Dylan Jovine

What makes a great a stock recommendation?

That is a question that has puzzled millions of investors ever since the beginning of capital markets.  Over time, though, the greatest number of the richest investors in history have proven that the answer is a great business purchased at a great price.

Ask the people who started Google.

Since they were the founders, they got millions of shares in the business at a great price, in exchange for 60 hours per week in labor … and are now billionaires.  A hundred years ago, the same would have been said about good old John D. Rockefeller: he also got a ton of shares of the company he started without paying a single dollar for them.  It was all earned through sweat equity as well.

Forbes 400 investors like Warren Buffett, John Templeton, Carl Icahn or Ron Perlman didn’t have to start the next Standard Oil or Google to become filthy rich: they just had to learn how to identify the truly great businesses and then purchase them at a reasonable price using cash, not labor. 

Naturally, of course, you might be wondering what makes a great business.

As I’ve explained here more times than I can remember, the simple answer is that it’s the business that gets the highest return-on-invested-capital for the longest period of time.

For example, it would stand to reason that for every $1,000 in capital (people, cash) a company spends each year, a $1,500 total return would obviously be better than a $1,200 return.

Wouldn’t you rather make $500 in net profits for every $1,000 you had at the bank, instead of $200?  Of course you would.

Therefore, any business that gets more bang for its buck would naturally be better than any business that doesn’t.  Once again, the companies that get the most bang for their buck over the longest period of time are great businesses.

That’s why Coca-Cola, Microsoft, Proctor & Gamble and Comcast are among the most valuable companies on Earth: their returns-on-invested capital are far above 12%, which the average American  corporation gets, and they’ve been doing it for a long time.

This is such an important concept in successful stock investing that I feel I wouldn’t be doing you justice if I didn’t explain it, in its entirety.

(Understanding this key point literally unlocks the door to success in both business and investing.)

Guns, Germs & Steel (and Capital?)

High returns-on-capital are synonymous with productivity.  And increased productivity means that you get more in return for the same resources.

To illustrate my point, let’s say that Company A has a staff of 10 people working for it (the labor portion of invested capital).  The combined revenue for the entire company is $1 million per year.  That means that revenue for each employee is roughly $100,000.  If you were able to increase sales to $1.5 million a year with the same 10 employees, you’ve increased productivity per person by 50%.

In other words, you’ve increased the “return” the company gets by 50% without increasing your invested capital (labor) to get it: you’re still using the same 10 people.

Throughout human history, the societies that have focused on increasing total output per worker (productivity) have always become the wealthier and most dominant societies on Earth.  That’s why the Federal Reserve Board monitors our nation’s increases in productivity so closely.  The higher the return (money) we get using the same population (capital), the richer we become as a society.

Let me take another moment to show you just how important increased productivity/return-on-invested-capital is to both a country on a macro-economic level and to an individual company on a micro-economic level.

(For those of you who have a hard time understanding these concepts, please hang in there for a minute longer.  It was tough for me at first many years ago also, but there is a huge pot of gold at the end of this knowledge rainbow, and I want to make sure you have access to it.  In addition, the only way I can maintain our reputation as what some people call the “smartest” investment newsletter service in America is to take time to explain this in greater depth so that you, and other members of our FAS family, stay more informed than any other investment newsletter family out there!)

In his seminal Pulitzer Prize winning book, Guns, Germs & Steel, author and scientist Jared Diamond offers invaluable insight into why some societies have become wealthier than other societies (and now that they’ve made a great PBS special, you don’t have to read the entire book; you can actually watch it).

Peeling back the layers of history, the author begins the book seeking to answer a simple question asked to him by a native of New Guinea.  I’m paraphrasing here, but the question essentially was, “Why do you (white people) always have more cargo (money/food, etc.) than us native New Guineans?”

In the book, Mr. Diamond offers a theory that the main explanation for why Europeans, Middle Easterners and Asians grew so powerful relative to other ancient civilizations (Africa, Mayans, Incas, etc.) was due to one reason and one reason only: Location, location, location.  They hit the geographic location jackpot.  

