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The Peril of Prognostication

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Changing the way investors approach investing once seemed like a difficult task. This is no longer true.

The meltdown of the securities industry, and the 2008 market crash, caused even the most die hard advocates of investing as usual to question the current system. They should since it has nothing to support it beyond massive advertising and lobbying budgets. Unfortunately, for many investors, that is enough to keep them in the fold, often to their great detriment.

The current model is built on the demonstrably false premise that brokers and advisers have superior insights into the markets which permits them to manage our money intelligently. This "expertise" is touted in the endless predictions of "financial experts" who peer into their crystal ball and tell the unwashed masses what the future will bring. While Jim Cramer is the best known in this group, there are many others, including James Dines, Bob Brinker, Gary Shilling and Louis Navellier.

Now there is some objective accountability for these predictions. It is a welcome development and a valuable service to the investing public. A scorecard calculating the accuracy of market predictions can be found on the web site of CXO Advisory Group. The analysis covers more than two years, with over 4600 measurements for 51 gurus.

The overall accuracy of the group was a pathetic 48%. You could replicate this performance by flipping a coin.

Cramer had a score of 46%. He strongly objected to the methodology used to rate him. The exchange of e-mails between him and the CXO group is fascinating. You can read them here. Make your own decision about the merits of this debate. I do have to wonder how many investors relied on this comment, which he is quoted as making on October 1, 2007: "I'm now confident that what would have been a given in 2008, a brutal recession...will now be avoided and prosperity assured."

Relying on financial "experts" who purport to be able to predict the future is insidious. Not only are they as likely to be wrong as right, but listening to them distracts investors from demanding long term historical data which -- while also not predictive -- would give them an objective basis to make investment decisions.

Instead of asking advisers (who are only too willing to respond) "where do you think the market is headed", investors would be far better served by insisting on answers to these questions:

  1. What is the long term (10-50 years) risk and return data for the portfolio you are recommending?
  2. How do these risk and returns compare to a comparable portfolio of low cost stock and bond index funds?

If your broker or adviser is recommending individual stocks, ask her this zinger:

A recent study examined the stock picking skill of 2100 fund managers over a 32 year period and concluded that only 0.6% beat the relevant index (which the authors of the study attributed to luck). Are you in the 99.4% of stock pickers with no skill or the 0.6% of stock pickers who believe they have stock picking skill?

Then run for the door!

Dan Solin is the author of The Smartest Retirement Book You'll Ever Read.


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