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Commonly believed to stand for "Initial
Public Offering," or the first sale of a
company's stock to the public. However, history shows
that IPO can more accurately be said to stand for "It's
Probably Overpriced," or "Imaginary Profits
Only," or "Idiotic, Preposterous, and Outrageous."
Because every once in a blue moon an IPO really does
turn out to be Microsoft -- a stock that goes up more
than 10,000% in a decade -- investors mistakenly conclude
that every IPO is "the next Microsoft." That's
like stepping into a casino just as a one-armed bandit
vomits out a silver stream of coins and assuming that
this particular slot machine has
the best payouts -- or that it's worth playing the slot
machine at all. Instead, as Prof. Jay Ritter's website
shows, the typical IPO does worse than the average stock,
Imagine a chimpanzee who's got your money and won't
give it back until you let him keep at least 1% of it.
A legal document issued by a company that is selling
securities to the public. Its purpose is to warn you
that there is nothing secure about securities, thereby
preventing you from suing the company if you lose money
after investing. Anyone who actually read the full statements
of risk in a prospectus would be too terrified to invest
a dime -- thus proving that no one ever reads them.
"Past performance is no guarantee of future results,"
declares the prospectus, right before it displays numbers
glowing with the irresistible promise of a golden future.
With this conflicted message -- you'd have to be crazy
to invest with us, but everybody else who did got filthy
rich -- a prospectus can only be likened to the beer
ads that invite you to keep on chugging and "Please
To be an intelligent investor, you must read a prospectus
the same way you read any other financial document:
From back to front, paying special attention to all
the fine print and footnotes, and forcing yourself to
confront the "risk factors" head-on. The stuff
the company doesn't want you to know is almost always
hidden in the back and buried in the tiny type of footnotes,
and that's the very stuff you most need to know for
your own protection. By U.S. law, a prospectus must
be available for free download at the Securities and
Exchange Commission's EDGAR website (http://www.sec.gov/edgar/searchedgar/companysearch.html).
If you buy any security without carefully reading the
prospectus first, you're not investing; you're walking
onto a military firing range with headphones and a blindfold
The buying and selling of stocks or bonds by a fund's
portfolio manager. The whole point here is to sell the
bad ones (or the ones that are no longer cheap) and
buy the good ones (or the ones that are still cheap).
If the portfolio manager knows what he's doing, he will
continually be removing stocks with low potential and
adding stocks with high potential. Unfortunately, that's
a big "if." First of all, if portfolio managers
have really researched their stocks thoroughly, why
do they hold on to their average share for only 11 months?
If they keep changing their minds barely one year after
they buy, they couldn't have done their homework very
well in the first place, could they? Secondly, it costs
money to buy and sell. The leading authority on transaction
costs, The Plexus Group (www.plexusgroup.com)
estimates that the typical U.S. stock mutual fund eats
up roughly 1.5% of its assets every year through the
high costs of trading. Turnover is like sandpaper: The
faster and harder a portfolio manager trades, the more
friction he causes, and the worse it burns. Finally,
several authoritative studies have shown that funds
would actually perform better if they had no turnover
at all. As the old saying goes, "the faster they
run, the behinder they get."
To find your fund's turnover rate, look in the "Financial
Highlights" table in its annual report or prospectus.
Under a heading usually worded something like "Supplemental
data and ratios," hunt down "Portfolio turnover
rate." It's expressed as a percentage. The typical
US stock fund has a turnover rate of about 85%-six times
what it used to be in the 1950s. To translate a fund's
turnover rate into a number you can understand, divide
it into 1200. That will tell you how many months the
portfolio manager holds his average stock. Say a fund
has a turnover rate of 107%. How many months does the
manager stick with the fund's average stock? Easy: 1200/107
= 11.2 months. So this fund manager, who probably tells
you in every annual report how he takes a "patient,
long-term view of the markets," can't even stay
put for an entire year.
Bond funds generally have a much higher portfolio turnover
rate than stock funds, since bond funds must sell all
their investments at maturity, while (in theory) a stock
fund can hold its shares indefinitely.
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