Tuesday, November 10, 2009

Investment Advice Often Reaches the Wrong People

There is no shortage of investing advice in the world. Some of it is good, some bad, and much of it is contradictory. However, just because two opinions are contradictory doesn’t mean that one of them is necessarily wrong. Unfortunately, we often gravitate to the advice that is wrong for us.

For example, consider the following two very general opinions:

1. Investors should be careful with their money.

2. You have to take some investment risk to get rewarded.

These opinions are somewhat contradictory, yet both true. They are also vague enough that people will read into them what they want. Let’s look at a couple of extreme examples to illustrate how this advice affects two investors.

Action Andy has his investment account leveraged to the maximum and owns just two stocks. He reads the first piece of advice about being cautious and rejects it because it sounds like his mother talking. The second piece of advice prompts him to re-mortgage his house and buy into the latest hot Initial Public Offering (IPO).

Fearful Frank has all his savings stuffed into his mattress. He rejects the advice about taking some risk because he can vividly remember all the bad things that have ever happened to him when he took a chance. The advice about being careful prompted Frank to get rid of his dog so that the money in his mattress wouldn’t get chewed up.

In these extreme examples, Andy and Frank rejected the piece of advice they most needed to follow. Most of us tend to reject ideas that don’t already fit into our beliefs. However, it can be a good idea to think about new ideas sometimes, even if you end up rejecting most of them. The odd idea that doesn’t sound right at first may be beneficial.

Some advice I encountered recently that will likely reach the wrong people came from Larry Swedroe who advises you to reassess your investment strategy in light of the recent bear market. The idea is to lighten up on stocks if you couldn’t stomach the paper losses.

The investors Swedroe has in mind are the overconfident stock pickers who take on far too much risk. For these people, Swedroe is spot on. Unfortunately, his message isn’t likely to resonate with these investors.

However, consider the investor who had a conservative 50/50 split between a stock index and a bond index and sold all the stocks near the market lows. This investor is likely to see Swedroe’s advice as supporting the stock index sale. Well into the next bull market this investor may decide to reassess his risk tolerance again and buy back in.

So, this hypothetical investor has used Swedroe’s perfectly good advice to justify a terrible strategy of selling low and buying high. Giving advice is a difficult game (when you genuinely want to help people) because often the wrong people take it.

3 comments:

  1. Being conservative could mean we should all go buy Canada Savings Bonds, after all, it was good enough for our parents, wasn't it?

    Rationalizing decisions by blaming "advice" given to us seems to be how things are done these days. It's not MY fault!!!

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  2. Too many people take "advice" without any contextual analysis. What may be good for one may not be good for another.

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  3. Keep posting stuff like this i really like it.

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