Sensible-Investor: Principles -- Part 3 

Caveat investor

If you’re a long-run investor (rather than a gambler), you should beware of personal finance advice that has these characteristics:

SPINNING THE ROULETTE WHEEL: Maybe you like to gamble, and maybe you are in a financial position where you can afford to devote a lot of time and a portion of your holdings to hunting for individual stocks that you can buy low and perhaps sell for a handsome profit. But that is not risk-averse investing, although personal finance publications and Web sites are full of it, because it's exciting and constantly changing. Only do this if it is a game that you like to play and a game that you can afford to lose.

PROPHESYING: Claiming to be able to forecast market movements. If someone really knew which way the market was about to move, that person could make billions by exploiting that knowledge, instead of a few bucks by writing or talking about it. As Malkiel writes, "With large numbers of people predicting the market, there will always be some who have called the last turn or even the last few turns, but none will be consistently accurate." ( Random Walk, p. 157) Paying attention to marketplace prophets can be a money-losing proposition if you pull your investments out of the market at times when you think it is about to go down. The reason: "market timers risk missing the infrequent large sprints that are the big contributors to performance." (Random Walk, p. 162) As Jonathan Clements puts it in The Wall Street Journal: "If you jump in and out of stocks in an effort to catch bull markets and sidestep market declines, you run the risk of being out of the market when stocks are bulldozing ahead. That is a real danger, because big stock-market gains are often concentrated in a few weeks or even days." (WSJ, C1, April 28, 1998) Andrew Tobias also agrees: "Clearly, if you knew which way interest rates were headed, you could profit in numerous ways. Many people therefore try to guess, and some, in any given year, guess right. Few, however, can guess right consistently, least of all you or I or the man on all-news radio." (Only Investment Guide, p. 70)

SHARING "SECRETS": Information about individual companies moves lightning-fast these days. If you hear see or hear a tip about a company in print or on the Internet, you'd be wise to assume that you're among the last to know. If there's any truth to the information, is there any reason to believe that full-time market watchers on Wall Street didn't learn it before you did? They can act in a split second to bid the stock price to a new level that reflects the new information. Don't expect to be able to move faster than they do and take advantage information you learn on television or on the Internet. As Burton Malkiel describes the situation, "The market is so efficient --“prices move so quickly when new information does arise -- “ that no one can consistently buy or sell quickly enough to benefit." ( Random Walk, p. 191) Further, he states, "There is a fundamental paradox about the usefulness of investment advice concerning specific securities. If the advice reaches enough people and they act on it, knowledge of the advice destroys its usefulness." (Random Walk, p. 456)

FEAR-MONGERING: People are remarkably adaptable. Children can attend college even if their parents saved little, although the education loans might be larger and the college less prestigious than if the parents had invested diligently. Senior citizens in the United States can still retire, even if their retirement savings are scanty. They may have to work longer, scrimp more on their weekly budget, have few or no options for entertainment and travel, and depend more than they would like to on family and the government. Stating this is not meant to discourage investing, but to encourage people to look at their prospects clear-sightedly, without despair or panic that can cause people to freeze rather than invest. Avoid personal finance advice that inflames emotions of guilty, avarice or panic. For your own peace of mind, resist the temptations of such emotions. As Andrew Tobias observes,

"Whether you choose mutual funds or a direct plunge into the stock market, bonds, or a savings account; whether you shelter your investments through a Keogh Plan or an IRA; and whether you spend now or save to spend later “ you will find that, by the prevailing American ethic anyway, you never have enough." (Only Investment Guide, p. 188)

What to look for in a Web site

These are six desirable qualities both in personal finance planning and in a personal finance Web site:

DIVERSIFICATION: Encouraging investors to diversify their holdings, as explained above.

ALLOCATION: Advocating and explaining proper asset allocation, as explained above.

EYE ON THE HORIZON: It's important to take into account how much time you have before you need to withdraw funds you invest. If you have 30 years to invest, you can tolerate lots of ups and downs in the meantime, as long as the investment's overall trend is up. By purchasing stocks or, much more simply, stock market index funds, you participate in the country's financial growth. "There is a long-run uptrend in most average of stock prices in line with the long-run growth of earnings and dividends." ( Random Walk, p. 143) But if you will need to withdraw your money in a short while, you should invest it where its ups and downs are limited. Otherwise, you'll be gambling – placing a bet that the value won't be down at the exact time when you need to withdraw your money.

