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Smart Advice for the HuffPost Investor: The Lenny Dykstra Controversy: Fair or Foul?

06/17/2008 09:43 pm ET | Updated May 25, 2011

Is famed ball player Lenny Dykstra the new financial guru? He claims that his stock picking skills have returned over 90% for each of the last three years. A very impressive track record!

No less an authority than Jim Cramer anointed him as "One of the great ones in this business."

The controversy over Dykstra was fueled by an article in Forbes that indicated that many of Dykstra's stock picks appeared in lists published by another stock picker. Dykstra, who was not known as "nails" for his timidity, promptly labeled the story "a smear job."

Let's take a closer look.

Being labeled by Jim Cramer as a "great one" is a mixed blessing. According to an in-depth study by Barrons, Cramer's stocks picks woefully lagged the markets in the two year period measured. His picks returned 12% vs. returns of 22% for the DJIA and 16% for the S&P 500.

But does all this really matter?

Roger Ibbotson lacks Dykstra's ball playing expertise, but his standing in the financial community cannot be debated. His is a Professor of Finance at the Yale School of Management and the founder of the highly respected firm of Ibbotson Associates that was recently acquired by Morningstar. He is the co-author of the standard reference for information on investment market returns.

According to a study he co-authored, stock picking is not a skill to be valued by investors because, on average, asset allocation explains "...100 percent of the absolute level of return."

Nevertheless, let's give Mr. Dykstra the benefit of the doubt and assume that he is a great stock picker whose stocks really did return 90% for the past three years. This is the beginning of the analysis and not the end.

A successful stock picker is able to select stocks that will outperform an index of comparable risk. Let me give you an example.

Let's assume that you knew Mr. Dykstra in October, 2002 and you followed his stock picking advice for five years, until September, 2007. During that time, he picked the following stocks:

Dell

Berkshire Hathaway

Wal-Mart

Home Depot

Brilliant, right?

Not exactly.

All of these stocks significantly underperformed the S&P 500 during this period.

Over longer periods, very few stocks (none of the ones mentioned above) outperform the relevant index.

And it gets worse.

Studies have consistently shown that the risk of holding positions in individual stocks is twice the risk of buying the index.

What does all this mean for the average investor?

If you rely on stock pickers, you are taking twice the risk to achieve the same expected return of the index. The chance of your stock picking guru being able to pick stocks that will outperform the index are exceedingly slim.

So is the Dykstra controversy fair or foul?

Neither.

It is irrelevant.



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