For years, financial advisor Suze Orman has preached that people should invest in index funds because most mutual fund managers don’t beat the market. (She’s correct.)

In 2005 she said:

“If you truly want a one-fund solution, I would recommend investing in a “total” stock market index or an “extended” market index. These funds own an even wider array of stocks than the S&P 500, which is focused on large established companies. The broader total and extended market indexes also hold mid-size and small stocks; it’s a great way to get exposure to all strata of the U.S. market.”

But recently, Suze Orman has changed her mind about what you should be investing in.

Now, she says, index funds are “out.”

You should be actively managing your own money. From June’s Money Magazine:

Q. You used to be a big fan of index funds. Now you’re not.

A. I know, I know. I’m switching for the first time in my life. All the stats say that index funds outperform 80% of managed funds out there. And a few years ago I’d have said just buy Vanguard’s S&P 500 index fund or its Total Stock Market index fund.

But today I think you have to be more active, and I like exchange-traded funds that let you own particular sectors, like iShares MSCI Emerging Markets, United States Oil Fund or the Metals & Mining SPDR.

Q. Oil and mining? You obviously aren’t worried that commodities are the next bubble.

A. No. I think it’s absolutely possible you could see oil go to $150 or $160. I’d never tell you to put 100% of your money into anything. But I think in this economy you need to manage your money more actively.

Suze Orman is admitting Wall Street’s dirty little secret: in bear markets, index funds don’t work.

If you invested $1000 into the S&P 500 index in March 2000, when the NASDAQ was peaking, by April 2007, it would have been worth less than $1000 (all dividends reinvested.) You would have lost money in those seven years.

And your return isn’t that much better if you continued to hold it until 2008.

The SPY (the S&P 500 Index) is down 9.32% through May 31, 2008.

Its one year performance is down 5.28%.

Over the last three years, you actually gained 5.73% a year. Not awful, but not stellar either.

No wonder most investors keep saying, “you can’t make money in the market.”

It certainly seems that way- if you’re in the index funds.

That’s why Suze Orman is saying to get out of the broad indexes. In a bear market, only certain sectors will outperform. In order to get larger returns, an investor has to figure out what those are and invest more strategically in those sectors.

That’s why stock picking becomes key in bear markets. Because, as Jim Cramer always says, there is always a bull market somewhere!

Heed Suze Orman’s advice: invest some money in specific sectors- instead of the broad market. In bear markets, indexes get mauled, but your portfolio doesn’t have to.

Every investor wants to hear a guru tell them he (or she) can make them money.

We all want to hear it’s easy. We all want to be told that there’s some method that can make us 20% a year.

And we’re willing to pay big bucks to get any information that might lead us to the holy grail of investing: year after year of blockbuster returns.

This is why we’re willing to buy the books, go the seminars, and pay thousands of dollars for newsletter subscriptions that are supposed to give us the answers.

But they never do.

Beware of those who tell you they can make you rich if you just listen to them.

Jim Cramer might come to mind- but I actually like Mr. Mad Money. He tells you you’ll have to work at it to get rich. And he doesn’t say he has all the answers. He makes investing fun. I’ve bought his books. They’re good reads.

But then there are others, like Lenny Dykstra.

Lenny who?

If you’re a baseball fan, you’ll recognize the name because Lenny Dykstra used to play outfield for the Philadelphia Phillies in the 1980-1990s. He’s retired now, but he’s reinvented himself as an investment guru, complete with his own column on TheStreet.com and now, apparently a $1000 a year newsletter.

What does Lenny Dykstra know about investing?

I have no idea.

But hey- he can make you rich, right?

Don’t get me wrong, I think it’s a great story to have a former athlete re-invent himself and actually be “good” at some other profession. Only, apparently, Lenny isn’t all that he seems.

But first- let’s look at the gushing. The New Yorker did a feature story on him in March 2008:

Improbably, he has since become a successful day trader, and he let me know that he owns both a Maybach (“the best car”) and a Gulfstream (“the best jet”).

Lesson #1: Stay away from an investment guru who tells you what kind of car he drives.

