April 10, 2007– There’s a quick way to determine if your stock portfolio is positioned to build wealth or dwell in mediocrity. Ask yourself if your investment strategy can answer these five questions:
(1) What specific stocks should I buy?
(2) When is the best time to buy the stocks I wish to buy?
(3) How is the best way to buy the stocks I wish to buy?
(4) When will be the best time to sell the stocks I am buying now?
(5) How is the best way to sell the stocks I am buying now in the future?
There is a very simple reason why people that try to mimic the portfolios of very successful investors never have nearly the same success. They only know the answer for 1 of the above 5 questions— what to buy. In fact, I could open up my portfolio to investment novices, show them all the stocks I own now, and out of 1,000 novices, all of them would have an extremely difficult time duplicating my future returns. In fact, it’s entirely plausible that investors would lose significant amounts of money on the stocks that will return the largest gains for me in the next several years. Why? Again, understanding a complete investment system will determine portfolio returns, not just knowing what to buy. In fact I could tell them one specific stock to buy and if they don’t buy at the right time, they are much more likely to sell out at a loss than keep it for triple digit gains.
The evolution of job titles for investment professionals from broker to financial consultant to financial advisor is ironic, because the original title, for the great majority of employees in this industry, is by far the most accurate. Most financial consultants are nothing more than brokers that broker the money you give them. They serve as middlemen between you and the money managers hired by the firm, and are interchangeable parts, so much so that the returns you earn from your portfolio will not differ vastly from consultant to consultant at the same firm, despite the many years of experience that may separate one from the other.
Way back then, when I worked as a “broker” at a Wall Street firm, I remember hearing a story about a very successful financial consultant that bought nothing but exchange traded funds (ETFs) for his clients. His rational for doing so was that expenses on mutual funds were too high (true), expenses on ETFs were low (true), and that since the overwhelming majority of money managers can’t beat the performance of the major domestic indexes (true), that ETFs were the best way to invest for all of his clients (false). You see, the last part of this equation is false because investment firms never train their brokers how to be superior stock pickers. They train them how to be superior salespeople.
So this particular consultant’s conclusion was erroneous because it was based upon the false premise that he actually was knowledgeable about all the best ways to invest money in the stock market. In fact, a story that I heard through the grapevine, though I was never able confirm this, was that this financial consultant outperformed the vast majority of financial consultants at the firm with his “I will only buy ETFs” strategy. Though I wouldn’t be surprised if this were true, it does not make a shred of sense for clients to pay management fees for someone that is merely going to just buy ETFs for you. I’m sure that his clients rationalized paying management fees for the purchase of ETFs by believing that this particular consultant’s asset allocation decisions for the mix of ETFs purchased for them added significant value. Again, this most likely was nonsense, because knowing what I know about big-time investment firm financial consultants, if I had to guess, I would have guessed that he employed a diversified approach to his clients’ ETF portfolios.
Furthermore, a strategy of pure ETFs would fail to answer the very first question posed by the 5 questions, “What specific stocks should I buy?” Any strategy that heavily incorporates ETFs or mutual funds is an admission on behalf of the financial consultant of their ignorance of never having learned any appropriate investment strategies that can yield superior returns year after year.
Diversification produces mediocrity. Concentration produces returns.
Most investors don’t understand this concept at all. They understand it but they don’t. What I mean by this is that most investors see the results diversification produces year after year – mediocre and subpar returns with an occasional stellar year only when the corresponding domestic index also has a stellar year. Yet, decades of investment industry propaganda has conditioned their brains so that somehow the mediocre results produced by the diversification strategy (as illustrated here) still never rings as being less than “true”. Somehow, the connection that diversification is just a sales strategy and does not build wealth still eludes the common investor.
Most investors don’t understand this concept at all. They understand it but they don’t. What I mean by this is that most investors see the results diversification produces year after year – mediocre and subpar returns with an occasional stellar year only when the corresponding domestic index also has a stellar year. Yet, decades of investment industry propaganda has conditioned their brains so that somehow the mediocre results produced by the diversification strategy (as illustrated here) still never rings as being less than “true”. Somehow, the connection that diversification is just a sales strategy and does not build wealth still eludes the common investor.On the opposite side of this very equation, most investors understand that if they possessed concentrated portfolios that they would have a better shot at much greater returns. However, they believe that such probabilities cannot exist without much greater risk. And this is where they are wrong. While it is true that a concentration in speculative assets adds a much greater risk of greater losses in addition to the possibilities of much greater gains, investment firms rarely ever explain investment risk and speculation properly. They are more likely to explain a speculative hedge fund to you not as a speculative asset but as an “alternative investment opportunity” because the management fees they receive from its sale are so high. However, they are more likely to explain a non-speculative asset that they don’t understand, for example, gold, as speculative simply because they lack the expertise to buy gold stocks.
Furthermore, investment firms are likely to confuse you further by explaining that volatility equals risk. Again this is not true (just search for my article entitled ). If, after reading that article, you still do not fully understand why maximizing clients’ returns will not maximize an investment firms’ profits, then I recommend that you search our free educational resources and download and read our free e-books. I am not going to describe in great detail the explanations why this is true as I have done so numerous times in the past and also within the e-books that are listed on my site.
Investment Firms Do Not Build Investors Wealth Because They Normally Fail All Five Questions
In the end, the great majority of investment firms fail on all 5 critical questions that must be answered to build wealth. The overwhelming majority of firms tell you the wrong things to buy, tell you the right things to buy are “too risky”; they don’t know when to buy (at low-risk entry points) or won’t buy in the proper manner; and consequently don’t know how to buy. Failing the first 3 questions, if they are not buying the proper “what”, “when” and “how” for investors, it’s then a given that they won’t be properly selling “when” and “how” as well. If, as an investor, you are truly concerned with building wealth, ensure that you have all 5 of the above questions properly addressed and fully answered. This will be the first proper step you take on the journey to build wealth.
[tags]diversification, wealth literacy, investment myths, advanced wealth building techniques[/tags]
