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The Foster Effect:

I’ve often been taught that in the stock markets thousands can be made yet millions are often lost: “When an investor can’t properly identify the amount of risk they’re exposing their money to mistakes can happen in the blink of an eye.”

Investing for some individuals appears no different than gambling at a casino in Las Vegas. You always hear about that one person hitting it big, but rarely see that the failures are much more abundant and tragic. An investor might feel the need be aggressive and take chances in order to increase their odds, but likely doesn’t understand that the odds will always remain in the house’s favour and winning is often a simple game of chance. Even the best poker players know that with all of their skill and deception that sometimes their fate simply lies with the cards they’re dealt. Index investing in recent years has built up considerable favourability due largely to its ability to model the house. If you have the opportunity to invest with the house and generally the house wins then you’re likely to increase your returns considerably over the long-term.

When I look back to my first attempts at investing I can’t help but realize how naive and simplistic my thinking was. I saw friends making thousands in 1999 by seamlessly picking stocks from columns in the newspaper and their gains accelerating at incredible speed. I was cocky, overly confident and felt that if someone with poor critical thinking skills could do so well that I could easily do that much better. After the embarrassment of a failed stock picking competition in the first year of business school I understood all too well what was at stake if you didn’t understand the risks present.

The difficulty I have now some nine years later is remaining objective in my responses to people investing for the first time when they seek guidance, advice or direction. Experience teaches you important lessons and you have to stay grounded in your view of where you’ve come and what you’ve done. That experience isn’t easily replaced when you understand that the process of learning helps to mould the type of investor you will become regardless of where you think you might go when you start. My advice or strategy today might not be appropriate for everyone when considering their specific situation; yet the fundamentals of sound investing principles should always be at the forefront for anyone choosing to invest on their own for the first time. I can never tell someone what they should do with their money because simply: it’s their money. I can give them the tools, resources and education I’ve learnt in the hopes that they’ll make solid decisions and find their own individual path, but the decision is always up to them on what they feel is most appropriate.

Over the past 18 months I’ve fielded questions from individuals wondering if my strategy of investing into dividend paying stocks is similar to those of Derek Foster and additionally my opinion on the author. Although there will be parallels between each strategy and good arguments are made by the author; I do not share the same view of investing and have real concerns over his role in attempting to educate investors.

One of the main challenges for any new investor is to remain objective, grounded and realistic. Anyone reading a book titled “Stop Working: Here’s How You Can” and looking to duplicate the author’s strategy is likely not being objective. The reason for this is simple:

Whenever you read, receive or pay for financial advice (author, advisor or friend) you need to ask yourself the question of, “Who stands to benefit most?” If the answer is not you, then the person providing the information likely has a very real conflict of interest. This simple principle is the reason to date that I have never accepted any monetary compensation or gifts for opinions (outside of consulting) when providing investment related advice to friends or colleagues. The world is full of capable marketers and new investors should be aware that these people are not out there with your best interests at heart: their real intention is to sell you something for their own financial gain.

The Foster Effect is simply that: a well marketed idea or following that provides little new insight into investing principles that many seasoned investors already understand as sound fundamentals of a successful long-term strategy. The issue at hand is that for a naive investor the advice and guidance provided does nothing to teach of any fundamental investing practices and promotes an adapted approach that disregards serious elements of risk that the author to a large degree neglects to acknowledge. An example I’ve used before in conversations is that there is NO business today that is absolutely recession PROOF. There are certainly businesses that are recession resistant, but no single business is immune from a period of slowing economic growth either directly or indirectly. A company can position themselves properly to minimize exposure, but PROOF suggests that something is invincible or risk-free and that is not the case at all in the business world or when investing.

The author himself has acknowledged publicly that his book(s), “Covers investing strategy for people who don’t have the time, much money, or any investment knowledge.” There is so much wrong with this statement I have difficulty knowing where to even form a response.

