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Plainmoney investing

Monitor your financial adviser?

That’s the issue in a USA Today financial column — how can you tell whether your broker is doing a good job for you? For people who are trying to play the markets, that’s a real issue. Is a stock touted by the broker a good deal?

For people following a sensible strategy of “buy and hold index funds,” that’s never a worry. You’re typically buying from a no-load source such as Vanguard or Fidelity. And you’re not trying to figure out what’s good or what’s bad — you’re just buying a little piece of all of it. For more on this strategy, go look at this.

It’s really this simple: The more you know about financial markets, the less you will try to play them. The less you know about financial markets, the less you should try to play them. Playing financial markets is a losing game for most of the half-informed people who try, and only a winning game for people with inside information or superior trading access.

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Plain Money ideas Plainmoney investing

“It’s not vulnerable to wild rides”

Reasons just keep mounting up to follow a simple stock market strategy of buying and holding index funds. There was a one-day “wild ride” on the major stock exchanges May 6, 2010. Stocks lost hundreds of points in minutes and then regained most of the loss in minutes. None of this caused distress for long-term buy-and-holders. Day-to-day fluctuations don’t matter much when you’re in the market for the long term. In fact, by making some investors more afraid of stock risk, these short-term swings can increase the overall return to holding stocks. The long-term return to holding stocks is so high that it’s referred to by researchers as the “equity premium puzzle.” The implication for the average investor? Buy and hold!

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Plain Money ideas Plainmoney investing

“It’s not a synthetic CDO”

Much has been made of transactions involving Goldman Sachs and big-dollar investors who lost big-time.

That has very little to do with the individual investor. Those were all big players taking big risks — and, unfortunately, it seems many of them didn’t know what they were doing.

This site’s recommended strategy, “buy and hold index funds,” has the great advantage of being understandable. You’re holding a little bit of every major stock in the economy. You’re not betting on one sector to grow or collapse. If the economy does well, you do well. Add this to the list of reasons for index funds: They’re not a synthetic CDO, whatever that is.

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Plain Money ideas Plainmoney investing

Index funds in your 401k

I’m sometimes asked, “What should I hold in my 401k plan?” Of course, my answer is “index funds” — tilted more toward stock index funds if you’re young, bond index funds if you’re old. My book explains some simple rules of asset allocation.

But what if your employer’s 401k doesn’t have index funds? Two answers: (1) Invest in the most broadly diversified mutual funds you can choose from. They’ll perform about like index funds. (2) You may have increasing opportunities to invest in index funds. This article in the Wall Street Journal points out that more companies are insisting on having index funds available to their employees.

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Plain Money ideas Plainmoney investing

Another reason for indexing

Another good reason for indexing: When “market professionals” make a bet on a part of the market to outperform the rest, they’re often wrong. Here’s a Wall Street Journal article on why bond mutual funds let investors down. In short, “Most intermediate funds held far fewer of the safest bonds than were in the index.” And if you held a fund based on the index, you weren’t making a gamble on which bonds would do the best (an ill-fated gamble, it turned out). My favorite bond index fund: The Vanguard Total Bond Market Index fund.

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Plain Money ideas Plainmoney investing

Have you already missed the bottom?

A popular, but flawed, way of trying to benefit from the ups and downs of the stock market is to sell out at the top and buy in again at the bottom. This is known as “market timing” and it’s very difficult to make any money doing it.

The problem is that no one knows when a bottom or top occurs until long after the fact. Therefore, when the stock market rallied in March, unless you were already holding stocks you were too late to buy in at the bottom. How do you react to all this? My favorite strategy is “buy and hold.” If you don’t try to sell out at the top you don’t have to worry about when to get back in. My prediction: Within two years, the stock prices of March 2009 will look extremely attractive. “Market timers” will kick themselves for not having gotten back in then.

One warning: If you “buy and hold,” there will be times when you wish you had sold out. It’s not for the faint of heart. However, for those willing to stay in the market long term, the rewards can be substantial.

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Plain Money ideas Plainmoney investing

It’s not a Ponzi scheme

Add this to the list of reasons why “buy and hold index funds” is a relatively good investment strategy: It’s not a Ponzi scheme.

A bit of explanation: In a Ponzi scheme, a shady operator takes in money, claiming to invest it. It pays off handsomely at first, it seems — but the payoff is illusory because it comes from scamming in new investors. Their money pays off the first investors, but now the Ponzi operator has to go find still more investors to keep up the appearance of a good return.

A Ponzi scheme was limited to scamming small-time ill-informed investors, or so we thought until Bernard Madoff was caught in a $50 billion Ponzi scheme that took in wealthy upper-crust clients. And that brings me to the point. If you buy and hold reputable index funds you can expect to make money over the long haul. You will have some bad years, like 2008. But you’ll never lose it all to a scam.

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Plain Money ideas Plainmoney investing

The “black swan” flies again

For the average investor, it’s hard to beat “buy and hold” over the long term, even though there will be times — such as now — that other strategies will look attractive. One such strategy is the “black swan” strategy popularized by Nassim Nicholas Taleb. The strategy is named in honor of the once-received wisdom that black swans were impossible — until black swans were discovered in Australia.

Taleb’s strategy essentially involves betting that rare events (financial “black swans”) will eventually happen, and being positioned to take advantage of those rare events. This year, that strategy has worked out well, producing returns of more than 50 percent.

So, should we all jump on the black swan bandwagon? Here’s why we shouldn’t:

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Plain Money ideas Plainmoney investing

Sound advice in a crash

Those who make big sudden changes in their portfolios almost always regret it. Example: If you sold right after the 1987 crash, you lost 24 percent. If you held on two years, until September 1989, you got it all back. So take a deep breath and think hard before doing anything.

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Plain Money ideas Plainmoney investing

The enduring wisdom of “Buy and Hold”

In my book, I recommend not investing in the stock market until you have your financial house in order and are willing to let the money stay in the market. And once you’ve reached that point, you buy and hold.

Recent events again confirm the wisdom of this position. Those who tried to flee the market meltdown of fall 2008 were, in general, too late. The panicked news coverage followed the worst declines. So an investor who read the coverage and then pulled out was “selling low.” That same investor, who won’t get back into the market until things look more optimistic, will at that time be “buying high.”

Do you see the pattern? “Buy high, sell low.” That’s a sure route to ruin. When all this turmoil clears, count on it: Those who do the best will be those who followed the sound advice of “buy and hold.”

And, one more thing: Suppose someone sold after the first ten percent of a market decline, and then bragged about having missed the worst of the decline after the market went down another ten or 20 percent. That bragging would turn to regret over longer periods of time, if history is any guide.