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[Alex] The world of investment advice[br]is a crowded and noisy place.

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The good news is,[br]you can turn down the shouting.

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And you also don't have[br]to follow stock quotes

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minute-by-minute in order[br]to be a smart investor.

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In the next few videos,[br]we're going to lay out some rules

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for smart investing.

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No, we're not going to tell you[br]how to get rich quick,

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but we will give you[br]some good advice

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for getting richer[br]slowly and steadily.

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Now let's start[br]with Investment Rule #1,

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"Ignore the expert stock pickers." What if I told you[br]that a blindfolded monkey throwing darts

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at the financial pages could select a[br]basket of stocks that would do just as

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well as one chosen by the experts?[br]That was the controversial claim made

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in 1973 by economist Burton Malkiel, in[br]his book, A Random Walk Down Wall Street.

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Years later, one of his undergraduate[br]students turned out to be

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journalist John Stossel. And Stossel,[br]he set out to test this claim. Now,

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blindfolded, dart-throwing monkeys, they're[br]not easy to come by and the lawyer's a

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little bit worried, so Stossel[br]threw the darts himself.

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- [John] My darts landed on 30 companies.[br]How would they do compared to the stocks

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recommended by managed mutual funds?[br]Oops! Better!

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- [Alex] Sure, Stossel got lucky on his throws[br]and he reaped high returns. But the lesson

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here turns out to be correct. Random[br]picking does just as well as the

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professionals. Let's take [br]a closer look. Most people

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invest in the stock market by buying a[br]mutual fund, a portfolio of assets like

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stocks and bonds managed by professionals.[br]There's thousands of mutual funds. Some of

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them are actively managed. They have[br]experts picking stocks and charging fees.

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The other type of mutual fund is called a[br]passive mutual fund. Passive funds don't

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try to pick winners or avoid losers. They[br]simply invest in a big basket of stocks

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such as the S&P 500. Now this [br]chart shows the percent of mutual

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funds that were outperformed by the S&P[br]500. You can see that in most years, the

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S&P 500 beat a majority of the actively[br]managed mutual funds. Okay, so perhaps

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you're thinking, "I got it. Most mutual[br]funds don't beat the market, but what if I

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invest in the ones [br]that do beat the market?”

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The problem with this strategy is that the[br]funds that beat the market are different

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every year. In other words, past[br]performance does not predict future

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performance. The funds that beat the[br]market this year - they probably got lucky.

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And they're unlikely to beat the market[br]next year. In fact, one study looked at

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the 25% best-performing funds. How many of[br]these funds were still top performers just

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two years later? Less than 4%. [br]And after five years, only 1%

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of the initial top performers remained in[br]the top quarter. So funds which are great

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this year - they're probably not going to[br]be so great in the future. They probably

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just got lucky. Okay, what about those[br]very, very few funds that do beat the

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market over many years? Hasn't Warren[br]Buffet, for example, the world's most

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successful investor. Hasn't he shown [br]that you can beat the market? Maybe.

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There's no denying - Buffet's a very smart[br]guy; he's made some very good choices. But

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it's actually harder to distinguish luck[br]from skill than you might imagine. Let me

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explain. Imagine that we started with a[br]thousand so-called experts, except all the

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experts do is flip a coin. Those who flip[br]heads say the market is going to go up

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this year. Those who flip tails, say the[br]market is going to go down this year.

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At the end of the year, 500 are going to[br]be right, purely by chance. Now suppose

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that those 500 then flip the coin again, and[br]they make a new predication. At the end of

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the second year, 250 of these so-called[br]experts, they'll have been right two years

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in a row. Again, purely by chance. Now[br]keep going with this logic. At the end of 5

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years, just 32 of the original 1000, they[br]will have been right about the market 5

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years in a row. Now these 32 - [br]they'll probably be labeled

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market geniuses. They'll show up on[br]television. Their services will be in high

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demand. Perhaps some of them will write[br]books about - how to predict the stock

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market and get rich quick. But the laws[br]of probability tell us, however, is that

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out of the initial 1000 experts, about 32[br]were going to predict the market correctly

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no matter what the market did.[br]So are some market geniuses truly

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skillful? Sure. But it also helps to be[br]lucky. And it's sometimes not obvious which

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is more important. In recent years, in[br]fact, Buffet's investments haven't done

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all that well. So lesson number one is[br]ignore the people who shout stock tips at you.

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- [Man] Dividends funded by debt and not[br]excess free cash flow are just too risky

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to own from now on!

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- [Alex] And definitely don't pay big bucks [br]for professional money managers. But what if

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you have some information about what looks[br]like a great investment? Can you beat the

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market? Well we're going to cover that [br]and the Efficient Market Hypothesis

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in the next video.

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- [Narrator] Check out our practice[br]questions to test your money skills. Next

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up, Tyler will show you how a tragic space[br]shuttle explosion can teach us about

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investing. Click to learn more.

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♪ [music] ♪