funds are not only a lower-cost way to invest — because they do not have the expense of paying a team of active fund managers — they offer the certainty of passively tracking a given stock market index. They therefore should not significantly underperform the market, something actively managed funds cannot guarantee.

So it may come as no surprise that the total amount invested in tracker funds managed by UK investment companies soared from £20bn in 2008 to nearly £28bn at the end of last year, according to the Investment Management Association (IMA).

But delve behind these figures and it's apparent this increase was not because these funds were increasingly popular with investors — merely a reaction that tracker funds track the market and the markets bounced back sharply.

Only 5.5pc of all funds under management are held in tracker funds according to the IMA but when it comes to sales, they are attracting just 2.5pc of individual investors' money.

With criticism in the media that investment charges are impacting on the performance of some actively managed funds – as well as reports that some active managers fail to match their benchmark index let alone beat it – why are passive funds not more popular?

"While trackers appeal to institutional investors such as pension funds and charities, which have long-term objectives and are in the main happy to accept market risk but at no more cost than is necessary, individual investors want their fund managers to deliver alpha, they want to beat the market," says Justine Fearns, research manager of independent advisers AWD Chase de Vere.

"Investors believe that if they pick the right active managers, they may be able to get that extra bit of performance."

Fearns also believes the poor sales of trackers is a reaction of the stock markets. She says: "Traditionally, trackers are used in more developed markets where news and information is readily available and it has been more difficult for active fund managers to consistently beat the market.

"In contrast, information is not always as free Ḁowing in underdeveloped markets, which creates more opportunity for active fund managers to beat the market.

"Similarly, in volatile and uncertain markets, like we have seen recently, individual assets can become mispriced, creating investment opportunity. This applies to both developed and underdeveloped markets and lends itself far more to an active stock-picking approach.

"If you know the market is going to perform strongly then you can get a good market return quite cheaply through a tracker. But when the markets start to come down, you will suffer the full effects of market falls with a tracker fund. So investors can tactically look to protect the downside with an actively managed fund."

Bearing the brunt of short-term falls in markets is one reason why those prepared to take a long-term view — institutional investors — may see the attraction of tracker funds better than individual investors.

Tracker funds have to blindly follow their given benchmark index which can cause sharp falls in the fund's value.

"This is the major drawback of tracker funds," says John Kelly of Chelsea Financial Services. "Even if the sector is overbought or likely to fall, the tracker has to buy it because it has to track the whole of the market."

Fearns says that low sales of tracker funds may also react investors' financial objectives.

"With interest rates low, many investors are looking for income from their portfolio and while a tracker will have an element of yield it will not match that paid by the best equity income and bond funds," she says.

The issue of tracker fund performance has also come under the spotlight. Some trackers buy shares in all the companies that make up the index they follow. Others use complex financial instruments to track that index. Although both types aim to track their benchmark, performance can still vary – and once charges are deducted there can be a consistent slight underperformance.

One recent survey found that while the FTSE All Company sector grew 372.50pc over the last 20 years, tracker funds showed just 330.9pc growth. However, much depends on which indices you compare — among the top 20 UK funds over the past five years is a mid-cap tracker which beat most of the 300 funds in the UK All funds sector.

However, the same claims of underperformance can also apply to actively managed funds – but with actively managed funds this can be far greater.

"There are some poorly performing active funds but if you do the research and get the right advice, you should consistently outperform the benchmark," adds Chelsea Financial Services' Kelly.

"However, with actively managed funds you do need to actively review them – ideally at least every quarter – as the funds you need to hold will change."

This is the key to successful active investing – it is vital to monitor your portfolio. Yet many individual investors fail to do this.

And performance also depends on what investors track.

Trackers are not confined to just the UK. It is possible to track global technology stocks, the global health and pharmaceuticals index and the major markets around the world — from Japan to the US and Europe — gaining access to sectors and geographical diversity for less than an actively managed fund and without the risk of buying the "wrong" fund that underperforms the benchmark.

So which is best?

"There is a place for both types of investment style – a tracker could provide long-term capital growth, but active managers may be able to outperform the market," says Fearns. "It's about balance — a balance of investments, risks and management styles."

