Millionaire Teacher (19 page)

If there are any long-term subscribers, they're nowhere near their break-even point. Can you hear his followers scrambling on the lowest slopes of the Grand Canyon? I wonder if they're thirsty.

Where there is a buck to be taken

We already know that the odds of beating a diversified portfolio of index funds, after taxes and fees, are slim. But what about investment newsletters? You can find more beautifully marketed newsletter promises than you can find people in a Tokyo subway. They selectively boast returns (like Gilder does), creating mouthwatering temptations for many inexperienced investors:

With our special strategy, we've made 300 percent over the past 12 months in the stock market, and now, for just $9.99 a month, we'll share this new wealth-building formula with you!

Think about it. If somebody really could compound money 10 times faster than Warren Buffett, wouldn't she be at the top of the Forbes 400 list? And if she did have the stock market in the palm of her hand, why would she want to spend so much time banging away at her computer keyboard so she could sell $9.99 subscriptions to you?

Let's look at the real numbers, shall we?

Most newsletters are like dragonflies. They look pretty, they buzz about, but sadly, they don't live very long. In a 12-year study from June 1980 to December 1992, professors John Graham at the University of Utah and Campbell Harvey at Duke University tracked more than 15,000 stock market newsletters. In their findings, 94 percent went out of business sometime between 1980 and 1992.
6

If you have the Midas touch as a stock picker who spreads pearls of financial wisdom in a newsletter, you're probably not going to go out of business. If you can deliver on the promise of high annual returns, you'll build a newsletter empire. If no one, however, wants to read what you have to say (because your results are terrible) the newsletter follows the sad demise of the woolly mammoth.

There are several organizations that track the results of financial newsletter stock picks and
The Hulbert Financial Digest
is one of them. In its January 2001 edition, the U.S. -based publication revealed it had followed 160 newsletters that it had considered solid. But of the 160 newsletters, only 10 of them had beaten the stock market indexes with their recommendations over the past decade. Based on that statistic, the odds of beating the stock market indexes by following an investment newsletter are less than seven percent.
7

Put another way, how would this advertisement grab you?

You could invest with a total stock market index fund—or you could follow our newsletter picks. Our odds of failure (compared with the index) are 93 percent. Sign up now!

If investors knew the truth, financial newsletters probably wouldn't exist.

High-Yielding Bonds Called “Junk”

At some point, you might fight the temptation to buy a corporate bond paying a high interest percentage. It's probably best to avoid that kind of investment. If a company is financially unhealthy, it's going to have a tough time borrowing money from banks, so it “advertises” a high interest rate to draw riskier investors. But here's the rub: If the business gets into financial trouble, it won't be able to pay that interest. What's worse, you could even lose your initial investment.

Bonds paying high interest rates (because they have shaky financial backing) are called junk bonds.

I've found that being responsibly conservative is better than stretching over a ravine to pluck a pretty flower.

Fast-Growing Markets Can Make Bad Investments

A friend of mine once told me: “My adviser suggested that, because I'm young, I could afford to have all of my money invested in emerging market funds.” His financial planner dreamed of the day when billions of previously poor people in China or India would worship their 500-inch, flat-screen televisions, watching
The Biggest Loser
while stuffing their faces with burgers, fries, and gallons of Coke. Eyes sparkle at the prospective burgeoning profits made by investing in fattening economic waistlines. But there are a few things to consider.

Historically, the stock market investment returns of fast-growing economies don't always beat the stock market growth of slow-growing economies. William Bernstein, using data from Morgan Stanley's capital index and the International Monetary Fund, reported in his book,
The Investor's Manifesto
, that fast-growing countries based on gross domestic product (GDP) growth paradoxically have produced lower historical returns than the stock markets in slower growing economies from 1988 to 2008.

Table 8.2
shows that when we take the fastest growing economy (China's economy) and compare it with the slowest growing economy (the U.S.) we see that investors in U.S. stock indexes would have made plenty of money from 1993 to 2008. But if investors could have held a Chinese stock market index over the same 15-year period, they would not have made any profits despite China's GDP growth of 9.61 percent a year over that period.

Table 8.2
Growing Economies Don't Always Produce Great Stock Market Returns

Source: The Investor's Manifesto
by William Bernstein

Similarly, as revealed in
Table 8.3
, Yale University's celebrated institutional investor, David Swensen, warns endowment fund managers not to fall into the GDP growth trap either. In his book written for institutional investors,
Pioneering Portfolio Management
, he suggests from 1985 (the earliest date from which the World Bank's International Finance Corporation began measuring emerging market stock returns) to 2006, the developed countries' stock markets earned higher stock market returns for investors than emerging market stocks did.