Simply stated, civilizations which existed in the relatively moderate climate areas at the same latitude and longitude as Europe to China were less affected by harsh elements of nature than those  civilizations which were built either north or south of them.  The further north, the colder the conditions were for farming; the further south, the warmer the conditions were for farming.

People who lived along this “lucky” geographic belt had several distinct advantages over people who didn’t.  The first stunning piece of luck was that they laid claim to fertile land, which enabled them to grow crops such as wheat and rice that could be stored for future use. 

Archaeologists today are now discovering facilities in the Middle East dated to 5,000 years ago which enabled the storage of crops they grew for future use.  The fact that the crops could be stored at room temperature and preserved led people to be able to farm in excess of their immediate needs.  This insured that they had enough food all year around, eliminating the need to hunt and gather each and every single day.

In contrast, people in other lands (such as  New Guinea) only had crops available to them for limited usage, as they would go bad in a short period of time, usually lasting no more than several days. 

The difference is startling:  cultures that developed in lands without the ability to farm crops with a longer shelf-life were forced to spend virtually every day of the year hunting and gathering more food.  This stunted their ability to devote time to other tasks.

Equally as remarkable is the effect that geography had on animal adaptation.  Of the 300 or so mammals in the world that weigh over 100 pounds, only 14 have ever been domesticated.  Incredibly, 13 of the 14 were found along the same geographic belt.

Not only did this supply ample livestock, but all year round it provided something equally as important: the ability to increase productivity.

What Farming 5,000 Years Ago Teaches Us About Investing & Economics

What does this history lesson have to do with the both the global economy and investing in the stock market?  Everything!

Let me explain using a simple but revealing example:  Imagine you lived in a village in the Middle East 5,000 years ago that had a population of 100 people.  Since you are geographically “lucky,” you are able to grow and store crops that can last for many months.  Equally as important, you are able to use domesticated mammals such as horses to help you in your farming.

Had you lived in a tribe in New Guinea that also had 100 people, each person would have had to spend time each and every day hunting and gathering food.  That means that all the tribe resources would have to be dedicated to that one task each day.

In contrast, your tribe in the Middle East is able to use domesticated animals to improve farming abilities and enjoy increased food productivity.  One horse alone is equal to the efforts of three people.  Thus, by using 10 horses (hence the true origin of the phrase “horsepower”) to help your tribe’s crops each year, 30 people are freed up to pursue other interests such as becoming blacksmiths, clothing makers, thinkers or scientists. 

The net result: Not only is your tribe able to produce the same amount of food as before (output), but now, you’re able to free up 30 people to produce additional goods and services!

The blacksmiths can make horseshoes, the leather-makers can help create saddles, harnesses and other horse gear, and the “thinkers” can help come up with new and better tools to integrate into the entire process and further increase productivity.

By using the “technology” of the day (horses, plows), the tribe is better able to increase its return (total output) on its invested capital (people in the tribe).

History has proven beyond a reasonable doubt that no society can ever become a wealthy society unless it continuously invests in technologies that help increase its productivity.  It was this search to increase productivity that foreshadowed the rise of machines during the industrial revolution, which in turn led to the rise of computers in today’s technological revolution.

Whether it be a horse, assembly line or computer, the net result today is exactly the same as it was 5,000 years ago:  fewer people are needed to make the same or a greater quantity of goods.

The same can be said of companies.

How I Find Great Investments for You

“Productivity” is the term most often used to describe the output of a country in relation to resources when studying the macro-economics of a given country.

When studying the micro-economics of individual companies, however, the phrase “return-on-invested-capital,” which means the same thing, is most often used.

In business, as in societies, the goal is to increase the amount of output (revenue and profits) per employee (invested capital).  Since the average American company gets a 12% return on its invested capital, my number one priority is to find companies that get more return for their investment.

It’s this quest (and this quest alone) that frames every single investment recommendation I make.  After I answer this question (by finding companies that are the most productive/have the highest returns-on-capital), my objective changes.

It’s at this point that I pare that list down to those companies which are then selling at a reasonable price per share.

I will delve further into that part of the equation (lucky you) and uncover the true secrets of the temple.  This will be truly beneficial for those of you who work/ run businesses or want to become better investors.

