Bad advice revealed - An
Selections from Sensible-Investor commentaries
about misleading financial advice, 1998-2000.
This installment of Today's Target is courtesy of
financial advisor Larry Swedroe. For similar analysis of
active investments, index funds, and how journalists write
about them, see Stocks,
Lies and Videotape and Principles II elsewhere in
Misinterpreting the data
Business Week is a highly regarded publication.
Unfortunately, while its reporting of the business news is
excellent, the value of its investment advice is
often wrongheaded. The reason is that their objective is to
sell magazines and gain advertising revenue. Their interests
are simply not aligned with those of their readers. What sells
magazines and ads is the hype of active management. Passive
management is not only boring, but once you have told your
readers to buy and hold a globally diversified portfolio of
passive asset class or index funds, what is left to say? You
can't keep repeating the same story every week.
The preceding explains why despite the
superior returns generated by passively managed funds,
financial publications are dominated by forecasts ands
stock selections from so-called gurus and the latest hot fund
managers. The following two quotations are good examples. The
first is from the August 1995 edition of Money magazine.
"Bogle [of the Vanguard group of funds, the largest
provider of retail index funds] wins: Index funds should be
the core of most portfolios today." The headline for the
cover story read: "The New Way to Make Money in
Funds." The second is from the February 1996 edition of
Worth magazine. "The index fund is a truly awesome
invention. A cheap S & P 500 or a Wilshire 5000 Index fund
ought to constitute at least half of your portfolio."
Despite these comments, for the reasons
mentioned previously, the publications will not give passive
management their wholehearted endorsements. Instead they print
stories with such headlines as "Sell Stocks Now," or
"Ten Stocks to Buy Now." Returning to
Business Week, one of its regular columns is called
"Inside Wall Street," the stock selections of
columnist Gene Marcial. The July 24, 2000, issue contained an
analysis of his 1999 stock picks. The article concluded that
Marcial's stock-picking results were "sensational."
They came to this conclusion by showing that Marcial's
picks trounced both the DJIA and the S & P 500
indices, while they only slightly trailed the NASDAQ. Business
Week measured the price performance of each stock recommended
in Marcial's column during 1999 and compared their price
performance against the S&P 500, DJIA, Russell 2000 and
NASDAQ benchmarks. Price performance was measured against
these indexes one day after the column was printed as well as
1 month, 3 months and 6 months after publication of the stock
It is worth noting that Marcial's picks were up an
average 8.8% the day after they appeared in print, compared to
an average daily increase of 0.5% in the S&P 500 Index.
Unfortunately investors couldn't buy at the previous day's
close. Also, unfortunately for investors, studies have shown
that when new information is known about a stock, virtually
the entire price move occurs in the very first trade. Thus
investors likely paid about 9% more for Marcial's picks then
the previous close, clearly reducing the value of his picks
for those investors that attempted to capitalize on Marcial's
Larry Putnam, a contributing writer for the website
indexfunds.com, took a closer look at Business Week's claim
that stock-picker Marcial "trounced" most indexes
and slightly trailed the NASDAQ index in 1999. When analyzing
mutual funds or stock picks it is important to make sure you
are making apples-to-apples comparisons, something Business
failed to do (thus providing misleading information). Putnam
compared the price performance of Marcial's 155 stock picks to
their appropriate benchmarks. Here is a summary of what he
- 85 (or 55%) of Marcial's 155 picks traded
on the NASDAQ and AMEX. These are typically smaller-cap
and technology related stocks.
- 70 picks (45%) traded on the NYSE. These
are more typically large-cap growth stocks.
- When you compare Marcial's picks with a
portfolio that is weighted 55% NASDQ Index and 45% S
& P 500 Index, his 155 picks should have increased
in price an average of 25.5% for the six month period.
