Would You Practice Brain Surgery?

Have you ever read something so stupid that you felt the need to smack yourself in the face with your palm?  Put more elegantly, a faceplam moment?  I’m sure you have.

I came across this article from CNN Money a few weeks back and I’ve been meaning to use it to make a larger point.  The article or the writing itself is not what disturbs me, it’s the responses from the interviewees that warrants a cringe.  Please take a few moments to peruse the article, you need not read the whole thing, I think you’ll get the point in a few minutes.

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I know my ranting about this topic won’t change anything, the readers of this blog are relatively educated regarding the market.  Even my well educated non financial friends think most of it is written in another language.  I assume a high level of market education when I write, this blog isn’t written for mom and pop.  So the reach of this post really doesn’t get to the individuals who need to hear it most.

Why do individual investors feel the need to self direct their investments?  Why do mom and pop believe that investing and trading are any less complicated than brain surgery?  I can’t think of any other profession where professionals who have years of experience and education compete against those with none.  If I walked into an operating room and told the brain surgeon that I was gonna give it a shot, what do you think they would say?

Now I don’t mean to pick on some of the people in that CNN Money article, I’m not insulting their intelligence, but I think they need to be made an example of when it comes to self directed investing, especially by members of my generation.  Let’s take a look at a few quotes.

This quote by a recent graduate of Northern Arizona University really hit me hard.

“It’s almost embarrassing to talk to anyone about my portfolio because I know how stupid it is to normally keep my portfolio in cash. I picture myself as a value investor, and I know I’m supposed to be buying in the downturn, but the swings of the market are intimidating. I’m just waiting to get the next piece of advice or news that will make me more comfortable about my decisions.” – Robert White (23 years old)

Oh god Robert, where should we start.  Robert says earlier that he has a $60,000 portfolio and just started a job as a financial planner (another faceplam).  My first issue is this, why does Robert believe he is a value investor?  Well I think that question is answered easily.  Academic finance thus far has almost exclusively focused on teaching the principals of how to value companies based on several different models.  My issue here is that kids coming out of school don’t understand the difference between academic finance, and how the market actually works.  So not only do kids not understand how to use these valuation models to actually trade stocks and other assets, but they have not been exposed to any other investment strategies.  They are told value investing, buy and hold is the right way to do things, by academics and the media.  So it’s not Robert’s fault that he thinks he’s a value investor, he is a product of a system.

Robert goes on to say that he’s intimidated by market volatility and that it’s stupid to keep his portfolio in cash.  Why does he feel it’s stupid to go to cash?  Maybe because he’s been told by everyone that market timing is impossible?  Another fallacy.  As well, if he is a value investor, why is he afraid of market volatility.  Value investors should believe that they have better information than the market, and that they are taking advantage of the market mispricing an asset, and the process of that price coming back into equilibrium with the real value may take a significant amount of time.  I can answer the question of why Robert is scared, it’s because he’s not a real value investor.  He doesn’t have the conviction that he has a better understanding of a company’s value than the market, how the heck could he, he’s 23!

He continues by saying that he’s just waiting for the next piece of advice or news to make him more comfortable about his decisions.  Where do we think Robert is getting his advice and news?  I need not say more.

Let’s move on to our next contestant.

“I currently have some short positions to make money in a down market, but I no longer believe in buy and hold strategy. For the long-term, I plan on holding international companies and growth-oriented mutual funds, but I’m going to wait for a significant downturn or signs of stability before I get back in.” – Shawn Lakhani (28 years old)

Shawn is 95% in cash and has been spooked by what took place in 08′.  At least he no longer believes in buy and hold.  If anything good came out of the crash of 08′, I think many no longer believe in buy and hold, not because they really understand why it’s wrong, but because they are just too afraid to leave their money in the market and trust its value will increase.

