Thursday, February 3, 2011

Brokerage Advice Can Be Hazardous to Your Wealth

I have a confession to make. As a young investor in the late 1990s, I was naive and quite taken by the Internet euphoria. At the time, I owned a single stock - PepsiCo (PEP) - which I still own to this day. However, I couldn't help but watch stock prices explode without feeling like I should be a part of the game. Granted, I didn't have much spare cash to work with, but when I did, I was advised by my broker to buy Munder NetNet - one of the pioneering Internet-focused funds that grew to a whopping $8.5 billion in asset size in April of 2000. I should have been smarter, but as an 11 year old investor, I believed in the transformative power of technology and the "new paradigm". Didn't you?

When all was said and done, my small investment in Munder was wiped out to the tune of 90% or so. And while our broker was confident that it would rebound all the way down, it was only then that I realized investing works best when you:

1). Keep it simple and index
2). Buy what you know

Contrary to what Wall Street tells you, it's OK to be conservative as a young investor. And by conservative, I mean that it's OK to invest in index funds. Interestingly, former bond trader and famous author Michael Lewis of Liar's Poker, Money Ball and The Blind Side fame, notes in a recent interview that he took advice from a broker and in 2008 purchased Lehman Bros. preferred stock and auction-rate securities - both investments were wiped out by the financial crisis and Lehman's bankruptcy. So, after this gut-check experience, what does Lewis advocate for individual investors? Surprise, surprise! He says, "
be conservative, don’t listen to brokerage advice, and index."

I couldn't agree more. Ultimately, Wall Street is all about sales and brokers are at the forefront of making sure products - investments in this case - get sold. Unfortunately, the first place they often look to unload their worst products are to unwitting individual investors. It's best to keep it simple by indexing and to avoid listening to brokerage advice!

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