Marcial's picks were up 26%. When compared to the
predicted 25.5% increase, the 26% reported increase for
Marcial's stock selections no longer look so
Marcial's returns do not take into consideration the fact that
investors were highly unlikely to have been able to take
advantage of the 9% first day price rise. They also ignore
trading costs (bid/offer spreads) and commissions. This is
particularly important when you consider that nearly half of
Marcial's picks were priced under $15, and about one third
were priced below $10. Stocks with such low prices are
typically very small-cap stocks. These small-cap stocks carry
much greater trading costs than do large-caps. For example,
the bid/offer spread (an estimate of trading costs) for the
largest 10% of stocks is just 0.65%. However, for the smallest
10% of stocks it is almost seven times as great at 4.3%. And,
then you have to add in commissions (buy and sell) as well.
subtract all estimated trading costs, Marcial's supposedly
impressive returns no longer look so hot. In fact, using any
reasonable estimate of the costs of implementing a "Marcial"
strategy would have produced returns that were substantially
below an appropriate benchmark. One other thing to consider is
that this analysis ignored the potential large tax
implications of such an active stock picking strategy.
Putnam's work points out how easily investors can be misled by
need to carefully examine all claims of superior performance
to ensure that they are both comparing apples-to-apples and
that trading costs (or estimated trading costs) are included
in comparisons of returns. Remember that a strategy must be
implementable to be of any value.
Larry Swedroe is the
author of "The Only Guide To A Winning Investment
Strategy You Will Ever Need.'' He is also the Director of
Research for and a Principal of Buckingham Asset Management,
Inc. in St. Louis, Missouri. However, his opinions and
comments expressed within this column are his own, and may not
accurately reflect those of Buckingham Asset Management.
flawed fortune teller
Even when the calendar says
it's still April, on the magazine rack it's May. That's a good
symbol for the suspension of disbelief needed by readers who
look to magazines for investment tips. Think of it. You won't
just get the latest tips on undervalued stocks. ("Shhh!
This tip is just for you and the hundreds of thousands of
readers like you. Rush to your stock broker before others find
out and move the price up.") You get so much more: At no
extra charge, you can get in early on the month of May.
And on the Internet, at no
extra charge, you can find exactly the same stock-picking
fantasy for free. You won't even lose the newsstand price of
the magazine, unless you fall for the fantasy and actually buy
the stocks. Even then, you won't be particularly likely to
lose money. The greatest likelihood is that you'll make money
at the same pace as the overall market. And if it takes a
fantasy of market-beating stock picks to get you to invest,
then cling to that fantasy.
The greatest danger posed by
magazines such as Money and SmartMoney might be that you'd go
into a stock-buying frenzy spurred on by each month's
suggestions. You'd then be using too much of your hard-earned
money for stock transaction fees, which would put your broker
on the road to riches, and you on the path to poverty.
Reading the stock-picking
articles in magazines like Money and SmartMoney is like
visiting a fortune teller. Do it for the entertainment value
SmartMoney is particularly
remarkable in that it keeps track of the successes
and many failures of its past forecasts. For
example, "The Next Great Internet Stocks" from
October 1999. (As this is written, three of those picks are
down; four are up.) If SmartMoney ran the fortune-telling
booth at a carnival, it would have a sign outside: "I
predicted that the Yankees would win the 1999 World Series. I
predicted that Bill Clinton would resign in disgrace. I
predicted the great Paris earthquake of 1998."
Money magazine has a more
limited review of its past picks, headed with the
less-than-encouraging admission, "Our recommendations had
a mixed performance for the year; however, all but two (in
red) remain good investments." For one of the picks,
Network Associates (down more than 50 percent), Money adds,
"If you haven't gotten out, do so now."
Recent picks from Money and
SmartMoney contain more than the usual entertainment value.
They show how quickly egg can be transferred to the face of
The latest featured
stock-pick portfolio from Money is "The
Investments for 2000." SmartMoney features "Amazing
Deals on 8 Brand-Name Stocks." Both magazines' stock
pickers made the mistake of including Bristol-Myers Squibb
just before it ran into trouble. As a result, SmartMoney
reduced its online list from eight to seven, and added this
disclosure: "This story, which can be found in the May
2000 issue of SmartMoney magazine, originally included
Bristol-Myers Squibb (BMY) among its recommended stock picks.
