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♪ [music] ♪
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[Man on TV] You'll be under water![br]You'll be losing money!
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In other words, the dividend gain[br] 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[br]to be a buyer.
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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."
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What if I told you that[br]a blindfolded monkey throwing darts
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at the financial pages[br]could select a basket of stocks
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that would do just as well[br]as one chosen by the experts?
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That was the controversial claim[br]made in 1973
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by economist Burton Malkiel,[br]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[br]turned out to be
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journalist John Stossel.
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And Stossel --[br]he set out to test this claim.
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Now, blindfolded,[br]dart-throwing monkeys --
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they're not easy to come by
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and the lawyer's[br]a little bit worried,
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so Stossel threw the darts himself.
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[John] My darts landed[br]on 30 companies.
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How would they do[br]compared to the stocks
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recommended[br]by managed mutual funds?
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Oops! Better!
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[Alex] Sure, Stossel[br]got lucky on his throws
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and he reaped high returns.
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But the lesson here[br]turns out to be correct.
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Random picking does just as well[br]as the professionals.
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Let's take a closer look.
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Most people invest[br]in the stock market
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by buying a mutual fund,
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a portfolio of assets[br]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[br]and charging fees.
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The other type of mutual fund[br]is called a passive mutual fund.
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Passive funds don't try[br]to pick winners or avoid losers.
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They simply invest[br]in a big basket of stocks
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such as the S&P 500.
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Now this chart shows[br]the percent of mutual funds
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that were outperformed[br]by the S&P 500.
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You can see that in most years,[br]the S&P 500 beat a majority
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of the actively managed[br]mutual funds.
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Okay, so perhaps[br]you're thinking, "I got it.
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Most mutual funds[br]don't beat the market,
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but what if I invest in the ones [br]that do beat the market?”
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The problem with this strategy is[br]that the funds that beat the market
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are different every year.
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In other words, past performance[br]does not predict future performance.
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The funds that[br]beat the market this year --
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they probably got lucky.
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And they're unlikely[br]to beat the market next year.
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In fact, one study looked[br]at the 25% best-performing funds.
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How many of these funds[br]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%[br]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[br]to be so great in the future.
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They probably just got lucky.
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Okay, what about[br]those very, very few funds
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that do beat the market[br]over many years?
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Hasn't Warren Buffett, for example --
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the world's[br]most successful investor --
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hasn't he shown that[br]you can beat the market? Maybe.
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There's no denying --[br]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[br]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[br]with a thousand so-called experts,
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except all the experts do[br]is flip a coin.
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Those who flip heads say the market[br]is going to go up this year.
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Those who flip tails, say the market[br]is going to go down this year.
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At the end of the year,[br]500 are going to be right --
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purely by chance.
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Now suppose that those 500[br]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,[br]250 of these so-called experts --
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they'll have been right[br]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[br]about the market 5 years in a row.
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Now these 32 -- they'll probably[br]be labeled market geniuses.
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They'll show up on television.
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Their services will be[br]in high demand.
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Perhaps some of them[br]will write books about
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how to predict the stock market[br]and get rich quick.
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What the laws of probability[br]tell us, however,
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is that out of the initial[br]1000 experts,
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about 32 were going[br]to predict the market correctly
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no matter what the market did.
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So are some market geniuses[br]truly skillful? Sure.
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But it also helps to be lucky.
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And it's sometimes not obvious[br]which is more important.
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In recent years, in fact,
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Buffett's investments[br]haven't done all that well.
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So lesson number one is[br]ignore the people
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who shout stock tips at you.
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[Man on TV] Dividends funded by debt[br]and not excess free cash flow
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are just too risky[br]to own from now on!
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[Alex] And definitely[br]don't pay big bucks
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for professional money managers.
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But what if you have[br]some information
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about what looks[br]like a great investment?
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Can you beat the market?
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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[br]our practice questions
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to test your money skills.
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Next up, Tyler will show you[br]how a tragic space shuttle explosion
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can teach us about investing.[br]Click to learn more.
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♪ [music] ♪