Mutual Funds Are for Losers
by Jay MacDonald
If Wall Street were a Hans Christian Anderson fairy tale, Phil Town would be the little boy pointing and laughing at the emperor's new clothes, or lack thereof.
By turns a Vietnam Green Beret, Grand Canyon river guide and spiritual seeker of enlightenment, Town's life on the fringes of society changed when he saved a raft from treacherous rapids on the Colorado River. One of the thankful survivors was a successful San Diego investor who, in turn, volunteered to save Town's financial future by teaching him the ropes of investing.
Blending Zen with Wall Street, Town's anyone-can-do-this advice, in his best-seller "Rule #1," amounts to: Don't lose money, find great companies, know their worth and acquire them at 50 percent off. Beyond that, he says the traditional advice -- invest in mutual funds, diversify, buy and hold -- is strictly for losers.
Let's cut to the chase: What's wrong with mutual funds?
First, if you intend to stay ignorant about investing, if you don't intend to get the education to tell a good business from a not-very-good business, you're going to have to give your money to somebody and let them invest it. In that case, the bad choice of the choices is mutual funds.
They're going to take nearly a percentage point a year and they're not going to deliver anything that an index fund doesn't deliver. So just go and get an index stock fund. Buy SPDRs or Diamonds (Dow Jones ETFs) or the Nasdaq and be done with it. Then you won't have all these management fees and you're going to (earn) the index for sure, which is the best you can do in a mutual fund over any 20-year period of time anyway. So you might as well do an index.
You're also a doubting Thomas when it comes to a balanced portfolio, right?
We're going to separate the world into two groups of people: those who are ignorant and are going to remain so about investing -- and they have to do mutual funds, what other choice do they have? -- and those who are going to learn what the best investors in the world have known for 100 years, which is just the basic fundamentals of what a great company looks like and what it's worth. When you know that it's a great company and you know what it's worth, then you'll know if it's on sale. You buy it on sale and you're off and running.
When you can buy Johnson & Johnson on sale, buy it. You're done. You don't need a mutual fund when you can buy Johnson & Johnson on sale; it's been around 120 years, it's going to be around another 120 years. That's not hard. That's all I want to tell people -- it's not hard. You don't need to buy lots of things, you can buy just one good stock and you'll be in good shape.
Surely you're not advocating that people put all their money in one stock? It may have worked for you, but are you saying this is a smart investment strategy?
For getting started, the key thing is to find one good one. Then, as you get better and better at it, you can pull more and more money out of mutual funds and maybe end up with four or five really good companies you like in four or five different areas of the market.
What about the argument for diversification? Shouldn't investors protect themselves from market volatility by diversifying among a few dozen companies?
One of my favorite Warren Buffett quotes is, "Diversification is a protection against ignorance." It's not meant to be mean, but if you don't know the difference between a wonderful business that is on sale and a bad business that isn't, you must diversify. That's your only logical choice. If you can't tell the difference between things, then you have to spread your money out across a lot of things. But when you can tell the difference, then diversification hurts your portfolio performance.
If I were to coach a novice investor, I would say first, let's diversify by getting rid of all your mutual funds and get SPY (or SPDR -- an exchange-traded fund that mimics the S&P 500). Wonderful stock, no fees. Yay, we just saved ourselves about 1 percent to 2 percent a year. The second step, buy one really good solid business; buy a Johnson & Johnson on sale, a Merck on sale, Coca-Cola on sale. Something that has been around for 100 years and is going to be around another 100 years. Then you've basically locked in, for that portion of your portfolio, a 12 percent to 15 percent return. Then add a really cool business that might be the next Apple; go for one of those because they're fun. Put $1,000 in and hope for seven doubles in the next five years.
Explain how you can tell when a stock is a screaming buy.
Here's what a screaming buy is, bottom line: a great business that is for sale at a substantial reduction to its value. You can't just have a company that is at a substantial discount to its value because if it's not a great company, it's real hard to say what that value actually is. The things that make a really great business investment boil down to the fact that you can say with a great deal of certainty that this is a durable business and that it will grow at at least a certain minimum amount per year. Otherwise, you don't know how to give it a value short of saying its liquidation value is this. Of course, no really valid business is going to sell for its liquidation value. Another of my favorite Warren Buffett quotes is, "It is much better to buy a wonderful company at a fair price than a fair company at a wonderful price." If you have the choice between a screaming deal or a screaming great company, you tend to lean toward the screaming great company, particularly as novice investors.
Give an example of some companies that you bought that you thought were good buys.