However, investors who are passive about monitoring and reviewing their active funds may be better off with passive investments. John Kelly sums up the problem: "Inertia is the biggest destroyer of returns."

Written by Telegraph.co.uk as part of Smart Investment Month in association with Legal & General Investments

http://www.telegraph.co.uk/sponsored/finance/smart-investment-guide/8101976/Keep-your-investments-on-track.html?utm_source=tmg&utm_medium=TD_8101976&utm_campaign=lg0611

Absolute Return Investing

At the other extreme, there are funds that are not benchmarked.  Instead, their objective is to target a particular return with a given risk level and a strong focus on capital preservation.  This strategy is called "absolute return investing" and is largely adopted by hedged funds.

Absolute return managers can invest in any asset class anywhere in the world.  Therefore, if the S&P 500 is falling significantly, absolute return managers can choose to allocate their money to a more favourable market like Europe and Asia, or even raise cash, to invest in another asset classes or invest short.

In a bull market, absolute return portfolios can under-perform against relative return portfolios.  However, in the longer term when markets go through the cycle of boom and bust, absolute return portfolios tend to outperform as big losses are avoided during the bear periods.

Benchmark Investing: Relative Return Investment Strategy

Fund managers who track a benchmark closely have a relative return investment strategy.

Their asset allocation strategy and stocks picked are close to their chosen benchmarks.  They then value-add by overweighting or underweighting stocks that they feel would help the fund outperform.

Investors who question the existence of fund managers, who consistently underperform their benchmark, have been advised to invest via index funds instead as they charge lower on management fees.

There are also managers who vary quite significantly from their benchmark.  With a larger tracking error, they can outperform it by quite a wide margin especially in volatile times.

However, when a broad based market heads south significantly, a fund that is benchmarked, like the S&P 500, will usually find it difficult to avoid losses.  

• Firstly, this is because the fund is mandated to stay invested in stock under the index.
• Secondly, the fund manager cannot stay invested in only a few profitable stocks, as they typically do not invest more than 5 percent of their portfolio in a stock or a group of related companies.

Tips for Investors Just Starting Out

Tips for Investors Just Starting Out
These tips help investing newbies seize the day.

By Hilary Fazzone 04-14-09 06:00 AM

Not so long ago, my newly employed friends and I applauded ourselves for being responsible and choosing to make high automatic contributions to our 401(k)s. A few years later, we've hardly been rewarded for taking the "prudent" route. Far from watching our savings grow, we've lost much of it.


For those of us in our twenties who are beginning to generate income and wondering how to make the most of our savings, the behavior of the stock market during the past few years has been uninspiring to say the least. To start, the performance of domestic equities over the past 10 years has been unimpressive. If one invested $10,000 in the Dow Jones Wilshire 5000 Index, which tracks the 5,000-largest public companies in the United States and which is a nearly complete representation of the broader stock market, three years ago, it would have been worth about $6,500 at the end of March 2009 (based on the return of SPDR DJ Wilshire Total Market TMW), an exchange-traded fund that tracks the Wilshire 5000).

What's more, the precipitous marketwide downfall that characterized the second half of 2008 called into question for many the worth of diversification, as nearly all asset classes apart from Treasury bonds suffered severe blows. This came as a shock to those who believed that diversification would help them avoid portfoliowide stumbles. Furthermore, the deleterious and hard-to-predict impact that heavy-hitting, low-transparency vehicles such as hedge funds have had on the broader market recently, combined with the market's recent apparent disregard for company fundamentals, has left many less-sophisticated investors feeling as though the deck is stacked against them.

Yet investor sentiment often runs the most negative when it's most opportune to invest, and right now is shaping up as a golden opportunity for newbies. By many measures, stocks look cheap. Although they've been early, many of the mutual fund managers with whom Morningstar analysts speak daily have been touting the cheapness of stocks for months.

Brian Rogers, T. Rowe Price's chief investment officer and manager of T. Rowe Price Equity Income (PRFDX), has said that stocks look inexpensive relative to historic norms. Marty Whitman and Ian Lapey have been increasing their personal investments in their own Third Avenue Value (TAVFX ) for the attractiveness of its current portfolio. Chuck Royce and Whitney George have been bargain-hunting for their Royce Premier (RYPRX ) portfolio.