 

Dylan Jovine

I’m often amazed by the sheer quantity of investment ideas I hear on a daily basis.  Regardless of the medium - print, electronic or television - we’re bombarded by a variety of “experts”, each with a different opinion about the exact same subject - where to invest your money.

Is the economy growing?  If so, you should be buying cyclical stocks.  Are interest rates going higher this month?  Sell your Savings and Loan stocks.

Trying to predict the direction of interest rates, the stock market or the economy is Wall Street’s great game - and its great distraction.

It’s a game because trying to predict the future is like riding a merry-go-round.  You go around and around without advancing much. 

It’s a distraction because it takes your mind as an investor away from far more profitable thoughts. 

But the biggest problem is that it simply doesn’t work.

Anybody who tells you that they know the direction of the economy, interest rates or the stock market is either a) inexperienced or b) selling you something you don’t want. 

And while it is not our intention to eliminate the jobs of many entertaining Wall Street soothsayers, it is our intention to share with you the four essential questions you should ask yourself before buying the stock of any company, public or private.

1. Do I understand the business?

Tip O’Neil, the late Speaker of the House, once said, “All politics is local.” All business is local, too.  But how does one come to understand a business?

Start by trying to understand a local company you enjoy doing business with. It doesn’t matter if it’s public or private, large or small.  One of the most successful Tycoons in America once told me that he learned how to analyze companies by studying the local pizza place.

Then ask yourself a few questions:  What do they sell?  Who do they sell to? How do they market themselves?  Where do they get their product(s) from?  Who are their competitors?  Are they different from their competition?

As you start to answer these questions, you begin to get a qualitative understanding of the business you’re studying.  The size of the company itself is irrelevant—if you know how to study the strengths and weaknesses of a small, private company, you will know how to do it for the large, public one.

Last but not least, don’t forget to use your own business experience to guide you.  Too often throughout my career, I’ve found successful businesspeople (employees and owners) who knew how to study their own company inside and out but, for some reason, didn’t believe it translated to other companies.

It does.  The knowledge you have about the company you work for is directly relevant.

2. Am I comfortable with management?

First let me state the obvious:  you have to be able to trust management with the cash register.  For private companies, it’s literal.  For public companies, it’s compensation and perks.  But there are other areas that are not so obvious that you must consider as well.

One scenario I think through is this:  What if, after a few years of great growth, the company were sitting on a pile of cash?  But the growth rate of the business has slowed and the company could not find any good investment opportunities.

What would management do with the cash?  Would they invest it into a low-returning business under the guise of diversification or would they return it to shareholders?

The answers to these questions offer important clues to management’s understanding of Return on Invested Capital.

3. What is the business worth?

We use many valuation tools here at Fallen Angel Stocks (and discuss them in detail in our newsletters,) but let’s focus today on earnings.  Specifically, let’s explore the relationship between price and earnings (p/e).

To estimate what a business is worth, you have to be able to value it.  To properly value a business, you have to be able to predict what earnings will look like in the future.  To estimate what earnings will look like in the future, use the past as a guide.

We go back through ten years of annual reports to get an average annual growth rate.  By going back ten years, we’re able to see how the company has performed through at least one economic cycle (expansion and contraction.)

If you’re looking at a private company, make sure you have audited financials for at least five years, and you have a business accountant verify them.

Once you have an average annual growth rate of earnings, apply it to earnings for each of the next three to five years.

This should give you a basic idea of what a company’s earnings will look like in the near future.

4. What do I have to pay?

Having a wonderful company with great earnings and a strong management team is one thing.  Getting it for a good price is entirely different (try convincing a dealer to sell you the latest Mercedes for $10,000.)

Hence, the sole objective here is to quantify the difference between value and price (what something is worth versus what you have to pay for it.)

Let’s take ABC Company (a public company) as an example.

If you’ve estimated that ABC Company will earn $1.00 a share three years from today and for the past 10 years has never sold below 12 x earnings, ABC may well be worth $12 in 3 years.

But what is ABC Company selling for today?  If ABC’s stock is now selling for $15 per share, it’s clearly selling for more than its worth—it’s overvalued.  If ABC is selling for $8 per share, it appears to be undervalued. 

