The Real Reason Your Stock Picks Are Wrong

July 13, 2017

It’s common knowledge that in the long run, stocks outperform treasury bills, which are short term loans to the federal government that can be considered a relatively risk-free form of cash. But according to a new study by Hendrik Bessembinder of Arizona State University, a majority of stocks in the CSRP database underperform treasury bills over both one-month and lifetime returns from 1926-2015. In fact, almost all the returns of the stock market come from just the top 4% of stocks! So what does this mean for you?

Picking individual stocks is basically gambling. The odds are simply heavily stacked against you. If you want to “invest” a small amount of money in individual stocks in the hope of outsized returns, go for it. (I actually do this myself.) Just make sure it’s money you can afford to lose and not your retirement nest egg or college fund.
Put your eggs in lots of baskets. It’s not just to avoid the big losers. It’s also to make sure you get the big winners too. For most people, this means investing in mutual funds or ETFs since it’s generally more difficult and expensive to buy enough individual stocks to be adequately diversified.
Be careful of active management. Considering how slim the odds are of picking that 4% of stocks, it’s no wonder that the vast majority of active money managers underperform. They either have to take the risk of missing that 4% and drastically underperforming the market (hence putting their careers in jeopardy) or more likely, they create “closet index funds” that mostly buy the entire market but still end up underperforming (albeit less drastically) due to fees and transaction costs. You can avoid these problems by simply investing in a diversified portfolio of low cost index funds. This way, you know you’ll have that 4%.

None of this means you should abandon stocks for treasury bills. Let’s not lose sight of the big picture here. A dollar invested in US stocks in 1926 was worth $448 in real inflation-adjusted dollars at the end of last year while a dollar in treasury bills was only worth $1.53, barely staying ahead of inflation. If you want your money to grow (and you probably need some growth to hit your long term investing goals), stocks are still where the action is. We just don’t know which ones yet.

Want more helpful financial guidance, delivered every day? Sign up to receive the Financial Finesse Tip of the Day, written by financial planners who work with people like you every day. No sales pitch EVER (being unbiased is the foundation of what we do), just the best our awesome planners have to offer. Click here to join.

What’s the Market Going to Do Next?

April 28, 2017

One of the questions I’ve been getting asked A LOT recently is what I think the stock market is going to do. My usual answer is that it’s going to go up, and it’s going to go down. The only thing I don’t know is how much it will go in either direction or when the tide will turn. In essence, I’m useless when it comes to predicting the future movements of the stock market. That usually leads to a conversation around their retirement timeline, their ability/willingness to absorb losses in the stock market and their opinions about the future.

It was right after one of these calls that I read this story about a hedge fund manager who is giving back $1.25 BILLION in cash to the investors in his fund! That’s astounding, primarily because that’s over a billion dollars that the fund will no longer get paid a fee to manage. Even a small fee on over a billion dollars is a pretty big amount of money to give up.

Why is he doing this? He’s concerned that the stock market is overvalued and that he can’t find the right investments to buy in order to give his investors the type of returns he would like to provide. Now, let’s not shed any tears for him. He’s still got over $16 billion invested, and I’m pretty sure that’s enough to keep the lights on and food on the table.

But it is tangible evidence of someone believing that the stock market might be a bit overpriced right now. There are also managers who believe that the market, because of economic growth, job growth and corporate earnings – is poised to move upward for quite some time. (I’m still solidly in the camp of “I don’t know which way the market is going.”)

But whether the market goes up or down or sideways in the next few months to the next 3-5 years shouldn’t prompt you to take any action. The key to long term wealth building (and that’s why we all invest) is to pick a strategy and stick to it in good and bad markets. Investors who did nothing in response to the market collapse of 2008 were better off within a few years than the day before the crash. Those who moved everything out of stocks as the market tanked or after the market tanked may still not be whole.

The first thing you can do is to understand who you are as an investor. Here’s a quick investment risk quiz that can help you figure this out and gives you some hypothetical portfolios that might be appropriate for your particular risk tolerance. When your overall risk level changes due to changing time horizons, retirement goals, age, family circumstances, etc, it’s time to reallocate your long term investments.