The man didn’t even use a computer until after 2003, but apparently he’s a stock picking genius:

“My approach in investing is much the same as my approach to hitting,” he wrote. “I would rather take a walk or single and reach first than shoot for a home run and strike out swinging.” According to The Street’s “Stat Book Scorecard,” Dykstra’s picks earned $183,650 on a hundred and three trades in an eight-month period last year.

“He had an Amgen trade,” Cramer said, referring to the biotech company. “It was like hitting the ball between the shortstop and the third baseman in a way that made me feel proud.”

He went on, “I have yet to meet anyone other than Lenny from the world of sports who was able to make the transfer so that they have something to say that has value added. Many sports figures have been successful salesmen, but I would most likely have hired Lenny at my hedge fund, back when I was doing that.”

Dykstra is now working on a book about investing, with the literary agent David Vigliano, whom he calls “the No. 1 book agent in the country.”

Lesson #2: Never invest in hedge funds that hire investment gurus.

But it gets better. Apparently Lenny wasn’t picking the stocks after all (at least not from the entire world of stocks.) According to a recent article in Forbes Magazine, Lenny was allegedly getting assistance from another stock analyst who had his own newsletter who provided Lenny with a list of stocks every morning.

Granted, Lenny still had to pick from those stocks for his own picks. But it doesn’t take an investment genius to do that.

From Forbes:

“At Dykstra’s insistence, Doubledown began negotiations to pay Richard Suttmeier, a stock analyst, to provide Dykstra with research assistance for the Dykstra Report and who, upon information and belief learned subsequently, provided Dykstra lists of recommended stocks daily.”

Who is Richard Suttmeier? A market strategist for financial Web site RightSide Advisors and formerly a contributor to RealMoney.com, a subscription Web site owned by TheStreet.com.

Suttmeier, 64, says he got his Wall Street start trading Treasurys in the 1970s. He later bounced around second-tier investment banks and landed at RightSide in 2006.

Suttmeier says that after he did a television appearance several years ago he received a call from Dykstra. “He wanted to learn how to read a [stock] chart,” Suttmeier says. “I taught him.”

The two men have kept in touch ever since. Suttmeier says Dykstra calls from time to time asking where to add to positions. Suttmeier also e-mails Dykstra a spreadsheet of stocks each morning but denies that he picks stocks for the former ballplayer.

“I am not his brain,” Suttmeier says. “Dykstra makes his own trading decisions.”

Lenny was going to charge $995 a year for his newsletter. Suttmeier charges $300 a year.

Lesson #3: Never pay $1000 a year for investment advice- especially from a guru.

What are you really getting anyway?

Hopes. Dreams. The lure of the holy grail.

Resist!

Save your money. The only “guru” you should know is Warren Buffett. You can get his advice for free every few months in interviews.

What will become of Lenny Dykstra, investment guru?

Stay tuned.

This week’s issue of Businessweek has an intriguing article called “Taxing the ‘Not-So-Rich’ Rich“. It’s all about how those earning $200,000 to $300,000 are also feeling squeezed by the rising gas prices, higher health care costs and higher college costs.

Take this family in Philadelphia:

By any measure, Dr. Howard Hammer and his wife, Hope, have a comfortable life. Hammer, 40, has built a thriving practice as an ear, nose, and throat specialist, while Hope, 39, has switched to part-time work as a real estate lawyer after years at a big firm in order to spend more time with Arielle, 7, and Matthew, 9. Home is a four-bedroom house in the Philadelphia suburbs, and between them, they bring in over $300,000 a year. “We can’t complain,” he says. “We’re certainly not struggling.”

According to the article, they are paying:

1. $3,000 a month for their mortgage
2. $2,000 a month to pay down his $160,000 medical school loans

Yet- things are tight for them.

A six-year residency gave Hammer a delayed start saving for retirement, so he worries if he’s stashing enough in his 401(k). By the time the couple contributes to the children’s college fund, there’s little extra at the end of the month.

How can that be?

Even after taxes, they are taking home at least $150,000 (and that’s on the low side.) Let’s just say $12,000 a month.

We know $5,000 a month goes towards the mortgage and the medical school loans.

Let’s say another $2000 goes into their kids college fund ($1,000 each a month).