Now here’s where you have to determine what rate of return is acceptable to you.  As an investor, if you require a 20% annual return on your money, then you should not pay more than $6.90 for ABC today ($12 per share in 3 years discounted by 20% to today’s dollars.)

If your required rate of return is 15%, however, then $7.80 per share is a good price to pay ($12 per share in three years discounted by 15% to today’s dollars.)
 
George Soros, the famed investor, is fond of saying that he’s an “insecurity” analyst, not a security analyst.

Keep that in mind when you begin to ask these questions about potential investments—they’re a starting point, not an ending point.

In the meantime, practice asking yourself these questions. Not only will you become a better investor, you’ll become a better businessperson.

We are still at the very START of the biggest investor bull run of our times. You’ve heard the numbers, you KNOW this is no fluke.

Public Transportations & Logistics

4 million car in 2000 –> 19 million car in 2005 –> approximately 40 million car in 2010 –> more than 130 million car in 2020    [Goldman Sachs]

China’s auto market grows 25% a year.

Financial Services

The number of credit cards increased 22.7% in 2006 with 50 million credit cards + 1.08 billion debit cards at the end of 2006     [People’s Bank of China]

All over China, banks will open, people will walk in & deposits will be made. TWO TRILLION DOLLARS are in the hands of China’s industrious savers & until now, only Chinese banks could tap into this amazing treasure chest. Today, U.S., British & Hong Kong banks will open accounts, take deposits, issue credit cards and authorize loans. In a land where the economy is growing at >10% and 40 cents on the dollar is saved by people who DISTRUST their own national banks, this is a day that investors will remember.

There are two main indicators to determine a stock market’s performance: liquidity and corporate earnings. A flood of money from exports and investments has boosted China’s liquidity dramatically over the past five years. And three consecutive years of double-digit economic growth generated even stronger corporate earnings. The strong liquidity and earnings combined with a high household savings rate (35%), rising inflation and a lack of other investment options have driven the Chinese stock market to new record highs almost every day during the past two months.

During the entire year of 2006, 3 million new retail brokerage accounts were established in China. But during the first quarter of this year alone, 5 million new accounts were established. That means growth in the first quarter was a staggering 65%! Last month, another record-shattering 5 million new accounts were set up. Interestingly, the average new account opened in 2007 is more than twice the size of the average account last year. This implies that novice Chinese investors entering the market now are both better educated financially and more affluent than investors who entered the market in years past.

Commodities, Energy & Natural Resources

China is world’s 2nd largest importer of oil, behind the U.S.
China is using up natural resources at an unsustainable rate.
China is already the world’s largest user of alternative energy resources (e.g. wind, water, solar power & etc) & construction materials (e.g. timber, steel, copper & etc).
All this steroidal economic growth in China & the Pacific Rim means just one thing for natural resources: increased for practically every natural resource imaginable.

China’s (together with India) demand for coal, iron ore, cement, grain, fertilizer, sugar & other commodities continues to drive strong imports of these raw materials, even as finished goods flow out to the world’s vast consumer-end markets.

China’s need for cement is equal to the entire output of the U.S. cement industry, 5 TIMES OVER. Duplicate this appetite into iron ore, coal, copper, natural gas, uranium, steel, gasoline, corn, pulp, almost any natural resource you can think of … and then … translate that need into investment opportunities, not only in China, but in Brazil, India, Europe, the U.S., Russia, Australia, even Africa … and you will begin to appreciate the extraordinary power of the 4 words: "BUY WHAT CHINA BUYS"

China’s per capita consumption of oil is ONE FOURTEENTH that of the U.S. It is ONE TENTH of that of Japan or South Korea. When industrialization BEGAN in the U.S., per capita consumption was one barrel. Now it is 30. Consumption in China is STILL just under 2 barrels. Simply doubling it to FOUR barrels will put global oil supplies in a jam. Doubling that to 8 — remember the U.S. uses 30 — makes petroleum geologists shake their heads. No one knows where all that extra oil will come from. If you understand the scale of the industrialization of China, it is easy to see why PetroChina is Warren Buffett’s biggest overseas investment.

The find for oil is massive. The extent of it and even its exact location are closely-guarded secrets. But it is destined to become legendary. Liwan 3-1-1, as this new oil field is called, lies just 155 miles south of Hong Kong, 5,000 feet below The South China Sea.

