STOP PICKING STOCKS! IMMEDIATELY! says reformed stock picker Henry Blodget

Advice for Ordinary Individual Investors

Experienced and successful investors recommend for several reasons that it's a mistake for ordinary investors to try to pick stocks.

First and foremost is that the ordinary individual investor is nearly always at the "bottom of the food chain," the last to get the good news and the last to get the bad news about events likely to affect a company's stock price.Trading on "inside" information is more common than Wall Street will admit. A Goldman Sachs director and former Procter and Gamble director was recently convicted of providing inside information on Goldman and Procter and Gamble stock which resulted in allegedly illegal profits to the Galleon hedge fund. (See link below.)

Second, trading costs drag investment returns down. Ditto for taxes on capital gains.

Third, stock brokers make their living by getting their customers to buy and sell stocks. Thus, their interest inherently conflicts with the interest of their customers.

Fourth, most people have jobs and other activities that don't allow them to spend the time required to research stocks thoroughly before buying them and keep up with each stock's outlook after it's purchased.

Finally, most people don't have enough money to invest to permit sufficient and prudent diversification by buying individual stocks. Prudent diversification requires investments in many companies, large and small, domestic and international as well as a significant part of the portfolio in investment grade bonds. Investment guru John Bogle, inventor of the index fund, recommends a percentage bond component in the portfolio equal to the investor's age. That is, an investor who is 50 should have 50 percent of his funds in investment grade bonds, preferably government bonds.

No-load, Low-cost, Tax-efficient, Index Mutual Funds Mayh be the Best Answer

Many of the best investor advisers including the ones linked below recommend that ordinary investors buy no-load (no sales charge or sales commission), low cost, tax efficient, index mutual funds of the type offered by Vanguard. Vanguard funds are not operated for profit by Vanguard. They are owned and operated solely in the interest of each mutual fund's investors. The is no sales charge to invest in any Vanguard fund and the costs are by far the lowest in the mutual fund industry. Moreover, Vanguard's index funds trade very little which minimizes the taxes on taxable investments and keeps the funds' costs low. Low costs and low taxes add up in the long run.

The best advisers also strongly recommend against attempting to time the market. Studies have shown that many or a majority of people tend to jump into the market as it nears a peak and become discouraged or panicked and sell when the market is low, thus buying high and selling low, a recipe for disaster or sub-par returns. The best way to building a nest egg for retirement is to save and invest steadily, each month and stay invested. Timing the market is very difficult especially in recent years when stocks have tended to move upward and downward quite suddenly, sometimes due to what are called unpredictable "black swan" events, with the result that if you're out of the market when there's a big move you miss out on a significant part to the rally.

Plenty of advice is available on line and on the phone for Vanguard investors. This enables most people to manage their own investments without paying an investment adviser. But if you do feel in need of advice, avoid advisers who are compensated by commissions on the funds and other products they sell. Why? Because as in the case of stockbrokers their interest tends to conflict with the interest of their clients because they tend to sell the funds and products that pay them the highest commissions which are not necessarily the best for their clients. Instead, seek out a good fee for service adviser who will analyze your needs and recommend the funds that will meet them without being influenced by commissions.

There is no single magic mutual fund portfolio formula. The simplest approach is to invest in only in a single total stock market index fund and a single total government bond fund. Many simply invest in an Index 500 fund plus a bond fund. Another way to go is to invest equal amounts in an Index 500 fund, an Index Small Cap (small companies) and a broad International Index Fund, plus an appropriate amount in a government bond fund.

Increasing Correlation Among Markets Impedes Diversification

I just finished an interesting article by Jeff Sommer in the NYTimes, April 3, 2011 which points out that in recent years the correlation among investment markets of various types around the world has increased considerably. Recent research shows that "when the risk is on" or when the "risk is off," bonds and equities go down or up together. This correlation in the movement of most types of assets diminishes the security provided by diversification more difficult to achieve. If stocks and bonds go upward and downward together it may be that keeping a bond component equal to one's age, as recommended by John Bogle. may not avoid risk to the extent intended. However, even if equity and bond movements are correlated, shorter duration bonds are not likely to fluctuate as widely as equities. What's the answer? Cash or gold buried in the back yard? Keeping a constant bond-equity-cash ratio and riding the fluctuations out may be the best answer for those with a long time horizon.