Table 8.3
Emerging Market Investors Don't Always Make More Money

Source: Pioneering Portfolio Management
by David Swensen

Emerging markets might be exciting—because they do rise like rockets, crash like meteorites, before rising like rockets again. But if you don't need that kind of excitement in your portfolio, you might be better off going with a total international stock market index fund instead of adding a large emerging-market component.

Whether the emerging markets prove to be future winners is anyone's guess. They might. But it's wise to temper expectations with historical realities, just in case.

Gold Isn't an Investment

Our education systems have done such a lousy job teaching us about money that you can conduct a little experiment out on the streets that I guarantee will deliver shocking results.

Walk up to an educated person and ask them to imagine that one of their forefathers bought $1 worth of gold in 1801. Then ask what they think it would be worth in 2011.

Their eyes might widen at the thought of the great things they could buy today if they sold that gold. They might imagine buying a yacht or Gulfstream jet, or their own island in the South China Sea.

Then break their bubble with the revelation in
Figure 8.1
. Selling that gold would give them enough money to fill the gas tank of a minivan.

Figure 8.1
Gold vs. U.S. Stocks (1801–2011)

One dollar invested in gold in 1801 would only be worth about $73 by 2011.

How about $1 invested in the U.S. stock market?

Now you can start thinking about your yacht.

One dollar invested in the U.S. stock market in 1801 would be worth $10.15 million by 2011.
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Gold is for hoarders expecting to trade glittering bars for stale bread after a financial Armageddon. Or it's for people trying to “time” gold's movements by purchasing it on an upward bounce, with the hopes of selling before it drops. That's not investing. It's speculating. Gold has jumped up and down like an excited kid on a pogo stick for more than 200 years, but after inflation, it hasn't gained any long-term elevation.

I prefer the Tropical Beach approach:

What You Need to Know about Investment Magazines

If investment magazines were altruistically created to help you achieve wealth, you'd have the same cover story during every issue: Buy Index Funds Today.

But nobody would buy the magazines. It wouldn't be newsworthy. Plus, magazines don't make much money from subscriptions. They make the majority of their money from ads. Pick up a finance magazine and thumb through it to see who's advertising. The financial service industry, selling mutual funds and brokerage services, is the biggest source of advertisement revenue. Few editors would go out on a tree branch to broadcast the futility of picking mutual funds that will beat the market indexes. Advertisers pay the bills for financial magazines. That's why you see magazine covers suggesting: “The Hot Mutual Funds to Buy for 2011.”

When I wrote an article in 2005 for
MoneySense
magazine, titled “How I Got Rich on a Middle Class Salary,” I mentioned the millionaire mechanic, Russ Perry (who I introduced to you in Chapter 1). I quoted Russ's opinion on buying new cars—that it wasn't a good idea, and that people should buy used cars instead.

Based on a conversation I had with Ian McGugan, the magazine's editor, I learned that one of America's largest automobile manufacturers called McGugan on the phone and threatened to pull its advertisements if it saw anything like that in
MoneySense
again. There are bigger forces at play than those wanting to educate you in the financial magazine industry.

I have an April 2009 issue of
SmartMoney
magazine on my desk as I'm writing this. It would have been written a month earlier when the stock market was reeling from the financial crisis. Instead of shouting out: “Buy stocks now at a great discount!” the magazine was giving people what they wanted: A front cover showing a stack of $100 bills secured by a chain and padlock with the screaming headlines: “Protect Your Money!,” “Five Strong Bond Funds,” “Where to Put Your Cash,” and “How to Buy Gold Now!”. Think about it. They have to. If the general public is scared stiff of the stock market's drop, they'll want high doses of chicken soup for their knee-jerking souls. They'll want to know how to escape from the stock market, not embrace it. Giving the public what it pines for when they're scared might sell magazines. But you can't make money being fearful when others are fearful.

I don't mean to pick on
SmartMoney
magazine. I can only imagine the dilemma it faced when putting that issue together. Its writers are smart people. They know—especially for long-term investors—that buying into the stock market when it's on sale is a powerful wealth-building strategy. But a falling stock market, for most people, is scarier than a rectal examination. Touting bond funds and gold was an easier sell for the magazine.

Let's have a look at the kind of money you would have made if you followed that April 2009 edition of
SmartMoney
.

It suggested placing your investment in the following bond funds: the Osterweis Strategic Income Fund <
www.osterweis.com/default.asp?P
>, the T. Rowe Price Tax-Free Income Fund <
www.3troweprice.com/fb2/fbkweb/snapshot.do?ticker=PRTAX
>, the Janus High-Yield Fund <
https://ww3.janus.com/Janus/Retail/FundDetail?fundID=14
>, the Templeton Global Bond Fund <
www.franklintempleton.com/retail/app/product/views/fund_page.jsf?fundNumber=406
>, and the Dodge & Cox Income Fund <
www.dodgeandcox.com/incomefund.asp
>.