In oil business jargon, Liwan 3-1-1 is an elephant — absolutely enormous — and it effectively doubles the oil reserves for its owners. And this extraordinary find is just the beginning. Amazingly, the exploration company struck oil the first time it sank a drill-bit!

Analyst team in China informs that Liwan 3-1-1 could be China’s "Spindletop." A find of such magnitude, it could shift the balance of power away from the Middle East. At the very least, it suggests that the South China Seas will become to China what Texas & the Gulf of Mexico have been to U.S. economic growth for the last century. Not only would this stabilize energy prices globally, but it would ignite a fresh China boom!

In China, solar power is every bit as important to the "Buy What China Buys" concept as oil, gas, nickel & aluminum. Solar is a $5 billion market racing towards $50 billion. Clean, local, renewable & reliable — it is the ONE initiative every politician from Japan to Germany has been able to agree upon. In the U.S., there is already a waiting list for solar panels for homes. Plus Wal-Mart, Target & other retailers are feverishly turning the roofs of their big boxes into solar power substations.

In China, there is an added incentive to go solar. Government-supplied power is intermittent & people in rural areas live in a state of perpetual brown-out. A solar panel on the roof is becoming widespread among the emerging middle class. Laborers, too, save for a solar-powered hot bath at the end of the work day. Given these factors, the projection for the solar panel market’s 10-fold growth is conservative.

China is driving down the price of solar energy much faster than Westerners realize. Economics of scale, improvements in efficiency, plus the industrial demand for energy that’s reliable all add up to a business that’s doubling by 2010.

The tiny China company at the forefront of this initiative will have $1 billion in sales in the next 2 - 3 years. With a 20% margin as a result of low, low production costs, plus a home-field advantage in one of the world’s fastest-growing alternative energy markets, this is a possible double in 2007 & ten-bagger by 2009.

Industrialization

The most spectacular example of China’s industrialization & the wealth created is surely the Three Gorges Dam. The Hoover Dam (in the U.S.), you’ll recall, created a new regional economy & raised a city, Boulder, out of the desert.

So consider: The Three Gorges project is eight times bigger than the Hoover Dam! It is arguably as important for China’s economic emergence as the Erie Canal was for America at the dawn of the Industrial Revolution.

Investing in the mining operations that have supplied the raw materials for this huge project - The Australian miner BHP Billiton, the Chilean miner Rio Tinto & the smelter China Aluminum all averaged more than 30% gains in 2006.

Making new moves to profit from one of the biggest construction projects on the face of the planet: Beijing’s preparation for the Olympics in 2008. Can the Olympics force up the price of nickel, aluminum & stainless steel? That is exactly what we are seeing right now, as these three commodities get sucked out of mines, smelters & mills in every corner of the globe.
     - Hot rolled coil & sheet steel prices have already tripled.
     - Copper futures have doubled.
     - China is now the world’s biggest user of nickel & prices are hitting record highs, as much as 6% a day.
     - Aluminum output in tiny Iceland has increased so much, it has tripled the island’s economic growth!

Unfold the untold story of China’s amazing industrialization. It gives you a winning strategy for oil, gas, gold, aluminum, nickel, zinc, copper & many other resources that are now hitting 25-year highs. This may be the biggest investment opportunity of our lifetimes — maybe several lifetimes.

Internet

Being one of the world’s largest online gaming markets, Chinese players are very serious about gaming. Hardcore gamers often show up at cybercafes with pillows & blankets to prepare for marathon session that can last up to 24 hours. China’s online gaming market is currently worth US$1 billion with revenue growth an impressive 74% in 2006. China has 40 millions gamers, 90% of whom play online games distributed by the U.S.

In 2004, the entire Chinese Auction market was about US$561 million & in 2005, that number jumped 200% & reached US$1.7 billion. In 2004, there were roughly 15 million online auction users in China. By the end of 2005, that number is almost 30 million - a 100% increase. E-commerce, in general, rose over 60% from 2004 to 2005 - growing from approximately US$43 billion in ‘04 to almost US$70 billion in 2005. Baidu.com up 400% at its IPO. Netease up 11,000% in 5 years, and Internet usage at 63% annualized growth.