OK. I loved Cognizant Technology Solutions, Whole Foods, Garmin, recently Apple. Cognizant Technologies has been a screaming deal for a long, long time and it's constantly on sale. It's a fabulous company. Garmin is a fabulous company that goes from being at retail price down to being on sale on a fairly regular basis. These are examples of companies that had the qualities we look for.
When did you start investing seriously?
In about 1980, I started up and was very fortunate to get in on some early stage investments that were good. I did a lot of different kinds of investing, everything from private to public businesses, and I caught one that just took off, just exploded. That, plus some other things that I did right, turned into about $1 million in about five years, and that allowed me to just quit.
Then I quit. That was it; I had all the money I needed. I went off to Iowa and raised my kids in a little private school. I did some basic investing out there, bought some land and subdivided it and sold it off, just to get places to live that I wanted to live in. The investing stopped. I loved pursuing enlightenment or consciousness. I was still chasing the rainbow. I wrote a couple of screenplays with a friend of mine that were horrible. I studied acting for a couple years. I was just sort of wandering and meditating and hanging out with my kids. Then I got divorced and suddenly a million dollars started to look like not so much money anymore, so that's when I started cranking it back up in about 1989 or 1990.
Your meditation seems to have led to a Zen-like approach to looking at stocks by removing the barrier of what stock is, and instead establishing a relationship with the companies in which you're investing.
That's a great way to say it, man. For me, it's very much about making friends. I would not make a very good hedge fund manager, probably. I would probably not be any good at managing other people's money. So the money becomes a very personal thing to me. It's my vote for how the world should be, and I do want a personal relationship with these businesses. I get really involved. I've been on the boards of companies. I want to know that the people I'm working with are really honest and really passionate people who are going to run my company really well. I buy one share of stock and that's my company.
You're not a big fan of stock analysts. Why not?
You listen in on these conference calls and the questions that are getting asked by the analysts are down in the forest so deep, they're asking questions about the color of that tree's leaf. And I kind of want to know what the forest is up to. Are you really going to tell me if the forest is on fire? I love people like John Mackey at Whole Foods who just come right out and tell you the whole forest is on fire.
Can you buy stock in a company that you philosophically oppose?
No. I think you've really got to put your money where your mouth is. The people out there pontificating about the values of the environmental movement, who have mutual funds that own all of these companies that they're calling the bad guys, are hypocrites. Every Friday, they put their 401(k) money into the company that they're trying to stop! It's like, what are you doing? I can't do that. That doesn't work for me.
If Wall Street were a Hans Christian Anderson fairy tale, Phil Town would be the little boy pointing and laughing at the emperor's new clothes, or lack thereof.
By turns a Vietnam Green Beret, Grand Canyon river guide and spiritual seeker of enlightenment, Town's life on the fringes of society changed when he saved a raft from treacherous rapids on the Colorado River. One of the thankful survivors was a successful San Diego investor who, in turn, volunteered to save Town's financial future by teaching him the ropes of investing.
Blending Zen with Wall Street, Town's anyone-can-do-this advice, in his best-seller "Rule #1," amounts to: Don't lose money, find great companies, know their worth and acquire them at 50 percent off. Beyond that, he says the traditional advice -- invest in mutual funds, diversify, buy and hold -- is strictly for losers.
Let's cut to the chase: What's wrong with mutual funds?
First, if you intend to stay ignorant about investing, if you don't intend to get the education to tell a good business from a not-very-good business, you're going to have to give your money to somebody and let them invest it. In that case, the bad choice of the choices is mutual funds.
They're going to take nearly a percentage point a year and they're not going to deliver anything that an index fund doesn't deliver. So just go and get an index stock fund. Buy SPDRs or Diamonds (Dow Jones ETFs) or the Nasdaq and be done with it. Then you won't have all these management fees and you're going to (earn) the index for sure, which is the best you can do in a mutual fund over any 20-year period of time anyway. So you might as well do an index.
You're also a doubting Thomas when it comes to a balanced portfolio, right?
We're going to separate the world into two groups of people: those who are ignorant and are going to remain so about investing -- and they have to do mutual funds, what other choice do they have? -- and those who are going to learn what the best investors in the world have known for 100 years, which is just the basic fundamentals of what a great company looks like and what it's worth. When you know that it's a great company and you know what it's worth, then you'll know if it's on sale. You buy it on sale and you're off and running.
When you can buy Johnson & Johnson on sale, buy it. You're done. You don't need a mutual fund when you can buy Johnson & Johnson on sale; it's been around 120 years, it's going to be around another 120 years. That's not hard. That's all I want to tell people -- it's not hard. You don't need to buy lots of things, you can buy just one good stock and you'll be in good shape.
Surely you're not advocating that people put all their money in one stock? It may have worked for you, but are you saying this is a smart investment strategy?