On April 19, however, Bristol shocked Wall Street by pulling
the FDA application on Vanlev, its potential blockbuster of a
hypertension drug. That changed the investment picture
dramatically as we discuss in our April 20 story, "The
Bristol-Myers Sell-Off Continues." At this
writing, Money hadn't updated its online article, which still
described how wonderful Vanlev was supposed to be.
ideas for the new millennium
For investors who love to
fantasize that they can outsmart the market, SmartMoney and
Money magazine follow up their recent market-trailing advice
with new lists of stock tips. (Psst! This is just between me,
you, and hundreds of thousands of other readers.)
(Its recommendations, you may recall, returned -14% to +14%
for 1994, 1996 and 1998, according to an analysis by Brill's
magazine. For the same periods, money that was invested in an
S&P 500 index fund returned 25% to 26%. More information
on the Brill's Content analysis is contained in the Sensible-Investor
In its January issue,
SmartMoney rolls out its "Best Investments for
2000," a list of 12 stocks and five mutual funds. To its
credit, the article notes that its list of 11 stocks for 1999
averaged only a 16.8 percent return in contrast to the S&P
500's return of 20 percent plus.
Next, Money magazine.
(Its recommendations returned 15% to 21% for 1994, 1996 and
1998, according to Brill's Content, trailing an S&P 500
index fund by 8 to 11 percentage points.)
Money got a jump on the
millennium with a December double issue on "How to Win in
the Net Century." (For a rough idea of how accurate this
issue will be, imagine what it would have been like to write a
guide to the 20th century for publication in December 1899.)
Money's attempt starts with an article on "The Smart Way
to Invest in the Internet," claiming to reveal "how
to tell the prospects from the pretenders." The article
lists leading companies in 12 Internet sectors, such as
"e-tailers," portals and auctions, adds a
two-sentence description of the competitive market, and sums
up the prospects as good, fair or murky.
This would be an accurate
account if each category's prospects were classified as murky.
Some evidence of the murkiness appears in the same article --
a fascinating list of hot prospects of the past decade, and
how they unexpectedly flamed out. These include:
- The Java programming language, 1996-98 - "never
threatened Microsoft's operating system";
- Push technology, 1996-98 - "clogged computer
- Network computers, 1997-98 - "prices for fully
functional PCs plummeted"; and
- Internet telephony, 1998-99 - "voice quality is
poor; long-distance rates are down."
So, why believe that Money
has now uncovered "The Smart Way to Invest in the
marksman for Today’s Target
An on-target article in
Brill's Content magazine for October takes aim at personal
finance magazines -- specifically at how their stock picks and
mutual fund recommendations have fared in recent years.
They've fared poorly -- no, make that terribly -- in
comparison to the S&P 500.
The article looks at the
returns that investors would have achieved if they followed
each magazine's cover-story recommendations in 1994, 1996 and
early 1998. In comparison, the article notes the returns for
investors who put their money in an S&P 500 index fund
during the same time periods. Here are the overall annualized
results. (The S&P 500 figures vary slightly because the
timing of S&P investments was varied to match the timing
of the magazines' recommendations.)
Kiplinger's 17.94% vs. 26.56%
for an S&P 500 index fund.
Money's 14.89% vs. 26.52% for
an S&P 500 index fund.
SmartMoney's 14.22% vs.
26.14% for an S&P 500 index fund.
Kiplinger's 18.74% vs. 29.92%
for an S&P 500 index fund.
Money's 20.98% vs. 29.86% for
an S&P 500 index fund.
SmartMoney's 14.29% vs.
29.48% for an S&P 500 index fund.
(Only January-July, so there would be 12 months of returns to
Kiplinger's 11.48% vs. 24.49%
for an S&P 500 index fund.
Money's 14.65% vs. 22.49% for
an S&P 500 index fund.
SmartMoney's -13.91% vs.
25.25% for an S&P 500 index fund.
