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♪ [music] ♪
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[Man on TV] You'll be under water!
You'll be losing money!
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In other words, the dividend gain
is not worth the principal loss
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Whoa! I can't take the pain!
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That's when you want
to be a buyer.
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[Alex] The world of investment advice
is a crowded and noisy place.
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The good news is,
you can turn down the shouting.
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And you also don't have
to follow stock quotes
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minute-by-minute in order
to be a smart investor.
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In the next few videos,
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
how to get rich quick,
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but we will give you
some good advice
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for getting richer
slowly and steadily.
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Now let's start
with Investment Rule #1:
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"Ignore the expert stock pickers."
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What if I told you that
a blindfolded monkey throwing darts
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at the financial pages
could select a basket of stocks
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that would do just as well
as one chosen by the experts?
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That was the controversial claim
made in 1973
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by economist Burton Malkiel,
in his book,
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A Random Walk Down Wall Street.
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Years later,
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one of his undergraduate students
turned out to be
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journalist John Stossel.
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And Stossel --
he set out to test this claim.
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Now, blindfolded,
dart-throwing monkeys --
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they're not easy to come by
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and the lawyer's
a little bit worried,
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so Stossel threw the darts himself.
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[John] My darts landed
on 30 companies.
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How would they do
compared to the stocks
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recommended
by managed mutual funds?
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Oops! Better!
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[Alex] Sure, Stossel
got lucky on his throws
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and he reaped high returns.
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But the lesson here
turns out to be correct.
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Random picking does just as well
as the professionals.
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Let's take a closer look.
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Most people invest
in the stock market
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by buying a mutual fund,
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a portfolio of assets
like stocks and bonds,
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managed by professionals.
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There's thousands of mutual funds.
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Some of them are actively managed.
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They have experts picking stocks
and charging fees.
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The other type of mutual fund
is called a passive mutual fund.
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Passive funds don't try
to pick winners or avoid losers.
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They simply invest
in a big basket of stocks
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such as the S&P 500.
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Now this chart shows
the percent of mutual funds
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that were outperformed
by the S&P 500.
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You can see that in most years,
the S&P 500 beat a majority
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of the actively managed
mutual funds.
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Okay, so perhaps
you're thinking, "I got it.
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Most mutual funds
don't beat the market,
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but what if I invest in the ones
that do beat the market?”
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The problem with this strategy is
that the funds that beat the market
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are different every year.
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In other words, past performance
does not predict future performance.
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The funds that
beat the market this year --
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they probably got lucky.
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And they're unlikely
to beat the market next year.
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In fact, one study looked
at the 25% best-performing funds.
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How many of these funds
were still top performers
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just two years later?
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Less than 4%.
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And after five years, only 1%
of the initial top performers
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remained in the top quarter.
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So funds which are great this year --
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they're probably not going
to be so great in the future.
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They probably just got lucky.
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Okay, what about
those very, very few funds
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that do beat the market
over many years?
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Hasn't Warren Buffett, for example --
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the world's
most successful investor --
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hasn't he shown that
you can beat the market? Maybe.
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There's no denying --
Buffett's a very smart guy;
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he's made some very good choices.
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But it's actually harder
to distinguish luck from skill
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than you might imagine.
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Let me explain.
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Imagine that we started
with a thousand so-called experts,
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except all the experts do
is flip a coin.
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Those who flip heads say the market
is going to go up this year.
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Those who flip tails, say the market
is going to go down this year.
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At the end of the year,
500 are going to be right --
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purely by chance.
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Now suppose that those 500
then flip the coin again,
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and they make a new prediction.
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At the end of the second year,
250 of these so-called experts --
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they'll have been right
two years in a row.
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Again, purely by chance.
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Now keep going with this logic.
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At the end of 5 years,
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just 32 of the original 1000 --
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they will have been right
about the market 5 years in a row.
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Now these 32 -- they'll probably
be labeled market geniuses.
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They'll show up on television.
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Their services will be
in high demand.
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Perhaps some of them
will write books about
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how to predict the stock market
and get rich quick.
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What the laws of probability
tell us, however,
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is that out of the initial
1000 experts,
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about 32 were going
to predict the market correctly
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no matter what the market did.
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So are some market geniuses
truly skillful? Sure.
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But it also helps to be lucky.
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And it's sometimes not obvious
which is more important.
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In recent years, in fact,
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Buffett's investments
haven't done all that well.
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So lesson number one is
ignore the people
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who shout stock tips at you.
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[Man on TV] Dividends funded by debt
and not excess free cash flow
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are just too risky
to own from now on!
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[Alex] And definitely
don't pay big bucks
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for professional money managers.
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But what if you have
some information
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about what looks
like a great investment?
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Can you beat the market?
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Well we're going to cover that
and the Efficient Market Hypothesis
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in the next video.
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[Narrator] Check out
our practice questions
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to test your money skills.
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Next up, Tyler will show you
how a tragic space shuttle explosion
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can teach us about investing.
Click to learn more.
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♪ [music] ♪