As an investor you need to do the work necessary to understand what you are investing in regardless of using an advisor or implementing a DIY strategy. If you are an investor who neither has the time, money or knowledge to invest on your own you should be seeking professional advice through a reputable financial advisor. Fees and any amount of underperformance when compared to the overall market is the price you pay for a lack of involvement in managing your own money. If you wish to take control of your finances because no one else will ever manage your money like you can, then you owe it to yourself to take the appropriate time needed to learn what should be required before you invest blindly into the market. There are simple strategies used by many today to contrast high fee/under performing investments that you can use while you learn what is needed to invest on your own. Reading a single book (or series) in my opinion doesn’t constitute a strategy that is not without serious elements of risk.

There are some valid concepts that pertain to investing in these books that are useful to investors. The author has stated that at one time that he studied every annual letter to shareholders of Berkshire Hathaway by its chairman Warren Buffett (which I’ve read back to 1977). No doubt the inspiration for many of Fosters’ ideas come directly from the teachings of Buffett, but there are also some, of major principal, that he chooses to neglect or forget.

To start he discusses some of the major concepts that Buffett puts into practice when looking for companies to buy. These include focusing on habit forming businesses, to not be over stimulated with macro-economic ideas, focus on stand alone businesses/products and targeting companies with enduring earning power. Neglected by Foster are points I consider much more important. Any student of Buffett would immediately understand the importance of knowing what you’re investing in and the risks associated with that company. For an investor with “no investing knowledge” to invest blindly into a stock that appears safe is a dangerous gamble. It’s not enough for a business to be simple and therefore stable/safe because you understand how the dynamics of it works. A company may be simple, but very unprofitable for many reasons. Developing a situational analysis on a company helps a new investor to focus quickly on how to learn and identify the strengths, weaknesses, opportunities and threats (SWOT) in order to gauge what might provide instability to a businesses predictability moving forward. Understanding insulation is also another very important element: termed the wide moat by Buffett. This protects a company from competition, but an investor needs to know how to identify those threats in political, economic, social and technological forms (PEST). A good defence leads to an impressive offence and an investor with limited experience and understanding certainly cannot expect to invest successfully without adequate understanding of how to control exposure to both risk & reward.

If the intention for the first book wasn’t bad enough, he has now written and published a second book in order to broaden his target market with a self-professed “dumbed down” version of the first. The main problem with the Foster Effect is that that it’s packaged in a way to sell a specific product and idea. Virtually all of the information has been re-packaged with this intent (to sell) and can be found elsewhere for free in a much more concrete educating manner. The packaged product marketed to new investors is meant to buy into a strategy more for his financial gain than yours. There is little doubt in my mind that how the strategy has been presented is not only misleading to someone who doesn’t know any better, but most certainly dangerous. An investor without the simplest understanding of capital markets, proper asset allocation, diversification, cyclicality or risk should have no business actively participating in individual security selection in the first place until they have an extensive understanding of portfolio construction.

Each investor is an individual and any investing strategy should reflect that. Beginners often need the most help because they are at the highest risk to get hurt financially by bad advice and unrealistic expectations forced upon them by someone perceived to be in a more knowledgeable position. Foster makes the classic mistake of marketing a process that provides the impression that what works for one person will work for others. I’ve made the argument continuously that this will not always be the case. I would never myself write of a simple strategy that I felt was dummy-proof or that a young child could easily follow on the road to financial freedom and early retirement. The past year we’ve seen all too well that risk is real and every investor should understand this fundamental element before putting their money into the market regardless of any guidance gained from someone with perceived knowledge or promised success.

In nursing I teach students that you have to take each nurse for what they are. You can learn a lot from each nursing mentor, yet need to be able to evaluate that advice and guidance in order to balance the skills and knowledge you wish to adopt into your own practice. Investing should be no different. If anyone stands to profit from the advice given to you it clearly throws into question the validity of their intentions.

The investment world for years has been full of declarations of “Look what I’ve done, it’s easy and here is how you can” without acknowledgement of what amount of risk was taken to achieve those feats. Risk has the potential to decimate returns and capital structures as many have experienced recently in the markets. What’s unfortunate is that there are individuals out there who stand to benefit/take advantage financially of new investors with their self-serving proclamations of success. All too often those statements come under scrutiny in time and show a person for what they really are: a marketer or salesman with a clear bias.