The magazines' lack-luster
returns are what investors -- whom the magazines like to call
"sophisticated investors" -- would have gotten for
following the articles' deceptive siren song. The magazines
keep singing that same song, calling on investors to pick
individual stocks and mutual funds, to disdain the merely
"average" returns of index funds - and not to worry
about crashing into the rocks of marketplace reality.
The strong performance of
large U.S. stocks in recent years has made this a particularly
tough time for stock-pickers to beat the S&P 500 index.
But it's always a tough time to beat the market -- it's always
a long shot. To see why, check out the Sensible-Investor
discussion of investing principles
Weeding, indexing and
Bloomberg Personal Finance
If you weed out the hype,
spin and wishful thinking, you'll find valuable information in
a new Bloomberg Personal Finance package titled "The
Ultimate Guide to Indexing: Everything You Need to Know to
Maximize Your Profits." It's the cover story for the
September issue. Among the strengths of the articles:
- An explanatory survey of the growing numbers of index
funds, from the venerable Vanguard S&P 500 index fund
to the latest foreign equity index fund.
- Presentation of the benefits of index funds in achieving
diversification with "low costs, low turnover and low
- Analysis of the distinctions among various indexes -
S&P 500, Wilshire 5000, Russell 2000, S&P Small
Cap 600, Morgan Stanley EAFE, etc.
- Explanation of the dangers of "enhanced index
- Clear presentation of the arguments for doing all your
U.S. stock investment through a total-market index fund,
after which an investor can "... golf. Garden.
Kiss your spouse. Your work here is done."
But how could an investment
magazine leave it at that? No, it must go further, implying
that there's something wrong with anyone who could be happy
without continually strategizing about investments. No, it
must encourage the "sophisticated investor" to be
"an inveterate tinkerer" instead of
"brainless." Sure, you can invest in index funds for
reliable returns, but you'll want to try to do better than the
total-market index by over-investing in one sector, the
magazine suggests. In other words, gamble. The gamble that it
recommends most highly: Weighting your portfolio more heavily
in small-cap stocks, which are "undervalued and due to
rise." (The magazine doesn't mention that this same
recommendation has been made for years, but the small-cap
marketplace hasn't yet responded to all the encouraging
Bloomberg even brings in a
patriarch of the indexing movement as an advocate of doing
some modest gambling as part of an index-fund strategy. Burton
Malkiel, author of "A Random Walk Down Wall Street,"
proposes shifting the 80-20 large-small cap ratio of a
Wilshire 5000 fund into a 65-35 ratio "for those who can
take on more risk." He admits, "It does smack of a
market-timing decision." Yes, it does. It sounds like the
owner of a casino, suddenly dissatisfied with his
"brainless" accumulation of profits from the gaming
tables, deciding to become "sophisticated" by going
out on the floor to bet at the roulette wheel.
SmartMoney (July 1999)
ignore-your-failures approach appears in the magazine's update
of its fairly disastrous recommendations last January for the
"Best Investments for 1999" stock portfolio. As the
magazine notes in its July issue, these included Compaq
Computer (down 24 percent through mid-May, and little changed
since then) and Warner-Lambert (down 16 percent through
mid-May, and doing a little better since then). The SmartMoney
spin on its portfolio? "Overall, it's up 5 percent
through mid-May. But while that trails the S&P 500 by 10
percentage points, there have also been some impressive
winners in the bunch." Sure! And if I disregard the times
when a coin comes up tails, I can rack up an impressive string
of consecutive heads.
Money (July 1999)
Can you make money by going
along with the crowd? That's the faulty conclusion you could
draw from Money magazine's feature on the stocks it calls
"The Six Best Bargains Right Now." Those
recommendations are drawn from a National Association of
Investors Corp. list of the most popular 100 stocks owned by
investment clubs. The magazine chose six of those to
highlight, guessing -- um, concluding -- that they were
"solid businesses poised to rebound from temporary
setbacks." But how could an investor possibly find
unrecognized stock bargains by taking advice from a survey
covering many of the nation's 37,500 investment clubs and a
Beating up on index funds
Street Journal, June 14, 1999. “Online Investing:
Essay’’ by Jonathan Clements.
do so many investment commentators like to beat up on index
funds? Perhaps because index fund investors don’t play along
with investing as a game. Index fund investors win – without
even following the rules of you-win-some, you-lose-some stock
picking and market timing. Typically, by simply sitting back
and matching the market’s overall returns, index fund
investors do better than investors who work much harder.