嘉信股匹评级资深副总裁福赛斯

　　毋庸置疑，巴菲特堪称是史上最伟大的股票投资者之一。儘管他的选股哲学整体而言并不难把握，也很容易投入实践，但是我却相信，至少有两种被视为巴菲特式的理念是来自于大众的误读，而对这些误读坚信不疑显然会让投资者受到伤害。

买进持有？

　　巴菲特无疑是一位长期投资者。他寻找那些可以以合算价格买进的出色企业，準备长期持有。遗憾的是，巴菲特的哲学通常都会被庸俗化为“寻找少数伟大的企业，买进并永远持有其股票”。

　　当然，我们的确认为从长期着眼进行规画和研究发现高品质股票之类都是很好的理念，但是这些说起来容易，做起来就难了。我的问题是，买进持有的投资策略究竟是否能够成功地运用到个股–而非共同基金–的身上？毋庸赘言，我们总是可以找出一些股票，如果我们多年前买进了它们并一直持有到今天，我们就会获得非常可观的利润。不过，我们应该记住，这一切其实都是后见之明，而且在众多的股票当中，像这样的其实只是极少数。

　　近期发佈的一份研究报告显示，较高的历史回报率往往都难以持续到未来。比如，一家企业过去五年的每股盈馀成长速度要超过市场平均水平，则其未来五年每股盈馀成长速度超过业界平均水平的可能性往往要低于普通企业。何以见得？竞争、市场饱和度、运营复杂度和技术的进步等等还只是一小部分足以遏制成长率的因素。更为糟糕的是，由于投资者往往都倾向于相信成长势头能够持续下去，那些高历史成长率的股票一旦无法满足人们的乐观预期，其股价遭到的冲击还将被放大。

　　换言之，买进和持有高品质股票的理念要实践下去其实是非常困难的，那么，巴菲特是怎么做的呢？儘管巴菲特在最初买进股票的时候，心里也希望能够“永远”持有，但实际上他显然不会那么做。和大多数人的想法相反，巴菲特其实是在几乎毫不停息地买卖股票。或者，他的投资理念应该更为精确地阐释为“以长期考虑为基础买进，不顾市场和行业短期波动的影响而坚持持有，长期业务前景不再具有吸引力时卖出”。巴菲特之所以持有某支股票很长时间，最重要的原因只能是这支股票仍然保持着最初吸引他的那些特质。不过，在过去十年当中，巴菲特其实也卖出了不少他觉得不值得继续持有的股票。

集中投资？

　　巴菲特还宣称，股票投资者应该保持足够的耐心，以找到真正伟大的企业，而且人们只应该买进自己能够真正瞭解其生意的企业。在波克夏公司1993年的年度报告当中，他表示，“如果你能够找到五至十支在自己的行业中拥有长期竞争优势而且价格非常值得考虑的股票，你就可以忘掉传统的多元化理念。”遗憾的是，巴菲特的研究及投资组合管理哲学却总是被人们曲解为“买进少数自己瞭解的股票，不必考虑多元化问题”。对于巴菲特的这一观点，我没有质疑的打算，但是对于投资者扭曲的版本，我却不得不指出，他们忘记了至关重要的前提。

　　要找到这样难得的投资机会，同样是说起来容易做起来难。我们必须明白，无论自己对一支股票进行了多么充分的研究，也无论我们对一家企业有多么充分的瞭解，我们都不能保证这支股票就一定能够获得超过平均水準的回报。股市的确能够为投资者提供额外的回报，但是这额外的回报只属于那些发现了某种尚未为他人所知的实质性因素的人。换言之，如果你知道的好消息是别人不知道的，市场会让你得到更多的利润，但是如果你知道的好消息是所有人都知道的，你得到的利润也不会比别人多。因此，儘管集中投资的确意味着提升整体回报的可能，但是同样意味着投资组合会在市场波动面前变得更为脆弱。如果你的选股决定是正确的还好，如果是错误的，结果不堪设想。

投资者的教训

　　将巴菲特的理念结合到我们的投资中，的确有可能提升投资组合的表现。始终保持长期眼光，坚持充分投资，研究机会时要耐心，不要被短期市场波动左右，买进持有股票直至前景不再可观……这些都是很好的理念，不过前提是不能被曲解。

Teeka Tiwari, Chief Investment Officer, The Tycoon Report

There’s a dirty little secret that the Wall Street firms hope you won’t find out.

