06/08/2010 08:41 pm ET Updated May 25, 2011

Goldman's Highly Selective Magic Touch

There's no denying the trading superiority of Goldman Sachs. For the first quarter of this year, in turbulent markets, the firm generated trading profits for its partners every single day!

While the acumen of Goldman's traders was stuffing the pockets of its partners, investors who followed the recommendations of its analysts were still taking the subway to work in the Big Apple.

According to an article in Businessweek, seven of Goldman's nine "top trades for 2010" were losers.

Here's one example: On April 1, Goldman predicted the Hang Seng China Enterprises Index would rise 19% to 15,000. At the time it was at 12,545. On June 4, 2010, it closed at 11,375.

You can't blame investors for following this recommendation with enthusiasm and confidence. It was supported by Dominic Wilson, a senior economist at Goldman. Wilson thought valuations of Chinese stocks were inexpensive and he predicted "robust' growth.

Investors also lost money buying the Polish zloty versus the Japanese yen and buying the British pound versus the New Zealand dollar.

In his classic book, Where are the Customers' Yachts?, written over fifty years ago (and republished in 2006), Fred Schwed, Jr. told the story of a visitor to New York who was struck by the beauty of the yachts owned by brokers. He famously asked: Where are the customer's yachts?

Many are still asking that question.

Sometimes they get it right. Investors fared much better in 2009 when most of Goldman's recommendations turned out to be accurate.

Here's the secret no one wants to tell you: When they are right it reflects luck and not skill. If skill existed, it would persist and not be random.

In a recent study of the performance of 1,034 large cap value funds, Bradford Cornell of the California Institute of Technology sought to determine the impact of skill versus luck on portfolio performance. Here's his conclusion: "When the model is applied to a sample of large cap value managers, the results indicate the (sic) most of the annual variation in performance is due to luck, not skill."

This is not surprising. The author notes his findings are "consistent with that reported in other papers on mutual fund performance", although the model used in this study is different.

In order to fundamentally change the way you invest, you need to understand Wall Street's favorite scam, which is pretending it has skill which it confuses with luck. There is no investment guru who can guide you through these turbulent times and maximize your returns. If the brilliant minds at Goldman can't do it with any consistency, accept the fact that relying on "financial consultants" and financial pundits is the first step on the long road to financial perdition.

There's a silver lining in this cloud of misleading information and outright deception. Investors are starting to get the message. Money is pouring into low cost index funds and Exchange Traded Funds at record rates. Investors understand there is an alternative to a system designed to buy their brokers yachts and leave them struggling to make their mortgage payments.

Investment professionals who actually add (rather than subtract) value are those who agree in writing to act as fiduciaries; who focus on asset allocation and who recommend only a globally diversified portfolio of low cost stock and high quality bond index funds or passively managed funds.

There are alternatives to the hype and predictions of false prophets. The system isn't going to change. It's working too well for the securities industry. Only you have the power to reject business as usual and take control of your financial future.

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