Bad advice revealed - An archive

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 Sensible-Investor.

Misinterpreting the data

(August 2000)  

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 tips.

  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 skills. 

  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 found:

•    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 "sensational."

   In addition, 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.

    Once you 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 misleading information.

    Investors 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.

The flawed fortune teller

(April-May 2000)

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 only.

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 stock pickers.

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.

Bad ideas for the new millennium

(January 2000)

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.)

First, SmartMoney. (Its recommendations, you may recall, returned -14% to +14% for 1994, 1996 and 1998, according to an analysis by Brill's Content 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 archive.

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 networks";
• 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 Internet"?

Guest marksman for Today’s Target

(November 1999)

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.)

1994 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.

1996 recommendations

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.

1998 recommendations (Only January-July, so there would be 12 months of returns to compare.)

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 gambling

Bloomberg Personal Finance (September 1999)

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 taxes."
• 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 funds."
• 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 words.)

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.

Not-so-smart SmartMoney and Money

SmartMoney (July 1999)

A typical 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 mass-market magazine?

Beating up on index funds

Wall Street Journal, June 14, 1999. “Online Investing: Essay’’ by Jonathan Clements.

Why 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 traditional broker.

One of Clements’ reasons for using an online broker is that it’s “more fun than an index fund.”

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 fund.”

“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 comfort?)

Money magazine’s world view, May 19, 1999

“The 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.

The 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 successes.

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

A look at SmartMoney’s Web site 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 at 11,000.

Remember. You heard it first from SmartMoney. (5/5/99)

USA Today’s mutual fund picks, March 10, 1999

Despite lackluster 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.

"The 11 Best Stocks to Buy Now,"SmartMoney, January 1999

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?

SmartMoney’s implicit 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?

“Where to Invest,” Worth, January 1999.

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 turmoil.

“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 sure 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.

"Investing," Money, December 1998.

“Investing for Risk-Takers” would be a better heading for this regular section of Money magazine. Some of the risky advice in the December section:

• Michael Sivy 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 surprised?