Stocks Are Products Just Like the IPod

The Ipod is a great example of marketing and design. Just as the first generation Ipod was beginning to reach its maximum sales, Apple released the Ipod mini and when that became popular and sold well they released the Ipod Shuffle. When Apple felt another market was ripe they introduced the Ipod for pictures and now the latest Ipod is the Nano.

There is no secret why Apple or any company that invents and/or manufatures a product continually upgrades and changes that product. They want to sell more and keep the revenue coming. Thatís why Microsoft is up to Windows XP after many previous versions and why the Corvette looks completely different in 2006 than it did in 1953.

As long as you know that these companies are doing this just to get your money, youíre ok with it because you can decide whether to buy the new Ipod or not. Thatís called being an informed consumer and while you might still buy things on impulse or simply because you want them, the choice was yours.

There are companies and even whole industries that we think differently about. We donít think of the investing industry like we do some company selling us a product but that is exactly what theyíre doing. And they use the same techniques that Apple, Microsoft, GM and every other company do. They invent products that will bring them revenue to make them richer.

Yes itís true that the difference between Apple and a stock broker is that you, the consumer, stand to increase your wealth with the products offered by the broker. You canít say that about the Ipod. But youíre also being sold a product, from stocks, mutual funds, bonds and increasingly more sophisticated products like options or even commodities, these products make the brokers and their firms rich.

Thereís nothing wrong with a company making money while providing you with a service, especially one that has the potential to make you rich as well. The problem is that these products are inventions that donít work very well. At least not for people like you and me.

The first mutual fund was established in 1924 as a way for a group of investors to disversify their portfolio and the concept worked wonderfully. Together they were able to buy a broader mix of stocks than they could on their own. Although the concept worked and was popular there was only modest growth in the number of mutual funds over the next several decades. By the end of the 1960s there were only 270 mutual funds in existence.

In 1972 John Bogle (a name worth knowing), the founder of The Vanguard Group, had an idea. Why not give the investor the opportunity to match the over-all market by investing in every stock in the S&P 500 Index. The added benefit would be the low cost of ownership since there was no active management necessary. Bogle estimated the fee at .5% but today it stands at just .19% significantly lower and a big advantage over the actively managed funds with an average fee somewhere around 1.5%.

Mutual funds and specifically index funds are examples of valuable products that offer great benefit to the investor. And for a while they were under control. Today however there are over 10,000 funds to choose from and fully 80% underperform the market average over the long term.

Today brokerage firms are coming up with more products they say offer value but really only increase the transaction cost for the investor making the brokerages richer still. Electonically Traded Funds (ETFs) which are mutual funds that act like stocks do offer some benefits. While mutual funds usually have a minimum required investment, ETFs donít. With mutual funds if you want to buy at 1pm you put your trade in and you pay whatever the price is at the end of the day. With ETFs you put your trade in and buy at whatever price it is at that time.

But do the benefits outweigh the risks. When someone buys a mutual fund they tend to hold onto it for a while but the nature of ETFs lends itselft to active trading, with a transaction cost every time you buy and every time you sell. The goal, as with stocks, is to buy low and sell high but fear and panic often cause people to do just the opposite and now you can make the same mistake with ETFs.

But ETFs are just the beginning because the brokerages want even more money. So theyíve made it easier to buy and sell options. While options do offer potentially high returns they also offer fairly high risk, higher than simply trading individual stocks. Professional investors have lost money on options and so can you although youíd never know it listening to the marketing folks.

The key to getting rich, the key to keeping more of what you make is to reduce the cost of doing business. Thatís why discount brokers have done so well. But these new products do just the opposite, increasing the transaction cost especially as you trade more often.

Iím a risk taker and it's served me well so far but since Iíve scaled back and changed my stategy by buying index funds and holding them much longer than I did individual stocks, Iíve actually done better. Iím not saying that Iím not smart enough to trade stocks or that you arenít smart enough either, Iím just saying that maybe the smarter thing is to back off and enjoy the ride.

Iím not alone in this thought and people much smarter than me, people who actually worked in the industry are saying the same thing. Check out Bill Schultheisí book or his website for even more information.