That still leaves $5,000 for cable tv, telephone, food, entertainment, car payments, gasoline etc.

Seems to me that they should have PLENTY of money left over to, say, stash at least $1,000 a month into a stock fund.

So why do they say there is “little left over”?

We aren’t getting the full story here. Some expenses are missing from this tale.

What the Upper Middle Class Truly Earn

Only 3% of all Americans report income in the $200,000 to $500,000 range. Only 1% report over $500,000 a year.

And these people are feeling the squeeze too?

The article argues that it may seem like a lot of money, in, say, Iowa, but in the New York or San Francisco metropolitan areas, you’re barely getting by.

And that’s partially true- because of the incredible cost of housing in those two areas. But there are teachers, nurses and librarians all living in those areas as well- and somehow they manage to get by.

Here’s another example from the article:

Yet for many close to that $250,000 cusp, what sounds like a lot of money often doesn’t feel like it. “Depending on where you live, $250,000 is middle class, at best,” says Michael Ginn, 49, a longtime media executive who lives with his wife, Dafne, 34, and 3-year-old daughter, Erin, in the New York suburb of Pelham; their second daughter is due in July.

Though his income has topped $300,000 for more than a decade, Ginn says he’s never felt so stretched. With the cost of everything from health insurance to upkeep on his 90-year-old home surging, even as he takes on new expenses for his growing family, Ginn can’t stash away anything near what he once did for retirement, let alone save for college.

“We’re just dog paddling now,” he says. He argues that if Washington is going to raise high-end taxes, then the local cost of living should be taken into account.

So- he’s made $3 million in just the last decade. Did he save even 10% of that? Let’s say he had. He’d be VERY well-off right now. He’d a juicy amount of money in a stock fund if he did some basic investing in a diversified portfolio of blue chip stocks.

Again- the article doesn’t tell us the REAL story. Where did all the money go? Why was nothing saved? He has a 3-year old, not a teenager, which costs more money. Maybe the house is simply too expensive?

If these richer people can’t save for retirement or college, how are the rest of us supposed to do it on incomes that are half or a third less than this?

I shudder to think.

Many of you will be better off than both of these families if you simply save a few hundred dollars a month in the stock market and let it grow.

Just because you make a lot of money, doesn’t mean you’re WORTH a lot of money.

Google has a P/E (price to earnings) of 41.

Research in Motion (RIMM) has a P/E of 60.

MasterCard (MA) has a P/E of 29.

What do these stocks have in common? They are all expensive. But the shares have taken off and investors keep buying. The usual investor belief is that they’re “growing” so that growth justifies the expensive price.

But does it?

Mark Hulbert, a columnist with Marketwatch.com, had an interesting article the other day about Pfizer. You remember Pfizer- one of the largest drug companies in the world. If you bought Pfizer in 1990, you would have been very well off (i.e. “rich”) by 2000.

But after 2000? Not so much. In fact, the stock has been “dead” for the last 8 years. Even with a nearly 5% average dividend over this time period, all that the stock has done has gone down. In May 1998, PFE traded around $37. Today, it’s at $19.95.

Sales grew 250% over the past decade; far outpacing the growth rate of the overall stock market. Earnings per share also grew by about as much, as did sales.

With all that growth- why is the stock dead?

Because, as Hulbert points out, in 1998, the stock was trading at 51 times earnings. In other words- it’s P/E was 51- far higher than the stock has historically traded.

Pfizer’s P/E right now?

18.

Is it “cheap” now? Not really- but it’s getting there.

No company grows at over 20% for forever. Not even Google.

The point of Pfizer is that investors thought that the growth could save the stock and that it would trade at 50 times earnings for forever. No stock EVER does.

Starbucks has historically traded above 30 times earnings. This premium was paid mainly because investors believed in the “growth.”

Now- as growth appears to be slowing, the stock has been slammed. It’s P/E now? 18. And the stock continues to slide.

P/E does matter. Don’t think otherwise. While it shouldn’t be the only consideration you look at when investing- it definitely should be among the criteria you use when buying stock in a company. No company can keep up the hyper growth forever. Don’t overpay for your favorite company.