Morningstar's stock analysts agree. The Market Valuation Graph that values in aggregate the entire universe of stocks covered by Morningstar analysts showed a ratio of 0.81 on Friday, April 3, meaning that stocks are 19% undervalued, according to our analyst team. Warren Buffett also agrees. The stock market cap/gross domestic product ratio that he uses to gauge the market's attractiveness indicates that as of March 2009, the total value of publicly traded U.S. stocks represented just more than 60% of GDP. At the end of 2007, by contrast, the stock market represented more than 140% of GDP. Buffett thinks that a higher ratio indicates overvaluation while a lower ratio indicates undervaluation.

For all of the uncertainties that plague the market, the long-term upside potential appears to be there, and the rewards are apt to be particularly great for new investors who have many years to see their investments compound.

How to do it is the question. What follows is an introductory, though not exhaustive, explanation of some of the best ways to begin investing.

Index Funds
One of the most difficult decisions in investing is what kind of stocks to buy. Broadly diversified index funds make that decision easier by giving you exposure to many different companies and industries in a single mutual fund. The Dow Jones Wilshire 5000 Index, for example, captures practically every stock in the U.S. market. The Russell 2000 tracks the smaller end of the market-cap range, and so forth. In addition to providing one-stop diversification, index funds can also be cheap. Traditional index funds and exchange-traded funds that track major indexes typically cost much less than actively managed mutual funds. Fidelity is an industry leader on the low-cost index-fund front. Vanguard also provides some of the most competitively priced index funds and offers them with relatively low minimums, which make it easier for new investors to dip their toes in the water. Dan Culloton, editor of Morningstar's Vanguard Fund Family Report, examined in a recent article how index funds fared during the recent bear market, and the results were competitive with active funds' returns.

All-In-One Funds
Generally speaking, those of us in the early stages of our investing careers can tolerate higher stock allocations, which can present greater downside risk but also greater return potential, because we have longer time horizons over which to recoup our losses. Still, given the behavior of the stock market in recent years and the uncertainties that do remain in the current downturn, new investors may be uncomfortable having the bulk of their assets in stocks. All-in-one funds such as those in Morningstar's moderate-allocation category provide a nice middle ground, giving you stock exposure but also muting volatility with some bonds and cash. Target-date funds are an all-in-one, low-maintenance way to shift from a higher to a lower stock allocation over time as your risk tolerance decreases. Both target-date and moderate-allocation funds tend to offer smoother rides than equity-only funds and are good alternatives for those who would like to start investing but are nervous about the downside risk of equities. Morningstar's Analyst Picks in the moderate-allocation and target-date categories are a great place to start looking for topnotch all-in-one options.

Dollar-Cost Averaging
When to buy a particular stock or mutual fund is another hot topic for investors just starting out. It's a mistake to get too hung up trying to buy and sell at the perfect time; the typical investor isn't any good at calling the market's highs and lows. Dollar-cost averaging, which is the default investing method for most 401(k) plans, is an easier way. Once you've decided that a certain stock or fund is a good long-term fit for you, dollar-cost averaging enables you to invest in it gradually and regularly over time. By investing uniform chunks of money at set intervals, you reduce the chance that you'll be putting a lot of money to work right before the market goes down. For a more in-depth discussion of dollar-cost averaging, click here.

There is much more to investing than the simple tips I've laid forth here, such as navigating fund fee structures and understanding investment vehicles such as 401(k)s, but these introductory guidelines are a good start for investors who are wary of the stock market and wondering how to make good, basic decisions at a time when opportunity is abundant.

http://news.morningstar.com/articlenet/article.aspx?id=286673

5 Reasons To Avoid Index Funds

5 Reasons To Avoid Index Funds
by Wayne Pinsent (Contact Author Biography)


Modern portfolio theory suggests that markets are efficient, and that a security's price includes all available information. The suggestion is that active management of a portfolio is useless, and investors would be better off buying an index and letting it ride. However, stock prices do not always seem rational, and there is also ample evidence going against efficient markets. So, although many people say that index investing is the way to go, we'll look at some reasons why it isn't always the best choice. (For background reading, see our Index Investing Tutorial and Modern Portfolio Theory: An Overview.)


