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.
NYTimesBusiness 3-15-15 "How Many Mutual Funds Routinely Beat the Market? ZERO by Jeff Sommers
"The study seemed to support the evidence suggesting that most people shouldn’t even try to beat the market: Just pick low-cost index funds, assemble a balanced and appropriate portfolio for your specific needs, and give up on active fund management.
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.
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.
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.
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.
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.
5-12-11NYTimes--Rajaratnam's Invaluable Circle of Friends
- Galleon Chief's Network of Friends Who Tell Secrets - NYTimes.com
What made Raj Rajaratnam stand out in the hedge fund world was his deep set of contacts inside Silicon Valley executive suites and on Wall Street trading floors.
4-24-11NYTimes "A Crack in Wall Street's Defenses"
- 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.
4-7-11NYTimes--"Materiality--A Standard that Raises More Questions Than it Answers"
- A Standard That Raises More Questions Than It Answers - NYTimes.com
Figuring out what constitutes material information is largely an exercise in futility because the Supreme Court has adopted a definition so vague that almost any tidbit about a company could fall within it.
Line Dancing with Correlated Markets by Jeff Sommer NYTimes 4-3-11
- When the Markets Move as One - NYTimes.com
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. Why are markets so highly correlated? The answer may be found in risk on, risk off, a bit of jargon
3-27-11FreePress--Black Swans Frequent the Stock Market, Gail Marksjarvis
- Black swans frequent the stock market | Detroit Free Press | freep.com
Who would have ever thought we'd see so many black swans so close together? Black swan events, whether in the stock market, economy or nature, are supposed to be stunningly unexpected, like spotting a black swan when you thought swans were only whit
Black Swan Theory--Wikipedia
- Black swan theory - Wikipedia, the free encyclopedia
The Black Swan Theory or Theory of Black Swan Events is a metaphor that encapsulates the concept that The event is a surprise (to the observer) and has a major impact. After the fact, the event is rationalized by hindsight. The theory was developed
Why Benjamin Graham, the World's Greatest Stock Picker, Stopped Picking Stocks by reformed Stock Picker, Henry Blodget
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."
If you are playing "beat the benchmark," don't expect to win
- If You Are Playing Beat the Benchmark, Don't Expect to Win
IF YOU'RE PLAYING 'BEAT THE BENCHMARK, DON'T EXPECT TO WIN N.Y. Times financial columnist Paul J. Lim points out that only a minority of actively managed mutual funds beat the broad S & P 500 benchmark. ...
"Winning the Loser's Game" by Charles D. Ellis
- Winning the Loser's Game by Charles D. Ellis
Here's some more good advice on personal investing. Ellis and Swensen are on the same wave length--no load, low-cost, tax-efficient index funds such as those offered by Vanguard.
Who is Charlie Ellis?
Crook Alert! Mutual Fund Conflicts and Crooked Practices
- CROOK ALERT!! MUTUAL FUND CONFLICTS AND CROOKED PRACTICES
Excessive Mutual Fund Fees Penalize Returns and Retirement Savings Over a lifetime, expenses can have a devastating effect. Just 1 percent annually will eat away more than 40 percent of your nest egg over 60...
3-23-11Goldman Sachs Chief gets Starring Role in Galleon Insider Trading Trial
- Goldman Sachs Chief Gets Starring Role at Galleon Trial - NYTimes.com
Lloyd C. Blankfein told jurors that Rajat K. Gupta, a former Goldman Sachs director involved in the case against Raj Rajaratnam, was in a position to know privileged information. Blankfein said he "had an inkling" about the SEC investigation of Gupt
Goldman Sachs Managing Director Accused of Providing Insider Trading Tips
- Ex-Goldman Sachs Director "Doing the Lord's Work" Accused of Providing Insider Trading Tips
Rajat Gupta, ex-Goldman Sachs director and, until he resigned last week a director of Procter and Gamble was charged by the Securities and Exchange Commission with giving inside information to Raj Rajaratnam...
3-30-11NYTimes "Ex-Galleon Worker Tells of Firm's Insider Trades"
- Former Galleon Employee Tells of Firm's Insider Trades - NYTimes.com
Adam Smith, a government witness, testified in federal court that he received and passed along tips about technology companies to Raj Rajaratnam, the head of the Galleon Group.
"Free Rolls"-- Why Hedge Funds are Not a Good Deal for Investors
- FreeRolls--Why Hedge Funds and Stock Options are Not a Good Deal for Investors
The compensation terms for hedge fund managers and for many corporate executives ostensibly are designed to benefit investors by rewarding performance by the fund or corporation's top managers. In practice...
Stock Market Analysis for Sophisticated Investors Only!
Official Vanguard Site
- Vanguard - what we offer - Vanguard\'s products and services
Learn about the investment options and account services that Vanguard offers.
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?.