For getting started, the key thing is to find one good one. Then, as you get better and better at it, you can pull more and more money out of mutual funds and maybe end up with four or five really good companies you like in four or five different areas of the market.
What about the argument for diversification? Shouldn't investors protect themselves from market volatility by diversifying among a few dozen companies?
One of my favorite Warren Buffett quotes is, "Diversification is a protection against ignorance." It's not meant to be mean, but if you don't know the difference between a wonderful business that is on sale and a bad business that isn't, you must diversify. That's your only logical choice. If you can't tell the difference between things, then you have to spread your money out across a lot of things. But when you can tell the difference, then diversification hurts your portfolio performance.
If I were to coach a novice investor, I would say first, let's diversify by getting rid of all your mutual funds and get SPY (or SPDR -- an exchange-traded fund that mimics the S&P 500). Wonderful stock, no fees. Yay, we just saved ourselves about 1 percent to 2 percent a year. The second step, buy one really good solid business; buy a Johnson & Johnson on sale, a Merck on sale, Coca-Cola on sale. Something that has been around for 100 years and is going to be around another 100 years. Then you've basically locked in, for that portion of your portfolio, a 12 percent to 15 percent return. Then add a really cool business that might be the next Apple; go for one of those because they're fun. Put $1,000 in and hope for seven doubles in the next five years.
Explain how you can tell when a stock is a screaming buy.
Here's what a screaming buy is, bottom line: a great business that is for sale at a substantial reduction to its value. You can't just have a company that is at a substantial discount to its value because if it's not a great company, it's real hard to say what that value actually is. The things that make a really great business investment boil down to the fact that you can say with a great deal of certainty that this is a durable business and that it will grow at at least a certain minimum amount per year. Otherwise, you don't know how to give it a value short of saying its liquidation value is this. Of course, no really valid business is going to sell for its liquidation value. Another of my favorite Warren Buffett quotes is, "It is much better to buy a wonderful company at a fair price than a fair company at a wonderful price." If you have the choice between a screaming deal or a screaming great company, you tend to lean toward the screaming great company, particularly as novice investors.
Give an example of some companies that you bought that you thought were good buys.
OK. I loved Cognizant Technology Solutions, Whole Foods, Garmin, recently Apple. Cognizant Technologies has been a screaming deal for a long, long time and it's constantly on sale. It's a fabulous company. Garmin is a fabulous company that goes from being at retail price down to being on sale on a fairly regular basis. These are examples of companies that had the qualities we look for.
When did you start investing seriously?
In about 1980, I started up and was very fortunate to get in on some early stage investments that were good. I did a lot of different kinds of investing, everything from private to public businesses, and I caught one that just took off, just exploded. That, plus some other things that I did right, turned into about $1 million in about five years, and that allowed me to just quit.
Then I quit. That was it; I had all the money I needed. I went off to Iowa and raised my kids in a little private school. I did some basic investing out there, bought some land and subdivided it and sold it off, just to get places to live that I wanted to live in. The investing stopped. I loved pursuing enlightenment or consciousness. I was still chasing the rainbow. I wrote a couple of screenplays with a friend of mine that were horrible. I studied acting for a couple years. I was just sort of wandering and meditating and hanging out with my kids. Then I got divorced and suddenly a million dollars started to look like not so much money anymore, so that's when I started cranking it back up in about 1989 or 1990.
Your meditation seems to have led to a Zen-like approach to looking at stocks by removing the barrier of what stock is, and instead establishing a relationship with the companies in which you're investing.
That's a great way to say it, man. For me, it's very much about making friends. I would not make a very good hedge fund manager, probably. I would probably not be any good at managing other people's money. So the money becomes a very personal thing to me. It's my vote for how the world should be, and I do want a personal relationship with these businesses. I get really involved. I've been on the boards of companies. I want to know that the people I'm working with are really honest and really passionate people who are going to run my company really well. I buy one share of stock and that's my company.
You're not a big fan of stock analysts. Why not?
You listen in on these conference calls and the questions that are getting asked by the analysts are down in the forest so deep, they're asking questions about the color of that tree's leaf. And I kind of want to know what the forest is up to. Are you really going to tell me if the forest is on fire? I love people like John Mackey at Whole Foods who just come right out and tell you the whole forest is on fire.
Can you buy stock in a company that you philosophically oppose?
No. I think you've really got to put your money where your mouth is. The people out there pontificating about the values of the environmental movement, who have mutual funds that own all of these companies that they're calling the bad guys, are hypocrites. Every Friday, they put their 401(k) money into the company that they're trying to stop! It's like, what are you doing? I can't do that. That doesn't work for me.
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