Why Most of the Investment Advice You’ve Heard is Wrong
by Alexander Green, Investment U Chief Investment Strategist
Friday, January 20, 2012: Issue #1691
A conversation with a friend last week sounded numbingly familiar.
“I just can’t seem to win for losing in the stock market,” he confessed. “Five years ago, my broker had me fully invested in stocks and I took a drubbing. Then when things were bottoming out a couple years later, he talked me into making my portfolio more conservative. As a result, I didn’t get much of a pop on the rebound. Now he’s trying to get me to reshuffle again. But I’m too scared to do anything.”
Since he was a friend, I felt obliged to tell him the truth: He’s getting lousy investment advice. Not because his broker failed to outguess the market… but because he’s guessing at all. As if that wasn’t bad enough, there’s a good chance that the advice he’s getting is tainted by self-interest.
Here’s what I mean…
It still astonishes me that the vast majority of investors – even ones who have been active for decades – still don’t understand that stock market success has nothing to do with figuring out the economy.
Look back at history. There’s no correlation between economic growth and stock market performance from year to year. Equities routinely plunge during the good times and rally during the bad. If you know this – and truly understand it – why would you invest your money based on someone’s economic forecast?
The same is true of market timing. It’s easy to look in the rearview mirror and see when you should have been in the market and when you should have been out. But when you look ahead, it is always a blank slate. No guru or trading system can change that.
Even if you could somehow divine what the stock market was going to do next – which you can’t – you still wouldn’t know which stocks would outperform and which ones would lag.
The only way to determine that is to look at business fundamentals. Companies that are doing all the right things – increasing sales, compounding earnings at high rates, growing market share, improving operating margins, paying down debt, buying back shares – will post superb returns, regardless of what the economy or stock market are doing. And those that are doing the opposite – experiencing flat or negative sales, lackluster earnings growth, small margins, high interest costs and diluting existing shareholders with new stock issues – will be laggards.
In short, stock market success is about analyzing businesses not investing in some self-styled expert’s macroeconomic forecast. Yet that’s exactly what the mass media and much of the investment advisory industry encourages people to do every day.
The media does it to attract viewers – and thus advertisers. The advisory industry does it sometimes out of ignorance but often just to justify its fees. This is especially true when you have a transaction-based relationship with an advisor where the more you trade the better he or she is compensated. Trust me. That doesn’t generate satisfactory long-term returns.
Every time you hear a pundit talk about “the new normal,” the rally just ahead or the prolonged economic slump we’re likely to endure, understand that you’re listening to opinions that are no more helpful than a weather forecast for three weeks from Sunday.
Both pieces of advice are worthless. But one is a lot more expensive – and harmful – than the other.
Good Investing,
Alexander Green
Related Investment U Articles:
- Is the Media Gaming You?
- Is Apple the Perfect Growth Stock?
- Tech Bubble or Just Hot Air? You Be the Judge…
- PepsiCo Rises on Third-Quarter Earnings
- Why You Should Invest in Growth, Not Value
8 Responses to “Why Most of the Investment Advice You’ve Heard is Wrong”
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Alexander Green is the Chief Investment Strategist of Investment U. A Wall Street veteran, he has more than 20 years of experience as a research analyst, investment advisor, financial writer and portfolio manager.
RIGHT ON THE MARK!!
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GOOD COMMENTS AND ENCOURAGES ME TO GET RID OF A LOT OF GARBAGE SUBSCIPTIONS THAT I NOW HAVE
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Very sound advise when applied to your personal account. Unfortunately I think it is necessary to try and time the market at it’s extremes when you are trying to manage your 401K investments which are limited to certain mutual funds familys otherwise the return you receive is generally the S&P index return if you are lucky..I know I can’t time the market but I prefer to give up some upside it I can avoid the 20% to 25% corrections. I have no clue where the market will be in the next month but base on it up over 20% since Oct probablity is it will be down within the next 3 months so I go to cash in my 401K and if it goes down 8-10% invest half back into the market and see what happens. If my 401K allowed me to select individual stocks then I would take your approach without a doubt and just follow your stock recommendation. It is a lot more work and of course I miss some of the upsides but it is so hard to come back from a 20% decline.
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A couple of things. I got similar advice. During the run up to the crash, my advisor was telling me that my misgivings about the economy were all wrong. Then in December of 08 he suggested securities that insured you against market drops, while limiting your upside. Dow was 9000, we had a new President coming in and no one knew what was coming. I said it was a good idea. He got back to me in Feb 09. I said “look, the Dow is now 6600, how much lower can it go? And we know what the government will do, they will print money.” He replied that they were responding to clients concerns. I was dumbfounded. “So, if your clients panic, you will too?” I said. I told him he should be buying. Shortly thereafter I decided to find my own advice.
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I do disagree that you can’t look at the economy. Major things CAN be seen. 2 examples. In early ’08 a lot of economic markers looked bad. Many of the forecasts for stocks just didn’t make sense. Not that I predicted THAT kind of crash, but I did get conservative. Second was the dot com crash. It was a momentum driven market, people bought stocks just because they were going up. The technicals on momentum turned lousy about 6 weeks before the market crashed. If you followed them you were OK. The problem was that many people convinced themselves that they weren’t buying momentum but a new way of determining value. That’s what got them into trouble. They ran past all the yellow caution flags that were out there because they refused to believe them or were afraid to lose customers if they were wrong.
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Essential content and well written.
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How true. My example is the recent runup in the price of gold should have resulted in increased earnings for gold supplying companies ( ie Goldcorp ) yet the percentage increase in gold did not result in the same general increase in share prices. Interesting that when a company has just had its selling price raised for its production by 50% can’t earn significantly more money and thusly have a higher P/E ratio driving up the price of its stock. Imagine if you ran a company that obtains a 50% increase in sales ( without any corresponding increase in cost of sales ) and you don’t have to do anything innovative. Don’t you think revenue should increase significantly ? I sometimes wonder what really drives share prices ? It obviously is not the economy.
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Wise words indeed. Makes me feel a lot better about the world I leave in. Where hard work is still be best way to success.
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