I ran across a Dilbert comic strip a while back, where Asok is convinced he’s a stock picking genius because his first stock purchase went up 5% in a week. Meanwhile, Dilbert points out that the market as a whole was 6%. Asok isn’t impressed. It must be a fluke.

 

If investing were a funny bone, this cartoon hits it head on. It addresses several problems with how people think about investing, which is why it’s simultaneously funny and painful. Here, we analyze a couple of those problems.

Recency Bias

Asok is ecstatic. Why? Because his first stock purchase went up 5% in a week. Therefore, he reasons, his unique insight and skill has allotted him the ability to earn lots of money in day trading. You think this is silly? You shouldn’t. A lot of people think this way. In 2000, people were taking out 2nd’s on their homes to day trade. The stock market had increased dramatically for several years during the 90’s. Everyone was making money. Everyone was a genius. That is, until March of 2000 hit and everyone who thought they were a genius found out they weren’t.

How about 2007? People were buying homes with “NINJA” loans because it was the investment of a lifetime. That is, until it wasn’t. When the fake, government-fueled real estate bubble burst, many of those buyers had to foreclose. Many others who had the intestinal fortitude to remain in their homes have been underwater since.

Today, investors are once again piling into the stock market. With central banks pushing interest rates to all time lows, retirees, who normally (and primarily) invest in bonds and cash, see stocks as the new bonds. Are stocks the new bonds? No, stocks are the old stocks (i.e. the ones that are way overvalued). Stocks are less likely to pay investors over the next 5-10 years as they are to make investors pay.

What we’re talking about here is recency bias. That is, the tendency for individuals to take short-term trends (1-3 years), and extrapolate them out over the next decade or two. When they do so, they make poor investment decisions (i.e. maxing out their credit cards to become a day trader). Asok would be proud, if he were a real person. What is real, however, are the consequences of chasing short-term trends.

Beating The Market via Stock Picking

The second fallacy is not so obvious, but just as serious. Asok’s vow to max-out his credit cards is ridiculous, right? Well, not so fast.

Asok believes he is a stock picking genius. He believes he can beat the market by picking individual stocks that outperform the majority of other stocks. Believe it or not, people like Asok really do exist. You’ve probably met one of these individuals. Perhaps in a casino, perhaps in their office. Perhaps at the same time.

Anyway, they probably want to manage your money for a fee. Should you let them? Well, you may say, “I’d like to see their past performance. I’d like to see that they outperformed in the past. That would give me confidence enough to pay them moving forward.” But what time frame would satisfy your confidence in their ability to “beat the market”? Asok thought he beat it for a week. Too short? How about a year? Five years? 30 years?

I would suggest the time frame is irrelevant. Someone who asks to manage your money for a fee because he or she can beat the market isn’t trustworthy.  And why would I say that? Because of common sense. See, these stock-picking geniuses haven’t pulled an Asok and maxed out their credit cards to purchase stocks. They haven’t “put their money where their mouth is”, so to speak. Deride Asok, but at least he’s being consistent.

Sadly, consistency is seldom sought and even more rare to find. If you say you can beat the market, then act like you can beat the market: borrow money at low interest rates and beat the market.  If you can’t, and you know you can’t, then its best (if you’re of questionable ethics) to tell people you can and invest their money, for a fee. This is ridiculous, right? Asok certainly thinks so. But go ahead, laugh at him maxing out his credit cards. Afterward, you can open up that account your stock-picking genius advisor recommends.

Conclusion

You may be thinking, “Isn’t Plan Financial an advisor that advises for a fee?” Yes, but our primary concern is helping our clients accomplish their objectives, not “beating the market.” We think that is simply a fool’s errand. Although we often do outperform, our disciplined investment process is designed to give our clients consistent, reasonable returns over a meaningful period of time. In short, we earn our keep by helping you make wise decisions, giving you the greatest likelihood of accomplishing your objectives.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material contains the current opinions of the author but not necessarily those of Plan Financial and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission. Plan Financial is a trademark or a registered trademark of Plan Life & Wealth Management, Inc., in the United States. © 2016, Plan Financial.