Let me back up for a second. The real goal of Wall Street is not to make you money, and it’s not to lose you money either (they just can’t help doing that).

Let me explain.

Wall Street has spent millions convincing the public that they are the sole keepers of your financial future; and for a small nominal fee (usually 1% annually), they will guide you through the perilous investment waters to deliver you to the land of your financial dreams. It’s an interesting fairy tale, and it would be a humorous one at that if it weren’t for the fact that so many people have bought into it.

I’m going to let you in on a huge industry secret! Are you ready?

The number one goal of any Wall Street firm is to keep you even.

Why?

Have you noticed that many firms have shifted away from commission-oriented transaction business to charging an annual fee instead? On the surface it looks like a good deal. "My objectives are tied with your objectives Mr. Jones," says your friendly neighborhood broker, "The more you make, the more I make."

But do you know why the firms have really made this move? It’s not because they’re good guys and wanted to do you a favor. They realized that they could not consistently show you above-market returns. So how could they keep your account, keep you even, and stop you from bolting? I can just imagine the strategy meeting that took place …

Business Development Guy #1: "I know! Let’s spend millions of marketing dollars convincing everybody that they cannot make money on their own! Then let’s convince everybody that the only way to make money is to buy a diversified mix of mutual funds and hold onto it for 30 years!"

Business Development Guy #2: "We need a new, catchy name for this scam er … excuse me … I mean approach. Oh, Oh, I know, I know, let’s call it MODERN PORTFOLIO THEORY!"

Business Development Guy #3: "Yes! Yes! That’s it. Oh, and by the way, take a look at all this yummy projected cash flow on those 1% fees we will be collecting for the next THIRTY YEARS!!"

But let’s take a closer look at this strategy before we dismiss it out of hand. Maybe the buy and hold approach is the right one after all, and why should we begrudge the mutual fund boys their 1% fee? After all, it’s not like they’re not working hard for that money … generating new ideas, poring over research, and committing huge amounts of energy to generating money-making ideas.

Actually, they’re not.

75% of all mutual fund equity is invested in the S&P 500. 87% of mutual fund performance is correlated to the S&P 500!! Want to know another dirty little secret that the Wall Street firms hope you don’t find out?

You don’t need them to enact this strategy!!

Do you want to know how to do this on your own?

Well here it is: Just buy 5 different exchange traded funds, one each for big cap & small cap growth, one each for big cap & small cap value, and a diversified international exchange traded fund. Dollar cost average in every month/quarter, and after thirty years you’ll have about an average compounded 11% rate of return (that is if you also reinvested all of your dividends). That’s it! Pretty simple huh? No wonder the firms love this approach! It’s so profitable for them. They have you feeding them money every month, and all they do is passively invest in mutual funds. That’s it! My eight year old daughter could do that!!

"But it’s only 1% a year, and I don’t have to be bothered with it" I can hear some of you saying.

Let me show you how much that 1% per year is costing you over a thirty year period. Let’s say you’re 35, and you invest $1,000,000 in a retirement portfolio of 5 diversified exchange traded funds as outlined above. You go about your business for the next thirty years, building your career, raising your family, going to church and living life. Lo and behold, age 65 is here before you know it. Now, all things being equal, your $1,000,000 investment - through the magic of compounding - should have grown to $8,000,000, right?

Wrong!!

You forgot about your friendly neighborhood brokerage firm. They have to be paid for all of the "work" that they did. Here’s what it cost: After thirty years of paying out 1% annually in fees, it has cut your retirement nest egg by a third! Instead of $8,000,000 you will receive $5,333,333!!

Think about that for a second. You just paid out over $88,000 a year in fees, and lost capital gains (two million, six hundred and sixty six thousand dollars) for something you could have done by yourself.

It is insanity to give up one third of your entire portfolio to enact this "no-brainer" strategy.

Isn’t it time to grab hold of your own financial reins?