Books by authors may contribute meaningful ideas or fundamentals that an investor may wish to incorporate into their strategy, but if you are an individual who is not able to pull the good from the bad then you’re likely to suffer the consequences of classic misinterpretation. Any investor should look to see who profits from advice before taking it as empirical in nature. Any student, just as in nursing, needs to stop and ask the critical questions needed before falling into any situation regardless of the perceived value or gains.

The Foster Effect is plagued by complications that many will not even identify. His skill as an investor can’t even be accurately evaluated due to the lack of information he provides readers for the purpose of self disclosure. That’s not uncommon amongst authors, but it is known that he took substantial risks using leverage that worked out well for him. As someone who understands the importance of balance in investing I have to ask what example this sets for his readers when looking to invest when he proclaims himself that the strategy is for “investors who don’t have the knowledge”? Derek Foster is no different than countless other authors who have taken a fundamental practice of life, investing or faith and bent those rules in order to suit their own end. The damage done to investor awareness is evident and alarming at one of the most basic levels: fundamentals.

Readers should note that this negativity is not intended as an attack against the author. He has obviously done a wonderful job because of how the books have resonated with a specific audience. But as I’ve outlined prior he is likely a more successful marketer than investor. His audience is one of massive impressionability and sometimes it’s not the specific strategy that is flawed, but how you approach it and his books clearly fall under the latter in my opinion. The real danger here is that he inspires investors with little or no knowledge to invest into equities and the approach is too risky and unproven for anyone to blindly follow without putting his investing activities into question regardless of how it was adapted over the years.

My main concern is this: since he is not a financial professional he takes no responsibility and lacks the credibility for people to follow his example, teachings, insights and opinions. New investors are impressionable, inexperienced and susceptible to any amount of poor advice that promises financial gain at the end of the road. This is often the tragic case in many well documented investing schemes or gimmicks over the years. I’m not disputing the end result of his strategy, but the perceived journey through which such investors might follow his strategy blindly. He can even argue as he has in the past the MPT (Modern Portfolio Theory) is inferior to his strategy and something often taught to academics in vain, but its investing fundamentals serve an important function to teach investors without formal training a simple understanding of systematic risk and capital preservation.

The bottom line for any new investor is this: you can’t expect quality returns if you’re not willing to do the work. You need to understand what you’re doing no matter the proposed outcome and there’s very little success found in shortcuts; otherwise everyone else would be doing it too. Seeking financial advice should be through a qualified financial professional who you can evaluate based on their education, level of knowledge and ability to recognize the unique needs you bring. Their motivation should not be to sell you something, but to engage in a process that benefits you first and them second.

I offer a contrasting view on the Foster Effect: if I hadn’t spent the time required to be trained and educated as a Registered Nurse in Canada, would you feel as comfortable having me care for a loved one as someone else who had? If your answer is yes, then you are likely more of a gambler than I am. Unless you have an incredible affinity for luck, then you’re likely to find out that the house wins more often than you realize and your investment returns will likely show that without the proper preparation and a basic understanding of risk.

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{ 17 comments… add one }
  • Susan April 11, 2008, 2:02 pm

    Excellent! I often have friends and relatives ask me what to invest in. As I bumble around trying to explain why there is no shortcut to investing success, their eyes glaze over. Now I can tell them to read your article, THEN I’ll help them find resources.
    Thank you.
    Susan

  • Nurse B, 911 April 14, 2008, 8:24 pm

    You are more than welcome Susan and I’m still working in my free time on a post in reference to your difficulties of “Seeing the Whole Picture”

  • Anonymous July 11, 2008, 4:17 am

    I admitted that I bought both of Foster’s book since it was an article in the Calgary Sun. I didn’t finish the second book since there wasn’t really anything new, only a water downed version of the first one. Thank you so much for the light reading and offering an unbiased opinion. It was refreshing hearing from a different angle.