Sounds unfair, so the losers beat up on the winners.
The latest example:
Gratuitous swipes at index funds by Wall Street Journal
personal finance writer Jonathan Clements in his June 14 essay
on 10 reasons to trade stocks online and 10 reasons to use a
One of Clements’ reasons
for using an online broker is that it’s “more fun than an
He writes, “Investing
isn’t just about making money. It’s also fun. And what
could be more fun than buying and selling stocks using your
computer?” (Perhaps spending the money you make from an
index fund would be more fun than sitting at a computer.)
Clements continues, “It sure beats sticking your money in an
index fund and merely matching the performance of a market
average.” (Commentators love to disparage “merely
matching” the market average – without pointing out that
the average money manager does worse than the market average.)
Clements then turns around
and bashes index funds from the viewpoint of full-service
brokerages, which he calls “more comforting than an index
“True, most investors would
get better results by putting their money in a market-tracking
index fund,” he admits. “But have you seen all the doggy
stocks in those funds? It’s so much more comforting to have
a broker looking out for you.” (More comforting, but with
worse results! How much would I have to pay for this cold
Money magazine’s world
view, May 19, 1999
Money 100 – The World’s Best Mutual Funds”?
Ah, yes, that’s Money magazine for you, dishing out its
familiar mix of hype, good sense, and wishful thinking.
hype? That title, which refers to a list that is limited to
U.S. -based mutual funds, of course. So why not call
them “The Galaxy’s Best Mutual Funds” or “The Best
Mutual Funds in the Universe”? Those descriptions are
equally true, as far as we know.
Good sense? The authors of
the list exclude mutual funds with high expenses and favor
stable fund management.
Wishful thinking? The
list-makers try to time the market, selecting some funds in
sectors that are currently out of favor, on the theory that
the time is near at hand. They also emphasize stable returns
in past years, although many studies have shown that few
top-rated, successful fund managers keep repeating their
Last year, Money unveiled a
similar list of 100 funds. Since then, those funds haven’t
done terribly, but they haven’t excelled either. In fact,
they’re not far from average. Somewhat more than half
(65%) of Money’s 1998 funds were in the top half of their
fund categories for the year, but that figure might be skewed
upward by the inclusion of some index funds, which almost
always do better than the average fund.
Mishmash a la SmartMoney
look at SmartMoney’s
in early May reveals a typical SmartMoney-style mishmash of
credulity, wishful thinking and
stock-market boosterism. The magazine sticks with its dubious
premise that more than the laws of probability were at work
when three out of a dozen pundits made roughly accurate
predictions about when the Dow would reach 11,000. “Nobody
saw it coming. Well, almost nobody,”
SmartMoney admits, but then it proceeds to continue quoting
its failed pundits as authorities on the future of the stock
market. Many of them now predict falling stock prices, a fact
that the magazine notes. Then, tellingly, credulously, it
adds, “Fortunately, not all of the Street's prognosticators
are so bearish” -- as if there’s any reality, and some
actual good fortune, that’s revealed in the fact that some
of the pundits predict a rising market.
What does the future hold? Ask
some of these same pundits. By the end of the year, the
Dow will be at 9,750.
No, make that 9,800.
Or maybe 9,850. Or 9,900.
Or maybe 6,400. Unless it’s
Remember. You heard it first
from SmartMoney. (5/5/99)
USA Today’s mutual fund
picks, March 10, 1999
performance by the mutual funds that USA Today recommended
last year (the funds achieved only half the total return of
the S&P 500), the newspaper has trotted out this
year’s updated list. The 25 recommended funds are
“steady performers to hold for the long term,” the
newspaper says, but it doesn’t mention index funds as a
higher-performing alternative. The site gamely links to last
year’s recommended funds, including a
chart that clearly shows how much better an S&P 500
index fund performed last year than 15 of USAToday’s
25 recommended funds.
