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Knowing the cost of everything and the VALUE of nothing November 2, 2012

Posted by shaferfinancial in Finance, Uncategorized.
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As I mentioned, I was reading on Warren Buffett and his thinking on investing. Buffett is a value investor, meaning he looked for good companies, with great business models that were fairly priced. How does this strategy connect to owning mutual funds? Well, it doesn’t. Here is what the experts were advising: Dollar cost average your mutual fund ownership by purchasing a standard dollar amount monthly for a long period of time. So, in essence, don’t worry about the cost of the stock you are buying, just buy it consistently and it will all average out. There is that word again; average.

The actual results of mutual fund ownership is out there for all to see. Individuals who purchase mutual funds underperform the actual funds by 3-5%. In other words they tend to buy high and sell low. This overcome only by a historically generally rising stock market. The experts tend to blame people for not following their buy-and-hold advise for this, but that is not even close to accurate. The fault does not lie in folks not having discipline, but in the insidious nature of the advise given.

Dollar-cost-averaging is really another way to say don’t worry about the actual price of a stock, just buy it.
This is the anti-Buffett strategy. Now the truth is there is a short-term strategy called momentum trading that has been successful for a few select folks that ignores the price of stocks. But, the financial experts were suggesting this as a long-term strategy. And it doesn’t take much imagination to understand that ignoring price of a highly volatile asset is just dumb as a long term strategy. And of course the data bears this out. Overall returns are dramatically effected by when you buy a stock; when it was fairly valued [Buffett strategy] or when it is expensive compared to its earnings.

But, of course how could you really know if a stock is expensive or fairly valued, since you don’t know anything about the company? So no discussion about relative value is really possible.

The truth is that dollar-cost-averaging is really a marketing ploy to get folks of modest means to buy into the stock market. Previous to this, that large market wasn’t available for stock salesmen.

So, after buying some expensive stocks that you know nothing about, what would you think would happen when a market downdraft occurs? Did you say, panic and selling? Doesn’t it seem obvious now? People know nothing about the companies they own, their ability to withstand economic downturns, their debt ratio’s, their products and looking at 20-50% drops in value they panic and sell. That is totally predictable behavior. And for stock salesmen to blame folks for that or feign ignorance of this fact is disingenuous at best.

Let’s review:
The stock market is hugely variable and that is extremely risky for folks trying to obtain retirement income;
Diversification dampens overall returns and encourages folks to not understand what they are investing in; and
The actual price of stocks being purchased is ignored with the result of buying high and selling low.

So far my education was outstripping my ability to know what to do. So, I continued to buy Berkshire Hathaway Bs and continue to study.



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