But Shawn, I’m sorry, there’s an important lesson for individual investors out there that you highlight very well.  The market is not the economy!!!  Shawn says that he is waiting for a significant downturn or signs of stability before he gets back into the market.  Pray do tell exactly how you are evaluating the economy Shawn and how the economy is supposed to be connect to asset prices?  Why also would you buy both if we take a significant downturn or you see signs of stability, does that make a lot of sense?  Look, in the 1980′s our domestic economy was screwed, but asset prices soared.  In the middle of this decade our economy was screwed, it was being inflated by the housing sector and nothing else, yet asset prices kept going up?  The economy after the tech bubble was robust, yet asset prices plummeted, why?  Because the market is not the economy, they are two separate things.

Let’s take a look at Jeremy, who in my mind signifies the “I’ll only invest in bonds now” crowd.

“I pulled 95% of my money out of the stock market in January and put it all into a Pimco bond fund, and I advised my wife to do the same. I told her that after enduring three giant pullbacks since we started investing in 1999, we were not riding out another one.” – Jeremy Sowinski (30 years old)

I’ve got one question for Jeremy, what happens if interest rates begin to rise rapidly.  What happens if we are in a bond bubble, what’s your plan?  The love affair with bonds these days is beginning to get ridiculous, it seems that investors believe there is zero risk in bonds.  Oh boy are they going to get a rude awakening when this one pops.  I don’t blame Jeremy at all, he represents such a large portion of the population, scared out of stocks and into bonds.  What will all these people think of the market when this bubble pops, what asset class will they run into next?  What are these people going to do if inflation skyrockets and their investments in bond begin to lose value?

“Since 2005, I had been investing in a Vanguard 500 Index fund. I lost a large sum — about 48% — between 2007 and 2008, but eventually it climbed back. In June, I decided to pull out the balance of $200,000. The recent market volatility and economic uncertainty has me gun shy, and I haven’t gotten a good reading from any analysts.  I don’t really know what I’m looking for, but I might dip my toes in value investing over the next couple of months. I haven’t tried that before, but with all the volatility in the market, I’m not confident to invest for the long term yet.”  - Jeremy Lessard (33 years old)

Jeremy relies on analysts, I feel sorry for him.  Many don’t understand that analysts are not there to tell you when or what to buy and sell, it is not their expertise or their job.  The job of an analyst is to look at company, industry, and sector fundamentals and tell traders and investors what they believe the value of the company is.  Their job is not to tell you when to buy and sell.  An analyst is a very valuable resource, they can tell you some very important information, but using them as a market timing resource will screw you just about every time.

Again, Jeremy thinks he’s a value investor, why, he has no clue, yea.  And again, with the volatility thing.

I’ll save you all from the rest, it’s like reading about a 20 car pileup on the highway.

Before I go any further, I just want to get back to the main theme here.  Why do these people believe that they are equip with the necessary knowledge or experience to be doing this themselves?  Why do people look at investing like they look at playing basketball with their friends on the weekend?  This is not a level playing field, you are playing against professionals.

So what should you all be doing if not investing on your own?  Find a competent investment manager, not a broker, not a good mutual fund, an investment manager, or don’t invest at all, I’m dead serious.  Now you may ask, how do I find such an investment manager who understands the market and how to manage risk.  The answer is to find a good financial advisor.  Everyone should have a good financial advisor, an independent financial advisor, not one from a big firm.  The big firms operate by just pushing your investments towards any number of big mutual funds and passive investments.  Find an independent financial advisor that knows quality investment managers and how to allocate capital to them.

When I speak to my friends, extremely smart people who don’t work in the financial world, and even some who do but have no clue how to operate in the markets, I cringe.  I try to steer them in the right direction regarding giving their money to professionals, but many believe being smart equals being able to make money in the markets.  So here’s my last point.  Intelligence has very little to do with making money in the markets, by investing or trading.  I’ve seen some pretty salt of the earth uneducated people consistently make money in different markets over a long period of time, and some extremely smart Harvard educated golden spoon in mouth born people fail miserably.  Being intelligent has very little to do with this game.

Now go gamble your money away on some triple inverse ETF.

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