Next, stick all your money into broad index funds. That’s the only way you’ll ever make money in the financial markets.
That’s the gist of what Burton Malkiel says in his latest book, co-authored with Charles Ellis, The Elements of Investing.
Today, I’ll show you why he’s only half right… and what you should be doing with your money for the long term.
Malkiel’s best known work was A Random Walk Down Wall Street. It’s the Bible for those who believe in the efficient markets hypothesis.
These people argue that the market is so efficient that it’s futile to attempt outperforming it. They say share prices will always reflect everything that can be known about the future prospects of a business.
In other words, the market is an efficient means of putting together all the information available on a company, judging its relevance and expressing all this in the price…
The sad thing is that it’s a belief in this hypothesis that can stop investors trying to beat the market. We know that’s not true.
Don’t let the efficient markets hypothesis stop you making money
Perhaps Warren Buffett sums it up best. He once said, “I’d be a bum on the street with a tin cup if the markets were always efficient.”
Or just look at British fund manager, Anthony Bolton. He delivered market beating average returns of 20% per year for 25 years.
Then there’s our own colleague, Dr Mike Tubbs. In his Research Investments advisory service, Mike’s recommendations averaged 40.2% between 23 January 2009 and 21 January 2010. The benchmark FTSE 100 index only managed 19.5%. So Mike beat the market by 106%.
[Keep an eye out for more from Mike. He’ll soon be opening up Research Investments to new subscribers. It’s one service you’re advised to try if you’re looking to beat the markets.]
Back to Burt Malkiel and his latest book does make some sense. But you need to take it with a pinch of salt.
One of his core beliefs is that investing in low-cost “total market” index funds will allow you to make money over the long term. Over long periods of time, stock markets have returned an average annual rate of return of around 9%.
But over-trading and the effect of dealing costs can damage that return substantially. Very broad index funds allow you the exposure you need, but without the need to trade in and out. The right funds offer you excellent diversification across different sectors and markets.
So by all means, use these types of funds for your core long-term portfolio. But don’t keep trying to time the market with these kinds of investments. As Malkiel puts it, you should also “diversify over time”.
What he means is you should build up your investments slowly with regular, periodic investments over time. That should allow you to bring your average entry price down.
Add individual stocks around your core portfolio
And once you’ve got your core investments in place for the long term, you should also not be afraid to try to beat the market with individual stocks.
Here’s Theo Casey from The Fleet Street Letter:
“Investors really need to toughen up.
“After all, the Lehman Brothers’ collapse last year ushered in the age of volatility. This is the new normal. Deal with it. We have to expect Dubai/Greece-like sovereign debt wobbles every now and then. Thankfully, neither of these regions would count as systemically important.”
Dubai wasn’t a big slice of Theo’s investment pie in The Fleet Street Letter. And neither is Greece. So his portfolio is not affected. And Theo is not worried about recent volatility. But he does have a pragmatic approach to dealing with the prevailing challenges of our time…
“ Greece won’t turn the bull market around. But interest rates might. You see, when the market collapsed last year interest rates, around the world, were slashed in tandem.
“With such a low level of interest, it was unthinkable to stay in cash. It was punitive to do so, hence investors around the world put their money to work in other markets – stocks, bonds, etc. When banks can borrow at zero and buy government bonds yielding 4%, stocks yielding 5% and corporate bonds yielding 6%, they needn’t bother with cash.
“This is the new carry trade – borrow in dollars and buy anything.
“Though, don’t mistake me for a rampant bull. Risk takers were rewarded in 2009, but in 2010, I think that careful stock picking will be more important.”
Theo has been tipping defensive stocks so far this year. His largest sector exposure right now is pharmaceuticals. They pay above average yields and, in 2008, when the markets were falling, drug stocks were the second best performing sector in the stock market. Number one was tobacco stocks, and Theo holds those as well.
By all means follow Burt Malkiel’s recommendation to get some cheap exposure with a broad market index fund. He mentions the Vanguard Total World Exchange Traded Fund (ticker: VT).
But don’t be put off holding a portfolio of your favourite individual stocks as well. This is the way you could end up beating the market. For Theo Casey’s top ideas, click here: The Fleet Street Letter.
Best wishes,
Frank Hemsley
For The Right Side
P.S. In Theo’s latest edition of The Fleet Street Letter, he shows you how you can let the world’s greatest money man look after your money. This has been off limits to most investors for years. But a recent event has opened up this incredible opportunity. Get this outstanding report right now by taking a look at The Fleet Street Letter.
Your capital is at risk when you invest in shares; never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.
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