Last Updated Feb 3, 2011 3:11 PM EST
I meet regularly with many high-net-worth individuals who get tremendous attention from the wizards of Wall Street. They're often trying to decide whether to hire someone like Goldman Sachs, Morgan Stanley, Northern Trust or Deutsche Bank as their financial advisor (providers of the most expensive tickets to sporting events you will ever "buy"). As active managers, they're each basically saying they can predict the future. They do this despite the lack of evidence that good predictors exist. (If you're interested in the subject of forecasting, I recommend reading The Fortune Sellers by William Sherden and Expert Political Judgment by Philip Tetlock.)
Consider the following quotations:
Warren Buffett "We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children."
Ralph Wanger "For professional investors like myself, a sense of humor is essential. We are very aware that we are competing not only against the market averages but also against one another. It's an intense rivalry. We are each claiming that, 'The stocks in my fund today will perform better than what you own in your fund.' That implies we think we can predict the future, which is the occupation of charlatans. If you believe you or anyone else has a system that can predict the future of the stock market, the joke is on you."
The belief in the ability to forecast the future leads investors to focusing their attention on trying to manage returns. It just seems to be a human need to believe that someone can protect us from bear markets. Unfortunately, there's only one person who knows where the market is going, and none of us get to talk to him (or her) about that issue. If this weren't true, priests and rabbis would dominate the list of the wealthiest people. We would all be better off if we reinstituted the Middle Ages practice of burning the fortune tellers (forecasters) at the stake for wrong predictions.
The overwhelming evidence on efforts to outperform demonstrates that while it's possible to beat the market (providing hope, which isn't a strategy), the odds of successfully doing so are so poor that it isn't prudent to try.
Smart investors don't focus on things over which they have no control (forecasting the future and managing returns). Instead, you should focus your attention on the things you actually can control:
- The amount of risk you take.
- Diversifying the risks you take. You shouldn't in individual stocks, sector funds or country funds because they contain idiosyncratic risks that can be easily diversified away and thus are what economists called uncompensated risks. Only people who can foretell the future should take such risks.
- Minimizing costs.
- Maximizing after-tax returns (not tax efficiency).
- Finding the best investment vehicles to implement the plan.
How to Avoid Financial Errors Don't Underperform Your Own Funds Don't Listen to Economic Forecasters Don't Lose Sight of What's Really Important The Greatest Beneficiary of a Passive Investment Strategy? Your Family
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