1. Lack of Downside Protection
The stock market has proved to be a great investment in the long run, but over the years it has had its fair share of bumps and bruises. Investing in an index fund, such as one that tracks the S&P 500, will give you the upside when the market is doing well, but also leaves you completely vulnerable to the downside. You can choose to hedge your exposure to the index by shorting the index, or buying a put against the index, but because these move in the exact opposite direction of each other, using them together could defeat the purpose of investing (it's a breakeven strategy). (To learn how to protect against dreaded downturns, check out 4 ETF Strategies For A Down Market.)

2. Lack of Reactive Ability
Sometimes obvious mispricing can occur in the market. If there's one company in the internet sector that has a unique benefit and all other internet company stock prices move up in sympathy, they may become overvalued as a group. The opposite can also happen. One company may have disastrous results that are unique to that company, but it may take down the stock prices of all companies in its sector. That sector may be a compelling value, but in a broad market value weighted index, exposure to that sector will actually be reduced instead of increased. Active management can take advantage of this misguided behavior in the market. An investor can watch out for good companies that become undervalued based on factors other than fundamentals, and sell companies that become overvalued for the same reason. (Find out how to tell whether your stock is a bargain or a bank breaker in see Sympathy Sell-Off: An Investor's Guide.)

Index investing does not allow for this advantageous behavior. If a stock becomes overvalued, it actually starts to carry more weight in the index. Unfortunately, this is just when astute investors would want to be lowering their portfolios' exposure to that stock. So even if you have a clear idea of a stock that is over- or undervalued, if you invest solely through an index, you will not be able to act on that knowledge.

3. No Control Over Holdings
Indexes are set portfolios. If an investor buys an index fund, he or she has no control over the individual holdings in the portfolio. You may have specific companies that you like and want to own, such as a favorite bank or food company that you have researched and want to buy. Similarly, in everyday life, you may have experiences that lead you believe that one company is markedly better than another; maybe it has better brands, management or customer service. As a result, you may want to invest in that company specifically and not in its peers.

At the same time, you may have ill feelings toward other companies for moral or other personal reasons. For example, you may have issues with the way a company treats the environment or the products it makes. Your portfolio can be augmented by adding specific stocks you like, but the components of an index portion are out of your hands.(To learn about socially responsible investing, see Change The World One Investment At A Time.)

4. Limited Exposure to Different Strategies
There are countless strategies that investors have used with success; unfortunately, buying an index of the market may not give you access to a lot of these good ideas and strategies. Investing strategies can, at times, be combined to provide investors with better risk-adjusted returns. Index investing will give you diversification, but that can also be achieved with as few as 30 stocks, instead of the 500 stocks an S&P 500 Index would track. If you conduct research, you may be able to find the best value stocks, the best growth stocks and the best stocks for other strategies. After you've done the research, you can combine them into a smaller, more targeted portfolio. You may be able to provide yourself with a better-positioned portfolio than the overall market, or one that's better suited to your personal goals and risk tolerances. (To learn more, read A Guide To Portfolio Construction.)

5. Dampened Personal Satisfaction
Finally, investing can be worrying and stressful, especially during times of market turmoil. Selecting certain stocks may leave you constantly checking quotes, and can keep you awake at night, but these situations will not be averted by investing in an index. You can still find yourself constantly checking on how the market is performing and being worried sick about the economic landscape. On top of this, you will lose the satisfaction and excitement of making good investments and being successful with your money.

Conclusion
There have been studies both in favor and against active management. Many managers perform worse than their comparative benchmarks, but that does not change the fact that there are exceptional managers who regularly outperform the market. Index investing has merit if you want to take a broad economic view, but there are many reasons why it's not always the best route to achieving your personal investing goals.

by Wayne Pinsent, (Contact Author Biography)

http://investopedia.com/articles/stocks/09/reasons-to-avoid-index-funds.asp?partner=basics4b1