August 22, 2006 –
Ever wondered if you’d be better off with an independent financial consultant or investing your stocks yourself than with a huge investment firm? To understand the answer to this question you must first be able to separate investment fiction from investment fact.
The key to sorting through all the “noise” that investment firms and financial consultants throw at you is to be able to deconstruct the myths they propagate. What is ultimately so confusing about working with big investment houses is that they combine fact and fiction into a top-notch convincing marketing campaign to get you to turn over your dollars to them.
For example, let’s consider the often repeated investment firm strategy of being fully invested. Though being in cash is most definitely good at times, no matter if global markets are up or down, there is still money to be made somewhere, whether in put options, investing in non-stock assets, or by investing in other parts of the world. However, I do have a problem with the way Wall Street firms use fear to achieve this. Let’s re-visit the commonly quoted “fact” that:
“If you had missed the best 90 performance days in [the U.S. stock] markets from 1963 to 1993 your average annual return would have dramatically fallen from 11.83% to 3.28% a year.” (Source: University of Michigan)
If we were to analyze this statement, then it is quite reasonable to analyze the assumptions behind this statement. Is it truly realistic to think that anybody’s luck would be so bad as to miss the best 90 days over 30 years even if they chose to be in and out of the market at certain times. What are the chances that they would miss all 90 of the best performing days? One in a 580 million?
Deconstructing Investment Firm’s Illogical Arguments
What if when you were out of the market, instead of missing the best 90 performance days, you missed the worst 90 performance days? Then what would your annual average returns be? 30% instead of 11.83%? See how deeply flawed this argument is. And this is the argument that financial consultants always use to sell you in staying fully invested. In fact, this selling point is often combined with the strategy of Modern Portfolio Theory, the name in of itself which is a misnomer. “Modern” portfolio theory was once revolutionary, when it was developed, back in the early 1950’s.
In simple terms, modern portfolio theory calls for diversification of your stock positions across various sectors and industries to offset the potential of a poorly performing sector. In other words if you own stocks in trucking and shipping companies, then you might want to own oil companies as well, because if oil companies lag, then that translates into cheaper fuel costs for trucking and shipping companies, and this sector should offset lagging performance in the oil industry. The only problem with this theory is that you are not trying to create a zero sum game with your stock portfolio, but instead, trying to consistently find winners.
The big firms will tell you that it’s impossible to predict what industries will be up in certain years and what industries will be down, so that is why Modern Portfolio Theory is necessary. Again, I view this is a myth designed to build smoke screens to confuse the average investor. In today’s information technology age, access to information is so good that it is possible to predict what sectors will trend upward in a given year, and even to predict at times, what sub sector within those sectors will trend upward. But as I mentioned before, this takes time, and time is money with big investment firms.
The Changing Information Landscape Will Make Investment Firms’ Strategies Obsolete
In fact, access to information is so good today, that to stay ahead of the investment curve, every firm should be teaching their financial consultants how to access information and evolve with technology to stay ahead of the game. Big investment houses will tell you that individual stock selection is not nearly as important to your performance as being invested in the right sectors. This is another myth. If you really give this more than two seconds thought, does this statement make any sense?
Do you truly believe that if you own a mining company in Canada versus one in the United States that may own rights to drill in completely different geographical locations that this will not matter to the stock price of these two companies? Do you really think that if you own internet companies in India versus internet companies in Japan, that the vastly different stages in the growth cycle of this industry between these two countries will not make a difference to the performance of your portfolio? Do you truly believe that if you invest in nanotechnology firms with a world leader like the U.S. versus nanotechnology firms in Russia, that it doesn’t make a difference? I could go on endlessly about just how ludicrous this statement really is.
Performance of your stock portfolio is all about selecting the right STOCKS in the right SECTORS in the right COUNTRIES at the right TIME. So why do investment firms work so hard to convince you otherwise? For the most part, because they don’t teach their financial consultants how to be great stock advisors and how to identify opportunities in the global markets that will maximize the returns in your portfolio. They teach them to be great salesmen and saleswomen and great marketing gurus.
Large investment firms do offer superior returns in certain areas such as private equity, currency hedging, and institutional investing where their sheer scale and scope offer advantages. But for the individual stock investor, your assets are far better off somewhere else.
Yet another entry where my man J.S. is right on point. If you’ve fought a lot of people in your time as I have, then you’ll know that the dog with the loudest bark is often the one with the smallest bite. The one that keeps yapping and yapping and won’t shut up is the one that you can almost certainly knock out with just one punch. It’s the quiet one that just smiles at you who is usually the most dangerous one. In sizing up an opponent, appearance doesn’t account for much in martial arts. I remember fighting 110 kg opponents and having no problem with them and then fighting a 65 kg. guy I thought I could destroy only to have all kinds of problems with him. In investing it’s the same.
The financial consultants are always yap, yap, yapping in your ear about why you need to be fully invested in the markets, why the markets in their country are the “safest” to be invested in, why you need to do this, why you need to do that. Yeah, I’d like to give most of them a flying fist of judah and shut them up because most of them have nothing worthwhile to say. Keep up the good points, J.S. and you might eventually become worthy of my dojo.
Thanks JKIM