I'll keep an eye out for an answer from the experts. Jeff Sommer's article is linked below.


Words of Wisdom from Warren Buffet

"When you combine ignorance and borrowed money the consequences can get interesting." (With reference to housing bubble.)

"When the tide goes out you can see who's been swimming naked."

"We try to be cautious when others are greedy and greedy when others are cautious."

To which John Bogle would respond, "Easier said than done."

Are You Brilliant, or Lucky? Jason Zweig in the Wall Street Journal

Are You Brilliant, or Lucky?

  • By JASON ZWEIG

Have investors finally learned that past performance doesn't guarantee future results?

You might think so. Investors are dumping mutual funds run by fallible stock pickers and replacing them with index and exchange-traded funds—"passive" portfolios that mimic the market rather than trying to beat it. Over the past 12 months, according to Morningstar, investors have pulled $132 billion out of actively managed stock funds and added $57 billion to passive funds.

But you would be foolish to conclude that investors no longer believe they can identify tomorrow's best money managers today. And, unless you turn traditional thinking upside-down, you would be even more foolish to share that belief with them.

Just look at what is going on in bond funds. Since the beginning of 2009, investors have added $1 trillion more to bond funds than they have withdrawn. Of that, says Morningstar analyst Michael Rawson, $751 billion—fully three-quarters—went into actively managed funds.

But interest rates are at record lows and bonds of all stripes pay similar yields. And most managers are boxed into specific areas of the bond market, limiting their ability to outperform. As a result, most active bond funds don't stand a snowball's chance in Hades of outperforming an index fund that costs one-tenth as much.

So investors haven't learned that it is hard to pick funds that will beat the market. They have merely learned that it is hard to pick stock funds that will beat the market.

When it comes to selecting bond funds, hedge funds, the short-term trading firms called "tactical asset allocators" and many other approaches, people remain as convinced as ever that past performance predicts future success.

Michael Mauboussin, chief investment strategist at Legg Mason Capital Management and author of "The Success Equation: Untangling Skill and Luck in Business, Sports and Investing," published last month, has some answers to this puzzle.

Precisely because most professional investors are so skillful, he says, their results end up being differentiated largely by luck, much the way contests between equally matched great athletes are often decided by a bad bounce of a ball. Just as athletes rarely admit that luck turned the tide, investors attribute differences in performance to skill alone.

In one classic experiment, people guessed the outcome of a coin toss. When told they got the first four tosses correct, they concluded on average that they would be able to guess 54 of the next 100 coin flips. "When you observe a good outcome," Mr. Mauboussin says, "your mind concludes that there must be a good process going on."

So when a fund puts up good numbers, you will naturally be inclined to think it has a sustainable edge.

If one manager beats the market by 10 percentage points by sheer guesswork, that number alone will make him seem like a genius, preventing many people from questioning whether he was just lucky. Another manager who outperforms by 0.2 percentage point with a sensible strategy over a longer period might never attract your notice at all, even though he is likely more skillful.

Outcomes don't just grab your attention more than process does; they are much easier to measure. So most investors look for top performance first. Only then (if ever) do they ask how it was earned.

Instead, Mr. Mauboussin suggests, investors should turn that thinking upside-down. Start by studying a fund's process, which has three components: analysis, or how the manager assembles the portfolio; behavior, or how the manager responds to the emotional extremes in the market; and organization, or how the business is structured to ensure that investors' interests come first.

You can size up a manager's analytical process by seeing how the portfolio differs from average. If the names and size of the top holdings are essentially indistinguishable from those of an index fund in the same market, you aren't looking at a future superstar.

A manager with a good behavioral process makes decisions based on policies and procedures, not intuitions—and doesn't credit good returns to his own brilliance while blaming bad results on irrational markets, financial crises or bad weather. The manager's letters to investors will give you an intuitive—but imprecise—feel for this.

Finally, is the firm owned by a giant conglomerate that cares only about maximizing its own profits? Did the fund launch when its investments were so popular they were overpriced? Has the manager closed funds to new investors when too much money came in to manage prudently?

Only after a fund or other investment strategy passes these tests should you look at its performance. That is at least as true for bond funds as for stock funds.

And if you aren't willing to spend the time ruling out luck as an explanation for performance, exercise a simple skill of your own: Buy an index fund instead.

A version of this article appeared Dec. 7, 2012, on page B1 in some U.S. editions of The Wall Street Journal, with the headline: Are You Brilliant, or Lucky?.

