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Smart Advice for the HuffPost Investor: The System Is Rigged Against You, Can You Beat the Odds Or Should You Stay On the Sidelines?

05/25/2011 12:25 pm ET
  • Dan Solin Author of the Smartest series of books

I can certainly understand the anxiety of investors. They are blindsided by news that only seems to get worse every day.

One reader believes the entire system is rigged against investors. Another has had enough and is staying on the sidelines. A third is on the cusp, waiting for someone to explain the big picture to him.

What is the prudent course for investors to follow in these stressful times?

I deal with these issues in this week's column.

Please continue to send me your thought provoking questions. I will do my best to answer them.

Question From realitytrumpsbull:

If you understand that the table is rigged, why would you play?

realitytrumpsbull,

I could not agree with you more! However, let's define what "table" you are talking about.

Investors who rely on brokers or financial advisors to pick stocks, time the markets or select outperforming, hyperactively managed mutual funds are playing a game that is stacked against them.

Your reference to a "table" in this context is very appropriate. These investors are gambling with assets in a manner not unlike a player at a casino gaming table.

This is the "table" that investors should avoid.

Fortunately, there is an alternative to this stacked desk. Investors can become the casino and get the benefit of the favorable odds that built those billion dollar palaces. All they have to do is change their goal from the low probability game of trying to beat the markets to the certainty of achieving market returns, using low cost index funds.

Question From knowhelpnow :

I don't know much about investing but I'm staying in cash and bonds until someone can explain just what is going on and can convince that this market isn't going to crash.

knowhelpnow:

I suspect that you are going to be looking for that person for a long time.

Many people will try to convince you that the market is not going to crash. The problem is that an equal number will tell you that it is.

I can give you a definitive answer, but it won't help you very much:

No one knows.

So what is an investor to do?

First, you should determine if you should be investing at all. Even in a very conservative portfolio, you will need to hold for a minimum of four years in order to have a high likelihood of achieving historical average annualized returns. The holding period increases to as much as twelve years for a portfolio that is invested 100% in stocks.

Regardless of market conditions, if you don't feel comfortable with the holding period for the risk level of your portfolio, you would be well advised to "stay in cash and bonds."

However, if you can overcome this hurdle, the current uncertainty in the markets should not deter you from determining an appropriate asset allocation and investing in a globally diversified portfolio of low cost index funds.

Staying on the sidelines until you find a guru who can predict the direction of the markets is not a prudent course. Here's why.

Being out of the market for even a very short period of time can eviscerate your returns.

One study showed that missing just ten trading days over a ten year period caused returns to drop by more than 50%.

Another study of the markets over a 90 year period showed that if you relied on a guru to pick the best times to invest, and she accurately predicted 100% of the bad days but only 50% of the good ones, your portfolio would underperform market returns.

Those are bad odds. Here are some good ones:

If you determine an appropriate asset allocation, invest in a globally diversified portfolio of low cost index funds and are able to stay invested for the period appropriate for the risk level of your portfolio, there is a very high statistical probability that you will achieve the historical annualized returns for that portfolio, based on all historical data (which is not necessarily predictive).

You don't have to listen to the predictions of any market gurus. You don't have to be concerned about current market uncertainty.

You can sleep at night.

Question From Mutex:

"If you have questions, please add them as Comments to this blog and I will answer as many of them as I can."

Okay, I'm challenging you to answer this question:

Most analysts acknowledge that the United States' current account deficit is unsustainable. If this is the case how do we turn it around and what happens to our economy if we do versus what happens if we don't?

Thank you.

Mutex,

I accept your challenge and up the ante. I am going to give you the answer to your question from a source far more qualified than I.

David F. Swenson manages the $22 billion endowment of Yale University. He is the author of an excellent book on investing, Unconventional Success: A Fundamental Approach to Personal Investment (Free Press, 2005).

In a recent article in The New York Times, he was quoted as follows:

I think nobody is in a position to react to these big macro-issues. Where is the dollar going to be or what is G.D.P. growth going to be in China? For every smart person on one side of the question, there is another smart person on the other side.

I agree with Mr. Swensen. Talking heads on TV love to ruminate about these "macro-issues" and to advise investors to take action based on their opinions.

Some of them are right. Others are wrong. Investors are simply confused.

My advice is to ignore these issues and invest based on sound academic principles that don't require knowledge of the unknowable.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.

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