Why you should not believe the “experts”

Our previous Whitecoat article demonstrated how full time experts running funds and large portfolios can’t beat the market more than the probability of a coin toss. But what about brokers, financial advisers and bloggers offering advice on the next big thing?

Surely they, even if only the more experienced, smartest and credible ones, can be followed as experts in their field? Afraid not, but please read to the end, because otherwise you will just think of us as haters.

For the record, our products at Kernel are not the panacea, we don’t hate property, banks or other type of assets (they all have their place) but we do want to help you understand wealth creation and some of the tricks previously reserved for the rich.

The self-proclaimed stock-picking gurus…

Who write method books or offer subscription-only newsletters. Can they pick stocks, uncover the secret method or help you time the market better? Well, the first question you should ask yourself is “If I had the rare and valuable ability to predict the future and choose the winning stocks and avoid the losers, what would I do?”

Surely you would tell no one and get very rich, very quickly. Or start a hedge fund, be paid a huge salary and bonus to make lots of people very rich, including yourself. In no circumstance does it make sense to sell a newsletter or book to other people and share that information, much less give the information away for free.

So, what does that tell you about the ability to pick stocks of those who sell books or newsletters?

It’s all a clever masquerade

That’s exactly what we find when we look at the data too. Consider this Market Watch article by Paul Merriman that discusses Mark Hulbert and his life’s work — to track the returns of investing newsletters.

Imagine that you’re publishing an investment newsletter. How do you attract attention and get people excited enough to subscribe? You certainly don’t do that by recommending buying index funds and holding onto them. Almost by definition, you have to do something different: something that appears to be “the right thing.” Something that gives your subscribers a reason to think you have something special.

Sometimes that “something special” is a massive amount of data along with a bit of analysis and some predictions….Other times, the “something special” is a system, either subjective or mechanical, for knowing when to get into and out of the stock market. Timing the market is an enormously appealing idea, and once in a while it works very well. But very few investors do well with this approach over the long haul.

Hulbert tracked a dozen timing newsletters, with returns ranging from 0.1% to 8%. The average was 4.3%. The market return over this time period was 5.6%. That 0.1% return, by the way, was from the most famous market-timing letter in the industry, Successful Investing, published by Doug Fabian.

All of the returns in that article, of course, do not include the cost of the newsletter, the cost of the trades, or any taxes due from the often frequent trades, which you would be required to pay if the IRD thought you were a professional trader. Those returns would be even lower.

What about selling shares?

Then there is the problem, even if you believe in your guru, that they rarely tell you when to sell. Now there are a couple of reasons for that. First, people pay for tips to buy, the company to talk about as the next big thing. Plus you wouldn’t want to promote selling a great company with great recent performance too early, effectively telling people the party is over. Nobody likes that guy.

The second issue with stock tip newsletters, is the potential of a “pump and dump”. The ideal scenario is to provide recommendations for small obscure “penny stock” companies, ignored by the professionals. For example, I send to 10,000 “subscribers” a well-reasoned success story full of upbeat stories and half-truths (for a company which I already hold) to watch the demand I encouraged increase the price, to the point where I sell my shares for a tidy profit, while my subscribers are buying. I wouldn’t want to tip you off to reduce my profits! (FYI – this is illegal as would be considered market manipulation).

By contrast are the full service firms/brokers who are individually accredited as NZX advisers. You normally can trust their conduct and integrity, but beware of the gatekeeper. Their incentives and motivations may not be the same as yours. You see, brokers get paid for each decision you make and as we outlined in the first blog, more decisions lead to worse outcomes for investors.

Even the best, most professional broker has a conflict

How would you feel, if you saw your broker quarterly and they said “the last few months have been average or even a bit below average but if nothing’s changed in your life there is no need to change your portfolio and incur costs, so we will leave it all untouched”. You would feel ripped off, lacking attention and question your expert’s ability.

The same has been found with doctors, who increasingly have a tendency to over-prescribe medicine, especially antibiotics. Otherwise we question their competence if they simply say you will get better from rest alone.

Should you ever use a financial adviser or broker?

Absolutely, in the same way as you seek a medical professional. Good financial advisers who understand your situation are great at helping with asset allocation (the proportion of shares, property, and cash), financial planning for different scenarios and changes, help with finding the most appropriate mortgage and insurance, and explaining products, consequences and risks. Occasionally, if you are comfortable they are not misaligned or conflicted, they may suggest a company or two that they believe is undervalued as a satellite or minority pick.

What about the analyst picks?

Analyst picks are educated guesses about the future strength of a company that the market immediately reacts to. If a major analyst issues a buy recommendation, excluding global events, the price will rise to “price in” that information. So if you hear about it a week or a month later, the information is not just old, but possibly contrary as the expected value is already included and maybe now overpriced.

The sad part is that none of this is new, it’s just that we all are persuaded or simply want to believe there are secrets to be discovered, that the game can be beaten and that more effort, more research will lead to a superior outcome.

The irony is this was written about back in 1940. A very humorous and timeless book by Fred Schweb, about Wall Street and the incentives at play. The title says it all: “Where are the Customers’ yachts”.

Next week, despite the real estate industry and property promoters and speakers benefiting from you thinking otherwise, we will give a counterargument to the obsession with residential property.


Kernel – where innovation meets investment.

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