  • Dividend Growth Investor August 22, 2008, 2:52 pm

    I also agree that Derek Foster doesn’t disclose EXACTLY how his portfolio reached 300K at the time of his retirement (plus a home which he had paid in full plus a rental property).
    I like your thorough analyses of stocks on this website Brad;

  • Nurse B, 911 August 30, 2008, 3:11 pm

    Thanks DGI!

    The comments are appreciated and I appreciate the encouragement on the stock analysis posts I present.

  • Anonymous December 22, 2008, 6:44 pm

    I have to point out that the period when foster started investing to the time he published his first book saw some of the largest year to year dividend gains for a large number of dividend paying companies in Canada and the U.S.

    I don’t think that it is hard to accept that he made that much money, enough to retire on. Nor do I think his ‘method’ is wrong.

    I like his first book and his method makes sense to me. I took his book to be what it appears to be, a primer, a beginners book, something to get you excited but you better do more than just read his book, you better invest some time to learn about investing.

    I suggest that to whomever asks me about investing, and the same for those who are experiencing medical problems, learn about your problem. I worked in a hospital for 15 years and and found a lot of ‘professional’ nurses who I wouldn’t trust to deal with a small sliver in my finger.

    Passing some university courses doesn’t mean that you are an intelligent person with common sense, it only means you can recall a lot of facts and regurgitate them back during tests.

    The same goes for financial advisers and brokers, only worse, because many people selling stock or mutual funds didn’t have to take courses, they only had to pass a test, which is geared almost entirely towards ‘the business of selling’ rather than helping a client meet financial goals.

    So, do I want my RN to have completed university? Yes, but I also watch to make sure they wash their hands, swab injection sites, and the vial top, and that they have the right vial, etc, etc, etc.

  • Canadian Dream January 9, 2009, 6:58 am

    I see what your getting at with this post, but at the same time I think you over estimating how much more the average person is willing to put in regarding investments.

    I remember a discuss I have with Preet one day regarding investment knowledge and he pointed out that even my limited investment knowledge at the time was more than 95% of the public in his opinion. That shocked me until I thought about it.

    Most people just blindly trust investment advisers and never buy investments directly themselves. The few that do try to control their investments often are speculating rather than investing.

    As much as we all hate to admit it Foster is on to something. Most people like ‘dumb down’ advice. The don’t want to know why it works or the details they just want to use it. PF blog readers really are a rare breed that do what to learn the why of it all.

    Anyways, just my two cents. Great article.

    Tim

  • Nurseb911 January 9, 2009, 1:55 pm

    Thanks for the comments Tim,

    I recognize the amount of time the average investor takes in their financial health and the main theme of this post was to make the point for due diligence rather than attack what Foster has done. As an author I feel he's been very successful, but as an investor and/or advocate for investor education I question his motives & methods.

    This post was meant to shake things up for an investor who might not have considered more than a few issues with the strategy and that a well balanced investing approach (through education as well) can prevent serious mistakes over the long-term The recession-proof vs. recession resistant is one of those issues I take with the approach. I just wanted to point out to a new investor that you have to think critically when investing and whether its Foster, an advisor or someone else ask yourself the question of conflict of interest to determine how you benefit from their advice.

    Great blog btw!

  • Anonymous February 15, 2009, 8:16 pm

    I enjoyed reading your article advising investors, especially those new to the game, to exercise caution when investing their hard-earned dollars. But I must tell you that Derek Foster’s method does work. Through the years, I have let the “qualified financial professionals” handle my money with amazingly poor results. These parasites do nothing but rape you of your fair share because their interests come before yours. I’ve NEVER made money with these people, no matter how “serious” I was about investing. But they were serious about lining their pockets before mine. Fast forward to now: I’m finally making money in the market doing it all by myself. And it’s not that difficult either. And no matter if you use technicals, fundamentals, momentum or whatever, ALL stocks have their ups and downs from time to time (like now!!).I have been using Foster’s system long before I read his book and it has been performing quite well. Of course, there are other ways to invest, but his way focuses on cash flow for income. And it does work quite nicely. Due diligence is always upon the investor and I trusted the so-called professionals that left me with very little in the end, save a lot wiser. Long ago, bridges were built by people who didn’t possess engineering degrees, yet its today’s bridges that collapse. So much for the learned…………

