Why You Should Ignore Stock Recommendations from 'Experts'
Investors use stockbrokers and investment managers for what they assume is their market-beating advice in picking stocks. FAIL. A new report from Bloomberg News finds that equity analysts are not only wrong when they list "best buys," they're spectacularly wrong. For all of their computers, MBAs, and six-figure bonuses, they follow the herd into stocks that underperform.
Mutual fund managers do the same. As a group, they rarely beat the market as a whole. You think you're "safer" in a manager's hands than in your own. The opposite is more likely to be the case.
Bloomberg looked at the stocks in Standard & Poor's 500-stock index that the analysts liked best last year. As a group, they gained 73 percent since the market started to recover from its March 2009 low.
That might sound fine until you read the rest of the story. The total S&P index rose 95 percent, with dividends reinvested, according to Morningstar, the financial publisher. By following the gurus, you fell substantially behind. Worse, you paid your broker or manager fat fees to miss.
Don't be fooled by thinking you're still all right (a 73 percent gain is better than a stick in the eye). Falling behind the market in any year has a depressing effect on your savings over the long term. There's less in your nest egg to benefit from future gains. Had you merely tracked the market in an S&P index mutual fund, you'd have retired richer than if you had relied on "expert" advice.
The revelations about "expert" performance get even doggier. The companies that the analysts liked the least turned out to be sensational winners -- gaining 165 percent since the 2009 low, Bloomberg reports. You'd have done better betting against your advisor than scooping up the stocks that he or she told you to buy.
You'll find similar results when you look at the records of the stock pickers who manage mutual funds. The top performers rate four or five stars from Morningstar. Fund marketers advertise those funds widely and the financial press gives them tons of good publicity. Investors flood the managers with money.
But Morningstar's own research shows that stars are worse than worthless as guides to future outperformers, especially at market turns. Five-star funds don't hold their positions long. Over the following three and five years, their average returns fall to the middle of the pack. When you follow the hottest managers, you are buying at the top. The standout managers for the next three or five years are running funds you aren't considering now. Naturally, you don't know who those managers will be.
Where did the analysts in Bloomberg's report go wrong? They predicted that health care and technology stocks would top the charts in 2010. Instead, those groups had two of the three smallest rallies among the 10 industries in the S&P, Bloomberg says, gaining less than 10 percent.
The stocks the gurus liked least -- banks and real estate firms -- rose 19 percent and 29 percent last year, respectively. S&P bank stocks are up 172 percent since March 2009.
How does Wall Street keep on getting away with this? Year after year, data shows that brokers and money managers -- even though they might have a winner or three -- don't beat the market over the long term. Yet investors keep on believing that, somehow, these "experts" hold the secret to getting rich.
There are many reasons why. We engage in magical thinking. We want someone to fatten our nest egg without our having to save more money. We don't know enough to pick stocks ourselves. We're not confident that we can make good decisions without advice (and we don't consider whether it might be bad advice). We remember the good stock picks our broker or manager made, and forget the bad ones. We never compare our adviser's record with the performance of the market as a whole, so we don't realize that we're behind. We can't bring ourselves to believe that the vast Wall Street stock-praising machine is all for naught, even though that is actually the case.
Oops -- I just realize I erred when I wrote that it's mistake to think that experts hold to secret to wealth. In fact, they do hold the secret, but only to getting rich themselves. OK -- they work hard, they mean well, they make you feel good, they're upstanding citizens, they hold your hand when the market turns down. That's irrelevant to performance. As a group, they don't live up to your dreams about their expertise.
For individual investors, the best choice remains low-cost index mutual funds that follow the markets as a whole: an allocation among indexes for U.S. stocks, international and emerging market stocks, and bonds.
P.S. As readers know, I never give stock tips. Still, you might wonder what Wall Street's brainy professionals hate this year, as a guide to an industry that might outperform. The answer, says Bloomberg, is S&P utilities. They offer a collective dividend yield of 4.32 percent -- more than twice the 1.86 percent yield of the S&P stocks all together. The gurus aren't interested. I wonder what the 2011 market will think?
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