Wall Street WARZONE

‘Super-Brain’ Investing: 6 Nobel Prizewinning Rules of Successful Portfolios

by Paul B Farrell, JD, PhD
| | 4/28/2010

“Investing is not rocket science,” says Paul Samuelson, Nobel Economist. “Investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” Even grade school kids beat the S&P 500 using a simple well-diversified portfolios made up of three to eleven no-load index funds. The formula won a Nobel Prize. And yet, in spite of the results, Wall Street’s mind-numbing hype and propaganda machine makes it virtually impossible for passive investors to focus on building a boring, dull long-term strategy.

For example, a couple years ago I estimated that the average investor was being overwhelmed by 43,000 fund and stock recommendations and pitches annually—in newspapers and magazines, on cable television, radio and online. The relentlessness and intensity of Wall Street’s noisy hype machine is purposely designed to distract, confuse and brainwash investors, and more often than not, they succeed, forcing Main Street investors into making costly mistakes and feeling inadequate about managing their personal finances.

How pros quietly invest their own family’s retirement money

Investors need a way to sift through all the useless chatter about the 14,000 funds, 8,000 stocks and countless bonds out there. So years ago I started tracking the best unexciting, dull, boring, simple, passive low-cost, low-maintenance portfolios I could find. The ones I found were being used by Nobel prize winners, money managers, financial advisers, behavioral finance experts and multi-millionaires for their own personal and family retirement savings. Moreover, I discovered their portfolios are very simple and very similar—with eleven or less funds. And much to my surprise, virtually all of these portfolios were build around low-cost no-load index funds. I even wrote a book about them, The Lazy Person’s Guide to Investing. Here’s a summary of what these successful investors tell me: Six basic tips that are guaranteed to help you diversify, lower your risks, level out bull/bear cycles, and generate returns close to or better than market benchmarks:

One. Live Below Your Means & Save 10%
Savings generate the money you need to invest and build a portfolio. Here’s the formula: Nothing saved, nothing invested, nothing compounding, nothing for retirement. If you go this route, you need money to invest in your retirement accounts, and that means regular saving, not spending every bit of your income. That’s how millionaires become millionaires. As Wall Street Journal columnist Jonathan Clements put it: “If you’re not saving at least 10%, you’re spending too much.” In The Millionaire Next Door, Tom Stanley and Bill Danko tell us the one habit all millionaires share: “Frugality: They live well below their means … The opposite of frugal is wasteful. We define wasteful as a lifestyle marked by lavish spending and hyper-consumption. … Being frugal is the cornerstone of wealth-building.” Commit the formula to memory: Nothing saved, equals nothing invested, equals nothing compounding, equals nothing for retirement.

Two. Trust the Explosive Power of Compounding
Albert Einstein put it very simple: “There is no greater power known to man than compounding interest.” Get it? Compounding is more powerful than nuclear energy, trust it, use it and become a millionaire. As Bill O’Neill, publisher of the Investors Business Daily and author of the perennial best-seller, How to Make Money in Stocks put it: “Think you’ll never have a million dollars? It’s easier to obtain than you might think—if you‘re young and patient. Thanks to the power of compounding a 25-year-old needs to invest only $1,720 a year to reach seven figures by age 65. … By age 65, the 25-year-old has invested only $68,800, less than 10 percent of his ending balance.” The rest comes from compound interest, reinvested dividends and appreciation!

Three. Swing For Singles & Bet on Every Horse
Passive investors win by being average, not falling into the Wall Street hype about “beating the averages,” about timing market cycles and active trading. Research makes it clear those strategies do not work, they just make fees and commission for the Wall Street Machine. Average means betting on the entire market, with a well-diversified portfolio of low-cost, no-load index funds. No-Load Stocks guru Charles Carlson uses a baseball analogy: Swing for singles.” Forget betting on homerun superstars. In Ordinary People, Extraordinary Wealth money manager Ric Edelman says: “You’re not in a horse race. You’re playing horseshoes … merely being close is good enough to win … If successful investors know they can’t pick the right horse, what do they do? Simple: They pick every horse.” They diversify their bets across on the indexes. How? This kind of investing is a no-brainer, folks: You create a well-balanced portfolio of three to eleven no-load index funds, and rebalance when you add new money each month.

Four. No Market Timing, No Day Trading … Never!
Markets are random and highly unpredictable says Wharton economist Jeremy Siegel, author of Stocks For The Long-Run. Siegel researched the stock market’s 120 biggest up and biggest down days over two centuries from 1801 to 2001. Bottom line: 75% of the time there was no rational explanation for the moves, up or down. And remember that classic study of 66,400 investors at a Wall Street brokerage firm over a seven year period: University of California Davis behavioral finance professors, Terry Odean and Brad Barber concluded: “The more you trade the less you earn.” The most active traders averaged 11.4% returns while churning their portfolios 258% annually. Buy-and-hold investors had an average turnover of only 2%, yet generated 18.5% returns. That’s a huge difference. Active traders lose money for three reasons: They have to pay higher taxes, more transaction costs, and incur more operating expenses.

Five. Buy Quality and Never Sell
Warren Buffett was once asked by Jack Bogle about his favorite holding period. “Forever,” said the Sage of Omaha. And the best time to sell is “never!” Okay, maybe there are some exceptions. But if you buy quality companies and index funds with proven long-term track records, you won’t be tempted to sell when the market dips and talking heads on cable news start panicking. Remember, the most important investment decision you’ll ever make is the up-front decision. So you plan carefully, picking stocks and funds on the assumption you will never sell! That’s the path to a millionaire.

Six. The Tortoise Always Beat the Hare
In researching 5,000 millionaires money manager Ric Edelman discovered that they average a mere six minutes a day on personal finance. They don’t waste time watching cable news, reading self-serving brokerages reports, attending seminars, studying stocks tables, subscribing to financial newsletters, pondering economic reports, reading daily newspapers, etcetera, etc. Millionaires spend six minutes a day on personal finances—then for the other 23 hours and 54 minutes they can do what really counts with family, friends, sports, avocations, careers—live their lives! They create diversified lazy portfolios that operate quietly, on autopilot, in the background, generating nice long-term returns with minimal effort.

These portfolios are simple: Former Smith Barney broker Bill Schultheis launched his famous Coffeehouse Portfolio in his 1999 best-seller, The Coffeehouse Investor. Wall Street laughed, the Coffeehouse was a joke. But the laughing stopped during the bear years of 2000-2002. It beat the S&P 500 by 15% each of the three bear years, while hundreds of dotcoms filed for bankruptcy, the Nasdaq dropped 80%, and the stock market lost $8 trillion. Here’s how the asset allocation of this super-simple seven-fund Coffeehouse Portfolio works: Just put 40% in an intermediate bond index fund and 10% in each of the six equity index funds. It’s that simple. Set it and forget it.

Keep it simple—just six minutes a day, then go live your life

So when you’re ready, step up to the plate and play ball! Or pitch horseshoes. Whichever you prefer. You’ll see several more of these Super-Brain Investor portfolios in the next section, which you can customize to suit your unique life-style needs. Learn how America’s passive investors get on-track to a million dollar retirement. Meanwhile, remember to have fun and please do not spend a lot of time on investing. There are a lot more important things in life—family, loved ones, hanging out with friends, sports, hobbies, movies with the grandkids … plain ol’ ordinary, everyday living. Want more info: Read my Lazy Person’s Guide to Investing.

FirstPubDate: Apr’05

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