7/2/2014 6:30 PM ET|
Connect the dots to better investing
When pieced together, seemingly unrelated news items can form a clearer picture of how to improve your investing strategy.
Sometimes it's necessary to piece together seemingly unrelated news items to come up with an intelligent, evidence-based plan for investing. This is definitely one of those times.
Here are three such news items. By connecting the dots, you may be able to improve your returns:
Dot No. 1: The odds against picking "winners"
Recently, an investor explained to me his process for selecting "winning" stocks. He buys stocks when "those he respects" tell him it's a good idea to do so. I asked him whether there was any peer-reviewed support for his system. He looked at me blankly.
The reality is there is an overwhelming amount of credible evidence demonstrating the daunting odds against beating the market by purchasing undervalued stocks. The latest evidence comes from a study, "New Evidence on Mutual Fund Performance: A Comparison of Alternative Bootstrap Methods," released in June by the prestigious Pensions Institute at the Cass Business School, which is part of City University London. The study looked at the monthly returns of 516 mutual funds based in the U.K. between 1998 and 2008. It found these funds underperformed the market by an average of 1.4 percent for each year during this period.
The study also found that, of the fund managers examined, only 1 percent generated superior performance in excess of operating and trading costs. However, according to one of the paper's authors, David Blake, professor at the Cass Business School, those fund managers extracted the excess returns for themselves as fees, "leaving nothing for investors."
If this is the track record of highly sophisticated, professional fund managers who have extensive resources at their disposal, why do individual investors persist in the discredited practice of stock picking? The only rational explanation is collective cognitive dissonance.
According to Motley Fool writer Morgan Housel, cognitive dissonance is "one of the most powerful theories in behavioral psychology." It describes the practice of ignoring data to justify behavior you inherently know is wrong. To demonstrate, Housel uses the example of a hypothetical investor who puts $1,000 on a penny stock, loses everything, and justifies his behavior by telling himself that he was just investing for entertainment.
Dot No. 2: The trouble with using brokers
The Financial Industry Regulatory Authority (FINRA) announced that it levied a fine of $8 million against Merrill Lynch, Pierce, Fenner & Smith. According to FINRA, the brokerage firm failed to waive mutual fund sales charges for some charities and retirement accounts. Merrill Lynch was ordered to pay an additional $24.4 million in restitution to affected customers. The firm had already repaid more than $64 million to the harmed investors.
The customers affected were approximately 41,000 small business retirement plans and 6,800 charities and 403b retirement plans. Participants in the 403b plans included ministers and employees of public schools.
Merrill Lynch's conduct after it learned that it was overcharging these customers is particularly chilling. According to FINRA, the firm became aware of these significant overcharges in 2006. Did it immediately make restitution? Did it report its conduct to FINRA?
Au contraire. It continued to overcharge its customers and did not report the issue to FINRA for more than five years.
This all-too-common ethical lapse is the latest, but not the only, reason you should refrain from relying on brokers for investment advice.
Bill Bernstein is a financial theorist and author of the seminal books, "The Intelligent Asset Allocator" and "The Four Pillars of Investing." His most recent contribution to financial literature is a superb 27-page e-book entitled: "If You Can: How Millennials Can Get Rich Slowly." Bernstein advises his readers to avoid "at all costs . . . any stockbroker or full-service brokerage firm."
Dot No. 3: Special problems with retirement accounts
Often, brokers giving advice to retirees have an obvious conflict of interest. If the retiree elects to keep funds in the 401k plan, the broker will lose out on fees and commissions that can be earned if the account is transferred to his firm. It's not surprising that many brokers confronted with this ethical dilemma resolve this conflict in favor of their own economic interest, to the detriment of the retiree.
- Also on MSN Money: Retirees lose, brokers win in 401k rollover boom
This conflict would not exist if a rule proposed by the U.S. Department of Labor were implemented. The rule would require brokers and other advisors to act in the best interest of the client during rollovers.
Currently, brokers are permitted to recommend investments that are "suitable" for the investor, even if those investments are not in his or her best interest. Registered investment advisors, on the contrary, are always held to the higher fiduciary standard and can only recommend investments that are in the best interest of their client.
You will not be surprised to learn that this "no-brainer" of a proposed rule is being strongly opposed by the Securities Industry and Financial Markets Association, a trade association representing brokers and other members of the securities industry.
Here's the takeaway from connecting the dots among these three stories:
- Limit your investments to a globally diversified portfolio of low management fee index funds, exchange-traded funds or passively managed funds in an asset allocation suitable for you.
- Do not rely on brokers or full-service brokerage firms for investment advice.
- If you are thinking about rolling over a 401k plan, rely only on the advice of a registered investment advisor who is required to act solely in your best interest.
More from U.S. News & World Report
VIDEO ON MSN MONEY
US News missed one:
Dot No. 4: Special problems with living in America
Often we forget that due to corporations operating 'off shore', there is an extra 'tax burden' placed upon small businesses (e.g. 'S' Corps, LLCs, etc.) to pick up the slack of the mega corporations. Hence, investing in one's own portfolio is hindered whether you are an owner or an employee.
Also, in some states (e.g. PA) where gambling was suppose to greatly reduce or ELIMINATE real estate school taxes, those school districts that don't maintained large debt loads don't qualify for the state's education funding program provided via gambling. Therefore, most all school districts float huge bonds to spend, spend, spend in disguise of providing 'better quality education for the children'. However, it is all about the false image to the public on the property owner's back to maintain 'local financial control' by those districts. Where is the return on the dollar?????.........test results don't even come close the 1960-70s. Again hence, another hindrance on personal investing caused by huge school tax bills for the bonds the school districts float.
Fixing the two above issues could be a big step toward better personal investing, but with the corruption in local, state, and federal government and an apathetic public, don't look for a 'quick fix'.
What a blindered view! Mutual Fund managers have to invest with two things in mind: 1) a good showing for the next quarter or year and 2) a decent showing compared to other fund managers in the next quarter or year.
Studies show if you pick Blue Chips with long records of annually increased dividends and fairly-steady slow growth, you may beat the market by 2-3% per year. Last year I did 33.2% vs the markets 31.5% (including dividends) and this year I'm at 9.38% vs the market's 8.39%.
The reason is that I can pick stocks that have excellent value-tested prospects that the Mutual Funds don't touch or where the funds have so much invested they have to invest in some stocks they don't like so much.
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
[BRIEFING.COM] S&P futures vs fair value: +5.70. Nasdaq futures vs fair value: +14.00. U.S. equity futures hover near their highs amid subdued action overseas. The S&P 500 futures trade six points above fair value. The benchmark index will enter the final session of the month with an August gain of 3.4%. Meanwhile, nine of ten economic sectors are on course to finish the month higher, while the smallest sector by weight-telecom services-will enter the session with an August decline ... More
More Market News
|There’s a problem getting this information right now. Please try again later.|
MUST-SEE ON MSN
- Video: Easy DIY smoked meats at home
A charcuterie master shares his process for cold-smoking meat at home.
- Jetpacks about to go mainstream
- Weird things covered by home insurance
- Bing: 70 percent of adults report 'digital eye strain'