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The Lure of Excitement is Killing Your Returns

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Dan Solin, Contributor
Author of the Smartest series of books
Happy young couple jumping into the pool while holding a bunch of balloons
Spend two minutes watching this video. Financial journalist, Robin Powell, interviews author Allan Roth about the lure of excitement to investors. Roth correctly explains this appeal. He notes we want to feel like we’re in control and “know what’s going on”. He observes how the securities industry uses our emotions “against us”, because it’s in their economic interest to do so.

If the industry dispensed sound, responsible advice, and told investors to limit their holdings to broadly diversified stock and bond index funds, it’s revenues would decline and many would go out of business.

The appeal of “doing something”

Roth’s views explain why recommendations from Jim Cramer about how to build a “North Korea-proof investment portfolio” appeal to some (albeit a dwindling number) of ill-informed investors. Cramer and other pundits foster the belief that investors need to “do something” to deal with current events. The “something” can range from “fleeing to safety” (like overweighting your portfolio in gold) to changing the mix of stocks you hold in your portfolio to favor those likely to prosper in the event geopolitical tensions continue to escalate.

Here’s what Wall Street and its shills in the financial media don’t want you know:

There’s no credible data that making adjustments to your portfolio as a reaction to publicly disseminated news does anything but harm your expected returns.

The dismal performance of tactical asset allocation funds

If anyone could profit from this “some something’ strategy it would be tactical asset allocations funds. These funds forecast the returns of asset classes and then adjust their holdings to purchase those likely to outperform. You’d think the professional managers of these funds would have insight far surpassing the talking heads in the financial media.

You’d be mistaken.

Most of these funds historically underperformed Vanguard’s Balanced Index Fund (VBINX). Reviewing this data, author Larry Swedroe had this takeaway: “Bottom line: big fees poor results. In other words, TAA [tactical asset allocation] is just another game where the winners are the product purveyors, not the investors.”

Keep this data in mind the next time Cramer and others encourage you to “do something.” They’re encouraging you to engage in a form of tactical asset allocation, which appeals to your emotions but is contradicted by strong evidence.

Who’s really smart?

Another way to combat your natural instinct to “take action”, is to ask this question. What’s the really smart money doing?

Before you respond, it’s important to define “smart money.” The media wants you to believe managers of hedge funds and self-styled experts who appear of cable news are “smart.”

I don’t quarrel with this characterization. They have been able to convince millions of investors to entrust them with their money and pay huge fees, despite the fact that the track record of most of them has consistently underperformed comparable index funds, which are far less expensive. But being “smart” enough to take advantage of you makes them uniquely unsuitable to give you advice.

Who qualifies as “smart” money? Academics who spend their life studying the financial markets and publishing the results of their research in peer reviewed financial journals.These academics include Ken French, Eugene Fama, Robert Merton and many others.

These researchers (many of whom have Ph.D in Finance) study the science of investing. It’s based on sound research and not musings or speculation. They have identified the real sources of investment returns and rejected “costly speculation and guesswork.” The fund family that has pioneered this academic approach to investing is Dimensional Fund Advisors. You can learn more at its website.

If you asked these professionals what they are doing to “North Korea proof” their portfolios, they would look at you in stunned silence.

You have a choice when you invest. Follow the pied pipers on the financial media who have few qualifications and little or no data to support their musings, or study the science of investing.

The “excitement” of “doing something” gets old fast when your returns continue to underperform low management fee index funds.

The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.

Any data, information or content on this blog is for information purposes only and should not be construed as an offer of advisory services.