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10 comments

roundup profile image

roundup 9 years ago

I enjoyed the Slate article. Makes sense to me.


Ralph Deeds profile image

Ralph Deeds 5 years ago Author

Why are markets so highly correlated? The answer may be found in “risk on, risk off,” a bit of jargon favored by financial traders and strategists. The phrase describes a simple, binary decision — whether to buy high-risk, high-return assets like stocks, or to move to a position of greater safety — that has come to the fore since the brutal financial shocks of 2008.

http://www.nytimes.com/2011/04/03/your-money/03str...


Ralph Deeds profile image

Ralph Deeds 5 years ago Author

http://dealbook.nytimes.com/2011/04/07/a-standard-...

We are told that beauty is in the eye of the beholder. That also appears to be the standard for determining whether information was “material” to establish securities fraud.

Materiality has become the focal point in the prosecution of Raj Rajaratnam, the co-founder of the Galleon Group, for insider trading. The defense contends that information prosecutors say was provided to him by insiders was already publicly available to investors, so there could be no fraud if the information could not affect the price of the stocks he traded.


Ralph Deeds profile image

Ralph Deeds 5 years ago Author

In Citigroup Case, a Crack in Wall Streets Defenses - NYTimes.com

In a case involving Citigroups Smith Barney unit, arbitrators say the financial crisis cant be blamed for all losses. TWO investors just scored a remarkable win against Citigroup. A few weeks ago, the pair was awarded a total of $54.1 million.

http://www.nytimes.com/2011/04/24/business/24gret....


Ralph Deeds profile image

Ralph Deeds 5 years ago Author

5-13-11NYTimes--Does Your 401k Plan Offer Index Funds? It should!

Index Funds Should Be Offered in 401(k) Plans - NYTimes.com

Index mutual funds are not required to be offered in 401(k) plans, but they should be, because of their many advantages over actively managed funds.


Ralph Deeds profile image

Ralph Deeds 4 years ago Author

7-16-12NYTimes--Big Investors Get an Edge from Brokerage Firms

Hedge Funds Tap Into Early Views of Stock Analysts - NYTimes.com

Polling analysts on their outlooks for a given company has become a way for large Wall Street firms to discover trading advantages from information that might not be public yet. Hedge funds get an early peek in changes in analysts recommendations.


Ralph Deeds profile image

Ralph Deeds 4 years ago Author

7-18-19NYTimes EDITORIAL "Not All Investors are Equal"

Not All Investors Are Equal

In the Facebook fiasco, brokerage firms that sold Facebook’s initial shares apparently warned large investors about doubts from analysts regarding the company’s prospects. Many ordinary investors who were not warned sustained considerable losses.


Ralph Deeds profile image

Ralph Deeds 4 years ago Author

9-15-12WallStreetJournal--SEC Fines NY Stock Exchange $5 Million for Delivering Advance Data to Preferred Customers

NYSE To Pay $5 Million Penalty to SEC - WSJ.com

NYSE Euronext agreed to pay a $5 million penalty to settle SEC allegations that it gave some New York Stock Exchange customers an improper head start on trading information.

Another good reason for ordinary investors to avoid the loser's game of picking stocks.


Ralph Deeds profile image

Ralph Deeds 3 years ago Author

June 10 & 17 The New Yorker "Inside Tracks" by James Surowiecki

James Surowiecki: Why Is Insider Trading on the Rise? : The New Yorker

There’s a host of evidence that insider trading has become widespread. The scope of something so clandestine is inherently difficult to pin down, but the number of insider-trading referrals to the S.E.C. from FINRA keeps going up.


Chuck Bluestein profile image

Chuck Bluestein 3 years ago from Morristown, AZ, USA

There are always exceptions. Tesla stock (TSLA) was $31 a share September 19, 2012. Today a year later it closed at $177.92 a share. They are also selling in Europe and China. They are looking to hire an engineer so that the car can drive itself in 3 years. They are building charger stations around the U.S. and the world.

Although this is not the main job of Elon Musk, CEO of Tesla Motors. His main job is CTO (chief technology officer) of SpaceX (also their CEO). So his main job is as a rocket scientist. He is a billionaire genius.

It is not too late for people to buy Tesla stock now and tell their friends and children years from now that they bought Tesla stock while it was still under $200 a share.

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