11 Best Stocks to Buy Now,"SmartMoney,
SmartMoney returns to its
annual stock-picking exercise despite a bruising 1998. Its
selections of a year ago have underperformed the S&P 500
by 14 percentage points. (But the magazine claims its
stock-picking technique has “produced market-beating
portfolios in five of the past six years.”) The
magazine’s basic stock-picking technique is to ask
investment forecaster Elaine Garzelli to list economic sectors
that are undervalued, and then to hunt for undervalued stocks
within those sectors. As the magazine admits, though,
“undervaluation in and of itself is not an indication that a
stock’s price will rise. Cheap stocks can get cheaper
....” Well, are the stocks cheap because investors
haven’t noticed the firms’ potential? Or is it because
knowledgeable investors have analyzed the firms and
concluded that they aren’t worth more?
message: After reading this article, you’ll be smarter than
the market. But if the market is so dumb, should you fear that
it will be swayed by fads and emotions and will continue to
undervalue the stocks your intelligence has led you to?
to Invest,” Worth,
Worth magazine just can’t
fathom the idea of investors putting money in an index fund
and then calmly waiting out the market’s daily and yearly
“It seems to us that there
are two options. One is to hunker down. Convert to cash, buy
bonds, wait for things to blow over,” says Worth writer
Clint Willis. “The other option, the one this magazine
always endorses, is to approach investing with the rigor of a
true investor. Stop expecting to stumble upon the no-brainer
investments, and start using your head.”
What about index funds?
They’re not even an alternative to consider, as far as Worth
is concerned. They’re “no-brainer investments,”
presumably, which investors should be careful not to
“stumble” on. As Willis dismisses them, “The idea of a
bet -- just put it in an index fund! -- seems dubious.”
(Nice rhetorical trick, isn’t it? First, distort the idea of
index funds by calling them a supposedly “sure bet.” Then
dismiss that distorted idea off-handedly.)
So, perhaps you decide to
start using your head. Should you put money in an investment
that outperformed all but about 12 percent of stock mutual
funds last year? That would be an S&P 500 index fund. But
Worth, like most personal finance magazines, doesn’t want
you to put your money in that relatively secure and
unnewsworthy investment. Instead, it wants investors regularly
to seek its advice in predicting the future and to think
that’s using their heads. In the January issue, for example,
it quotes pundits predicting that small-company stocks will
excel in 1999. That’s what pundits predicted for 1998 too,
with remarkable inaccuracy. But this year will be different,
Worth assures us.
Money, December 1998.
Risk-Takers” would be a better heading for this regular
section of Money magazine. Some of the risky advice in the
predicts that technology stocks will “take off.” But
has the market already incorporated tech stocks’ future
prospects into today’s prices? That’s the real
question. Sivy does admit that “A lot of analysts are
still taking a wait-and-see attitude toward tech
stocks.” (January 1999 update: So far, this Sivy
prediction was on target.)
- Sarah Rose proposes investing in stock of credit-card
issuers, which she predicts will rise because of improved
operations and industry consolidation. There’s a problem
with this reasoning! The basic question again is not just
whether those improved prospects will be realized, but
also whether the market has already incorporated
tomorrow’s improvements into today’s stock prices.
- Oops. The Barr Rosenberg Market Neutral fund is in the
Money 100 list of top funds, but if you had taken
Money’s advice and invested in it, you would have seen a
gain of only 2.2% in 1998. The fund invests on the basis
of a complex computerized strategy that hasn’t paid off.
But the fund manager “believes the fund will live up to
expectations over the next three to five years.” Are you
Stocks, lies and
quick introduction. Why most
personal finance magazines, television
shows and Web sites give crummy
investment advice. What “down-to-
earth guide” means.