Monday, October 20, 2014

Stock Market Momentum

People tend to think of the stock market as something that moves up and down like an airplane. There are problems with this way of thinking that cause investors to make poor choices.

If the stock market really were like an airplane, it would have momentum that makes it difficult for the market to change direction from rising to falling or vice-versa. The truth is that prices can change on a dime because they are determined by the bid and ask prices of traders who can change their minds in an instant. There is a technical concept of momentum in stock prices, but it isn’t the same as momentum in physics; there is no physical object that must be slowed down and turned in the other direction.

The problem with a false analogy like the airplane is that it creates the illusion that if markets move in one direction a few days in a row, they are almost certain to continue that way for a while. But this isn’t true for stocks.

The recent downtrend in stock prices has many commentators saying that we are “in a correction.” But all we can say with any certainty is that we have had a correction. It may or may not continue. Saying that we are in a correction implies that falling prices will continue over the short term, which is far from certain.

The wiring of our brains makes humans very good as finding patterns. The trouble is that we sometimes see patterns that aren’t there. Stock prices over the short term are largely random. If you think you see a pattern, blame your brain.

Friday, October 17, 2014

Short Takes: Lessons for Bill Gates, Robo-Advisors, and more

I wrote one post this week reviewing a book that solidified my view that I won’t pay any attention to market predictions:

Clash of the Financial Pundits

Here are some short takes and some weekend reading:

Bill Gates discusses three things he’s learned from Warren Buffett.

Dan Bortolotti discusses the effect robo-advisors will have on the financial advice industry. He concludes that “To justify their fees, advisers will need to improve the level of personalized planning services they deliver.”

Million Dollar Journey shows where to get help for starting or growing a business.

Big Cajun Man makes his case for allowing couples to split their income. We’ve been getting lots of hints that this is coming but only for couples with young children.

Tuesday, October 14, 2014

Clash of the Financial Pundits

The book Clash of the Financial Pundits by Joshua M. Brown and Jeff Macke promises to tell readers “how the media influences your investment decisions.” For the most part the authors deliver on this promise. In the end this book solidified my view that it’s not worth paying any attention to those who make market predictions, but that’s not what the authors intended as the takeaway for readers.

Much of the book consists of transcripts of interviews with various financial pundits, the most well-known of which is Jim Cramer. While I found these interviews somewhat interesting, the best parts of the book were short chapters 9, 13, 15, and 19, none of which contained interviews.

Chapter 9 explained that the pundits who attract viewers are those who make the most outrageous predictions. “So long as you’ve still got a recognizable name, you’re still in the [punditry] game.” “And being right is irrelevant, so fire away!”

Chapter 13 explains that among pundits “it’s better to be confident than accurate.” Whether you really know what will happen isn’t important. What matters is “acting like you know.” This is “what the public wants anyway.”

Chapter 15 makes the very good point that well-known investment rules contradict each other. It goes on to list 18 pairs of rules that are contradictory. One example is “no one’s ever been wrong taking a profit! But let your profits run and don’t sell your winners.”

Chapter 19 shows how pundits make predictions in ways that allow them an out if the prediction turns out to be incorrect. They “couch their predictions in outrageousness and wackiness” or use “the subtle art of making a suggestion that can later be construed as a prediction” if the prediction turns out to be correct.

The authors try hard to make the case that to “have some hope that your portfolio will help you maintain your purchasing power through decades of retirement” you have to pay some attention to financial media. I’m not convinced. You need to learn about asset allocation and many other things, but you don’t have to listen to anyone who makes market predictions. As Charlie Munger said “Our job is to find a few intelligent things to do, not to keep up with every damn thing in the world.”

I liked a quote from Ben Stein: “I have to say that every time I see anyone make a specific prediction about the future ... I shake my head because those predictions are useless. There’s only one guy whose predictions are incredibly useful; that’s John Bogle.” Bogle is considered the “father of index investing.”

In an exchange between Jeff Macke and Jim Cramer, they agree that their critics should just “take the other side of every trade.” This would be a dream for pundits. Everyone either loves you or hates you, but they all watch you. I think Cramer’s picks are just random and so I don’t pay any attention.