DON'T WASTE YOUR TIME: You can spend as much time as you want monitoring your investments, but don't think that you must. Life is short, and you may not want to devote too much of it with your eye on your money. A buy-and-hold strategy that relies on index funds will reduce the amount of time you need to spend monitoring investments. A good personal finance Web site will explain this option for you. As Burton Malkiel notes, "simply buying and holding a diversified portfolio suited to your objectives will enable you to save on investment expense, brokerage charges and taxes; and, at the same time, to achieve an overall performance record at least as good as that obtainable using technical methods." ( Random Walk, p. 163) If you want to try to pick winning stocks and you have the resources to allow you to do so prudently, you can try. "The problem is that it takes a lot of work to do it yourself, and as I've repeatedly shown, consistent winners are rare." ( Random Walk, p. 432) Even if you didn't care about wasting your time, the evidence in favor of index funds is strong. Consider these comments from three personal finance advisors:

"Even if you stick with (specific) stocks through thick and thin, you could still suffer lackluster results, thanks to market-lagging performance by your stocks and funds. Because of that danger, consider using index funds for at least part of your stock portfolio. Index funds buy the stocks that constitute a market index in an effort to match the index's performance. By keeping a portion of your money in these funds, you guarantee that whatever the market delivers, that is what you will get." (Jonathan Clements, The Wall Street Journal, p. C1, April 29, 1998.)

With a stock index fund, "Over the long run, your performance will just about match that of the stock market as a whole ... which is better than most mutual funds, do, because most burden your investment with higher management fees. This is a very simple concept but profound: just by investing all the money you have earmarked in the (index fund), you will generally do better than most bank trust departments, mutual fund managers, and private investors ... with far less effort." (Only Investment Guide, p. 185)

"When you're buying big American companies, low-cost index funds outperform most of the active managers over time. So here's the question: If active managers can't beat the market on a regular basis, after expenses, why should you pay them to miss? Buy index funds instead." (Making the Most, p. 702)

FEES and TAXES: A good personal finance Web site should try to help you save money on both. Brokers' commissions, mutual fund sales charges and other expenses can and do eat into the profits of investors who trade stocks actively or who rely on mutual fund managers to do so for them. This means that, although finding a mutual fund manager who consistently outperforms the market is difficult or impossible, it's not hard to find ones who consistently fall short.

"This last point is important; although there can be no consistently superior performers in a fully efficient market, there can be consistently inferior performers. Repeated weak performance would not be due to an ability to pick bad stocks consistently (that would be impossible in an efficient market!) but could result from a consistently high expense ratio and consistently high portfolio turnover with resulting trading costs," according to Bodie, Kane and Marcus in their investment textbook.

You can also lose money by paying for bad advice, whether in print or on-line.

"Don't waste money subscribing to investment letters or expensive services," counsels Andrew Tobias. "The more-expensive investor newsletters and computer services only make sense for investors with lots of money – if then. Besides their cost, there is the problem that they are liable to tempt you into buying, and scare you into selling, much too often, thereby incurring much higher brokerage fees and capital gains taxes than you otherwise might. There is the added problem that half the experts, at any given time, are likely to be wrong." (Only Investment Guide, p. 135)

The same applies to actively managed mutual funds, according to Burton Malkiel:

"Most investors would be considerably better off by purchasing a low-expense index fund that simply bought and held a broad-stock index, than by trying to select an active fund manager who appears to possess a 'hot hand.' Since active management generally fails to provide excess returns and also tends to generate greater tax burdens for investors because they regularly realize capital gains, the advantage of passive management holds with even greater force." (Random Walk , p. 214)

SOCIALLY CONSCIOUS INVESTING: Many investors don't care whether their money is invested in tobacco stocks or in shares of a baby food manufacturer, as long as the dividends keep rolling in. But for other investors, morality plays an important role in investing. An ideal personal finance Web site would provide investors with whatever information they want to know about potential investments, but Sensible-Investor has found few sites that provide useful data about socially conscious investing.