  • Nurseb911 February 15, 2009, 10:26 pm

    Anon,

    My beef with Foster isn’t the strategy of investing over the long-term in high quality dividend paying companies vs. active management. My concern is that his literature does little to educate investors about the serious risks that exist with equity investing. He throws caution to the wind and provides a watered down version of what is already well acknowledged as sound investing practice. He takes all the credit, but none of the responsibility while continuing to work as an author (he never retired).

  • Anonymous February 16, 2009, 3:03 pm

    Thanks for letting me comment Nurseb911. I understand your point(s), yet there are many authors who indeed have the credentials that Mr. Foster does not possess and have lead many astray on the wild search for qualified and good companies. Even the “educated” have suffered dearly in the past (and not just the recent past either)knowing fully the seriousness and risks involved with investing in equities. What say they right about now? Derek Foster simply points out another way to generate income in sound(?) companies that pay reliable cash flows. I’m not defending Derek in any way. He’s just showing us how he has done it, and maybe not revealing all the cards he used to play the game (leveraging). So be it. And perhaps he has spared us all the lingo and jargon that the so-called investment professionals use to conduct the “smoke and mirror” shows that are meant to make investing look complicated and beyond the ability of us mere mortals, who then decide to let the “pros” take care of their money. Well, we all know how that worked out. If anything, being educated at this juncture in the stock market only serves to embarrass these people even more. They have no excuse for making such errors. Weren’t they “educated” enough? Or maybe they didn’t realize how “serious” we were about our financial futures. Yep, I’m not too impressed with these clowns at all.
    At least we have great websites like this one to further school us in the ways of the market, that allows us to believe that we truly can do this investment thing on our own. Onward we go!!

  • Nurseb911 February 16, 2009, 9:13 pm

    I think you bring up an excellent point Anon:

    Any investor, no matter their level of education, should always be aware of the advice/information being provided to them and look for a conflict of interest. Advice that comes at a cost needs to be examined for who benefits more (you or them).

  • Beri February 21, 2009, 6:27 pm

    I am still not sure how far you like the author to take the topic of education or risk involved. He is not a licensed financial advisor, and he does mention that there are risks always. Now basing his logic on investments that have withstood time and many ups and downs of the economy is a good platform to start on.

  • Anonymous February 22, 2009, 8:29 am

    I think we give way too much credit to the “licensed financial advisor”. What exactly does that mean anyway? In my past experience, it was just a license to steal from me and under-perform what I could have been doing on my own. In the previous bull market, my advisor was realizing “steady” 5% returns (net) while the market was cranking out double digit gains. Yeah, he was that good. But no more of me feeding into their legit money scams. It’s over-for good. If a “professional” is that good, shouldn’t he/she guarantee their work? And I’m not talking about those paltry seg funds either. Let’s start with an 8% return while gauranteeing the principal. What?! No takers? Gee, I guess there isn’t any true “pros” out there.
    Learn all you can about your own finances. It isn’t that difficult, especially when compared to how poorly your portfolios have done in the past with the pros. And there’s nothing like the satisfaction of knowing you did it yourself! Happy investing!

  • Richard March 5, 2009, 11:44 am

    I have read and enjoyed all 3 of Foster’s books. I love the idea of creating a passive stream of dividend income. I found that the books really didn’t give you all of the information you needed to make informed investment decisions. No stock is reccession proof. Recently, Foster has his income greatly reduced by the dividend cut of APF.UN, COS.UN, and others. I feel bad for anyone who may have blindly followed his portfolio.

    Richard
    http://72rule.blogspot.com

  • Anonymous March 16, 2009, 12:21 pm
  • Nurseb911 March 16, 2009, 6:00 pm

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