I liked one of Cramer’s quotes: “if you really understand [what you’re talking about] you can make it simple.” This is very true. Those who make things seem complicated often have a poor understanding of what they’re talking about. You need to understand a subject well to be able to explain it clearly.

In the authors’ conclusion they say that “predicting the future consistently cannot actually be done—by anyone” and “that despite this inability to be right all of the time (or even most of the time), there is still value to be gleaned from the words and ideas of the market commentariat class.” I disagree. All evidence is that people who act on ideas to beat the market end up losing to the market, on average. Mechanical strategies with appropriate levels of risk are a better bet than trying to outsmart other traders. What investors often need is an antidote to market pundits. During the 2008-2009 crash, Warren Buffett tried to remind people that the U.S. has a great economy and that the future would be better than the past, despite the then current troubles.

Another frequent justification in this book for the existence of pundits is that people wouldn’t watch a show that just said to buy index funds. This is true. I fully expect financial media to do whatever makes money. But attracting eyeballs isn’t proof that they are a net benefit to the viewers.

Overall, I found this book to be an easy and interesting read. It clearly lays out the techniques financial media use to attract viewers, which I liked. It even suggests that viewers should be very selective about what they watch. But, in my opinion, they still overstate the value of pundits.

Friday, October 10, 2014

Short Takes: Reinventing Finance, Lower Vanguard Fees, and more

Here are my posts for this week:

The Alchemy of Finance

“Invest However You’re Most Comfortable”

Here are some short takes and some weekend reading:

Marc Andreessen believes we can improve finance by completely reinventing it. If you think Andreessen is right about this, you may not want to concentrate your portfolio in bank stocks.

ETF Insight reports that Vanguard is lowering their ETF management fees in Canada. I’m happy I’ll save enough money to take my wife out to dinner a few times.

Boomer and Echo compares 5 different robo-advisors already operating in Canada or coming to Canada soon.

Mr. Money Mustache teaches how to get rich with science. As usual, he writes very well and makes you think.

Canadian Couch Potato has some interesting examples of how taxes affect ETF performance. Portfolio turnover matters in addition to the mix of dividends, interest, and capital gains.

Big Cajun Man asks whether spousal RRSPs have any use now that we have pension splitting. He got some good ideas in the comments section for how spousal RRSPs are still useful.

My Own Advisor’s latest dividend update drew quite a few comments, mostly from active stock pickers.

Karen Cleveland at Canadian Business has some sensible ideas about what to do when you’re sick. Spoiler: stay home. You think you’re being a hero by going in to work, but others just want you to stay away from them. Another thing to consider is that staying home is doing your part to reduce the virulence of infections. Any infection that causes people to isolate themselves is a genetic failure. Infections are most successful if they’re as virulent as possible without making people stay home.

Thursday, October 9, 2014

“Invest However You’re Most Comfortable”

It sounds wonderfully inclusive to say that everyone can succeed at investing by approaching it in whatever way they’re most comfortable. In reality, this just isn’t true.

One elderly couple I know has been living off GIC interest for many years. Even worse, they’ve just been accepting the interest rates offered by big banks instead of seeking out the best rates. They now have very little left and are forced to live extremely modestly. Given the large nest egg they started with decades ago, they could still be living a middle class lifestyle. But they stuck with what made them comfortable.

I’ve known two people well who tried to make money with stock options. Both lost all the money they devoted to the effort. They didn’t like the idea of making money slowly and went for some big scores. So much for seeking success investing in their own way.

Many of my colleagues over the years have invested their money trading individual stocks. This was particularly true during the tech boom in the late 1990s. It can be tricky to learn people’s true returns because they usually don’t know themselves how they’ve done. They tend to boast about their successes, but you can get them to moan about their losses if you ask right. I’m willing to guess that few of these people managed to do as well as market returns.

I was comfortable with stock-picking for many years. However, if we eliminate the spectacular returns I got on one stock in 1999, my stock-picking record was underwhelming. If I had continued stock-picking with this level of underperformance instead of switching to indexing, by today my portfolio would be smaller by about the value of my house.

It makes so much sense to seek out friends and activities that make us happy and comfortable, but this doesn’t apply to investing. It pays to reason your way through deciding how to invest your life savings.