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June 01, 2005

"Pick Winning Stocks! You Can Time the Market Like a Pro!"

Guess what? This is the dirty little secret of Wall Street.

 

The financial services industry make their money by selling you the impossible - a pipe dream - the ability to consistently predict the unpredictable.

 

Just today, the following advertisement arrived in my inbox, courtesy of Barron's:

 

Not only will The Money Show be in a brand-new location, it will feature a brand-new focus as well: stock selection and real estate investing for income & growth.

 

Since when are these new? Hasn't Warren Buffett very recently warned investors away from both stock picking and real estate?

 

Selecting which stocks are right for your portfolio can be a daunting and time-consuming task.

 

Don't you mean an impossible task?

 

Adding real estate to the mix, especially now in the face of rising interest rates, can be even more confusing.

 

As if stock picking wasn't foolish enough, you also want us to try to time interest rates, something our most learned and esteemed economists are unable to do?

 

Experts in both arenas will help you narrow down the plethora of possibilities and provide you with timely and actionable advice on how to incorporate both into your portfolio.

 

Experts? You mean bell-ringers, candy men, cheap jacks, dealers, drummers, hawkers, hucksters, medicine men, merchants, outcriers, pitchmen, pushers, and peddlars, don't you?

 

Last week, I posted an investment scenario and listed six mutually exclusive alternatives for investing your money. I asked which you would pick at different ages.

 

Just to remind you, the scenario was that you had accumulated $100K in retirement funds. We have a crystal ball that tells us twenty years from today, the S&P 500 will be either 20% higher or lower than it is today but it doesn't tell us which way it will go, only that the odds are 50/50. No other outcomes are possible.

 

The choices were:

 

A. Buy and hold a market basket of stocks and hope that it goes up 20% instead of down 20%

B. Try to time the market - get in when it is going up and out when it is going down

C. Try to pick stocks using historical data, company fundamentals, technical analysis, sector analysis or some other stock-picking methodology

D. Put your money in bonds which will return on average about 5% but have a small risk of loss

E. Put your money in a principal protected cash equivalent like CDs paying 2%

F. Put your money in an investment that will lose significant value if the market declines but will generate a consistent cash flow of approximately $1000 per month over the ten year period.

 

I asked which of these investments you would choose at age 35 and at age 55, if you had to pick only one and were locked in for the entire twenty year period.

 

In comments left in response to my post on the "buy and hope strategy", some people seemed to have missed the point. Whether the scenario unfolds over twenty years (less likely but still very possible) or five years (more likely), doesn't matter.

 

Dead money is a sin. And that is what you have for as long as your portfolio remains underwater in a capital appreciation investment strategy foisted on you by an industry that makes a lot of money from your naïveté.

 

So let's not focus on the number of years. It's irrelevant. It's the general concept I want you to understand. Also, as I did in the first scenario analysis, let's increase the starting number to $1 million instead of $100K, just to make it more realistic.

 

With that being said, let's dispatch choices 2 and 3:

 

Market timing and or stock picking - the evidence is pretty overwhelming here that neither of these two things do anything but lose you money. And yet, consciously or unconsciously, it is what most people do.

 

I have written on both pretty extensively on this blog, and pound on both relentlessly on my radio show. But for the uninitiated, here is a recap:

 

This is what you are trying to time or pick stocks in. This is the return of the U.S. stock market, by year, going back to 1873.

 

 

According to 2004 congressional testimony, the average managed mutual fund returns 2.5% to 3% less than the market and 80% of managed funds under-perform the market return in any given year. These guys get paid millions of dollars a year and they can't do it.

 

According to the database maintained by Hulbert's Financial Digest, the risk adjusted return of the average newsletter writer is less than half that of the market itself. They have every financial incentive in the world to out-perform the market - wouldn't you agree? They can't do it.

 

In a first-of-its-kind study of the trading records of 78,000 households who pick their own stocks done by Brad Barber and Terry Odean, the results were exactly what you would expect. Again, the stock pickers were performing worse than the market itself. We can't do it.

 

According to the Quantitative Analysis of Investor Behavior which has been done every year for over 20 years by Dalbar, a Boston research firm, the average stock mutual fund investor has had an average return of only 2.5% annualized over the last nineteen years - a period in which inflation has risen annually at the rate of 3.1% and the S&P 500 by 12.2%!

 

Look at the chart above. Imagine when those bars are going up, your portfolio isn't going up as much. And imagine when those bars are going down, your portfolio is going down more! The evidence is overwhelming. That is exactly what is happening to the vast majority of people who try to pick their own stocks or hire people to do it for them.

 

So exactly who is making the money here? Because it surely isn't you! Not if you invest by trying to predict the future.

 

If you are going to have to one day live off your portfolio, with little or no assistance from pension or government programs, you need to make as much as you can, as consistently as you can, and avoid losses like the plague.

 

Stock picking and market timing create the exact opposite result.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Posted by Kim Snider on June 01, 2005 | Permalink

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