Sunday, November 29th, 2015

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Buy What The Experts Are Buying

The stock market is showing signs of improvement and it seems a rebound may be just around the corner.  That means it’s time to consider increasing your 401k contributions and investing any extra cash that’s been sitting on the sidelines for the last few months.  It also means you’re faced with the decision of where to invest your hard earned money.  Mutual funds are the safe, popular choice, but remember mutual funds are just a collection of stocks, and they sometimes carry very high minimum investment requirements ($1,000 to $25,000) along with commissions, loads, and other annual expenses.  The problem many investors face is they want the professional management of mutual funds, but they can’t afford the high price tag after fees and expenses are added in.  There’s a way around this problem and it’s possible to “cut out the middle man” and get all the benefits of mutual funds without having to pay the high cost.

First you’ll need to find one or two mutual funds you’d like to purchase.  If you don’t already have a fund in mind try referring to the list of the top 25 mutual funds published by Kiplinger each year (the list is available for free at www.kiplinger.com).  When you begin researching mutual funds you’ll see the minimum purchase amounts range from about $1,000 to $25,000 per fund.  Not many investors can afford these minimums, especially if you’re still in school or just starting your first job.  But the opportunity to invest is not lost.  Each fund you’re researching is run by a mutual fund manager, and that manager is responsible for deciding what stocks to buy and sell within the fund.  You may not have known that what stocks each mutual fund manager buys and sells is public information and is available for free to all investors.  In fact, a list of each fund’s holdings can be found on almost any stock research website including www.morningstar.com and www.finance.yahoo.com.  The top stock holdings are also listed directly on each fund’s website and in their prospectus, which is the fund’s primary selling document and acts as the fund’s owner’s manual.  A prospectus can be requested free of charge directly from each mutual fund company. 

Your next step is to research the different stocks owned by the mutual funds to make sure they’re a good fit for your portfolio and meet your investment needs and risk profile.  You should then calculate how many shares of each stock you can afford to buy. 

Finally, you’ll need to determine how to actually purchase the stocks you want to buy.  You can either buy them directly from the parent company or you can open an investment account at a brokerage firm which allows you to trade stocks.  For advice on how to open an investment account see my article titled, “Where To Open Your Investment Account."

By purchasing individual stocks instead of mutual funds, you’ll be able to avoid high minimum investment requirements and save on mutual fund expenses and commissions.  This strategy is also a great way to learn from the smartest investors for free.  Take Warren Buffett’s Berkshire Hathaway fund for example.  Just one of his fund’s “A” shares will cost you well over $90,000 (ticker symbol: brk.a).  But you can see a list of what stocks his fund owns for free and then purchase those stocks directly for only a few hundred dollars.  Of course, you won’t have Warren Buffett’s expertise of knowing exactly when to buy and sell each stock, but you’ll be able to closely copy his investment style without having to break the bank.

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5 Responses to Buy What The Experts Are Buying

  1. Flawed Strategy says:

    Copying the positions of major mutual funds is a fundamentally flawed strategy.

    1) The author correctly points out that the list of stocks many funds own are publicly listed. But this is precisely the reason copying their positions will not work: everyone else is able to see the exact same information and many others are attempting the same strategy. Once a fund reports that it holds a certain stock, it has already made the purchase. Presumably, when the knowledge becomes public that a major mutual fund owns a certain company, the stock of that company appreciates because individuals follow the methodology described in the article. But because of this appreciation, the chance that an individual investor will be likely to buy the stock at a desirable price is slim.

    2) However, if problem 1 was the only drawback, investors could still perhaps achieve respectable returns simply by copying the holdings of major mutual funds. Yet, for any investor that is unable to afford the typical $2000 minimum investment, the brokerage fees associated with emulating the portfolio of a major mutual fund will eradicate their hopes of achieving even average returns. Even if the person only chose ten stocks to buy, and went to an online discount broker, they would accumulate about $100 in fees. $100 for someone who cannot meet a $2000 minimum is no small amount. Additionally, given that many mutual funds, including Fidelity’s Magellan Fund, hold upwards of 25 stocks, the individual, novice investor has no hope of tracking the fund by purchasing individual stocks, at least not in an affordable way.

    3) The author is correct that actively managed funds do have fees associated with them that eat into an investor’s return and, therefore, many investors would do well by avoiding such funds.

    However, the answer is not to attempt to become a lemming and buy the individual stocks of the fund on your own. The average investor would be much better off investing in a passively managed, low expense-ratio index fund. He or she would achieve a superior level of diversification compared to both actively managed funds and individual stock selection and would also avoid many of the fees associated with active funds.

    To suggest that investors with little capital, particularly investors with as little capital as college students have, would do well by purchasing individual stocks that they see some major fund owns is simply incorrect and disingenuous.

  2. RPG CFA says:

    It’s the COMMENT that is flawed. The article is GREAT.
    1) If a young investor wants to buy stocks they usually turn to penny stocks or some fly-by-night stock they hear about on Mad Money. But if they read this article they would know they can learn from THE BEST INVESTOR EVER Warren Buffet FOR FREE. If they don’t like him they can buy some of the stocks owned by the 25 BEST mutual funds named by Kiplinger. That’s much safer than the alternative.
    2) Yes, there may be $100 in transaction fees but that is a 1 time fee whereas a mutual fund may charge a 2% expense charge EVERY SINGLE YEAR.
    3) If you buy a passively managed index fund who’s the lemming now? You’re only following the entire market and your investment will live and die by what it does. That’s the real definition of a lemming.

  3. Ridiculous says:

    You’re right, actively managed funds do have high fees. But…with index funds you could get fees down to something like 0.25% a year. Index funds beat 80% of actively managed funds, and you’re absolutely out of your mind if you think the average teenager is going to do better picking stocks than a professional, active fund manager. The fact of the matter is, index funds are far superior to individual stock selection–just because teenagers are attracted to penny stocks is no excuse to give them this advise. Warren Buffet himself has recommended index funds to the average investor, and I certainly would not call him a lemming.

    And transaction fees are accrued every single time you make a transaction. If you are copying an active fund, you will definitely suffer transaction fees on a regular basis, which is simply unaffordable for an investor with $2000.

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  5. Inflation says:

    Do what China is doing and buy commodities. Invest in hard assets (silver, gold, platinum, EVEN oil…). You can do this by owning the physical metal or owning a related stock. The Fed is hellbent on papering over losses. Take advantage of it.

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