When pressed for time, I ask a one question risk tolerance quiz. “On a scale from 1 to 10, where 1 is the most conservative investor in the world (money in the mattress) and 10 is the most aggressive (willing to put all of your money on a couple stocks and see what happens) – what number would you give yourself?” If someone answers 3 or 4 then 30-40% of their long term investment portfolio could be allocated toward high growth/high risk investments like stocks.

It’s by no means a comprehensive approach, but it has a very consistent answer with the other quiz above as well as other similar quizzes. In a former role, I had about a dozen clients take 5 or 6 different risk profile quizzes. They all came out with roughly the same answer and it was pretty darn close to the one question risk quiz.

So in spite of the fact that a hedge fund manager is giving back a big chunk of money to investors because he thinks the market is overvalued and other managers are incredibly optimistic about the markets moving forward, your goal as an investor is to understand who you are, get to an asset allocation that is consistent with your time lines and goals, and don’t get too high when things are good or too low when things are bad. From my experience, emotions are the enemy of good decision making and this applies to investing as well. Markets, like many things in life, are cyclical and if you’re patient and consistent, good things usually happen.

Is the Stock Market Too High to Invest?

May 23, 2013

Usually when I talk about investment mistakes, I refer to what is known as the “greed, hope, and fear” cycle. This is the well-known tendency of investors to invest more aggressively when the stock market is doing well, hope it will come back when the market begins its inevitable downturn, and then eventually sell near the bottom out of sell fear. Investors are then typically reluctant to get back in until things “settle down,” which means when the market has gone up for an extended period of time and is possibly nearing another high point. This causes investors to buy high and sell low, the opposite of what you want to do. Continue reading “Is the Stock Market Too High to Invest?”

The Stock Market’s Going to Go Down…Unless it Goes Up

April 19, 2013

A question I get asked a lot lately is what I think the stock market is going to do. We are near (or at, depending on when you read this) all time highs in the stock market. 401k balances are rising. Stock prices have risen pretty quickly. A client company of ours has seen its stock rise from $40 to $56 per share in the last several months. Things look great and when I turn on the financial networks, many of the “experts” are predicting a strong market for the next several years. And, that scares people…. Continue reading “The Stock Market’s Going to Go Down…Unless it Goes Up”

When It Comes to Investing, Don’t Just Follow the Money

January 16, 2013

This week, USA Today came out with an article on how more money poured into stock mutual funds in the last week than any other week in the last eleven years. Now at first glance that may come as good news as investor confidence seems to be returning in the wake of a resolution to the fiscal cliff dilemma, but before you jump on the stock market bandwagon, remember the words of renowned investor Warren Buffett. When asked about his philosophy on investing, he is known to have said he is greedy when others are fearful, and fearful when others are greedy. In other words, Warren Buffett, one of the greatest investors of all time, has a tendency to go against the flow when it comes to investment decisions. Continue reading “When It Comes to Investing, Don’t Just Follow the Money”

The “Secret Sauce” Behind Successful Investing

August 24, 2012

Much to the chagrin of dentists everywhere, Tootsie Roll has been a staple of the candy business for a very long time. This article talks about the Tootsie Roll Company being a very secretive organization. (And we thought it was just the CIA that operates in relative secrecy)! Tootsie Roll doesn’t give tours, they don’t give interviews to analysts and they don’t operate with much transparency. It’s as if they have some magical mystery formulas that they don’t want the rest of us to know. Continue reading “The “Secret Sauce” Behind Successful Investing”

Why Didn’t I Sell?

August 08, 2011

“Why didn’t I sell before the market dropped?” is a question I got from a caller to our helpline last week. This is a common question, as you can imagine, after a big drop in the market or during an extended bear market. This caller was extremely frustrated because he was stuck between a rock and a hard place. He had already turned in his paperwork to retire within the month (too late to cancel) and was making a transfer from his 401(k) to a pension purchase to provide additional fixed income – essentially changing the goal of this money from long term growth to income. The market drop would lower his monthly income for the rest of his life because his lump sum was being used to calculate his monthly income payment. He was distraught. Continue reading “Why Didn’t I Sell?”