Why Most of the Investment Advice You’ve Heard is Wrong

by Alexander Green, Investment U Chief Investment Strategist
Friday, January 20, 2012: Issue #1691

A conversation with a friend last week sounded numbingly familiar.

“I just can’t seem to win for losing in the stock market,” he confessed. “Five years ago, my broker had me fully invested in stocks and I took a drubbing. Then when things were bottoming out a couple years later, he talked me into making my portfolio more conservative. As a result, I didn’t get much of a pop on the rebound. Now he’s trying to get me to reshuffle again. But I’m too scared to do anything.”

Since he was a friend, I felt obliged to tell him the truth: He’s getting lousy investment advice. Not because his broker failed to outguess the market… but because he’s guessing at all. As if that wasn’t bad enough, there’s a good chance that the advice he’s getting is tainted by self-interest.

Here’s what I mean…

It still astonishes me that the vast majority of investors – even ones who have been active for decades – still don’t understand that stock market success has nothing to do with figuring out the economy.

Look back at history. There’s no correlation between economic growth and stock market performance from year to year. Equities routinely plunge during the good times and rally during the bad. If you know this – and truly understand it – why would you invest your money based on someone’s economic forecast?

The same is true of market timing. It’s easy to look in the rearview mirror and see when you should have been in the market and when you should have been out. But when you look ahead, it is always a blank slate. No guru or trading system can change that.

Even if you could somehow divine what the stock market was going to do next – which you can’t – you still wouldn’t know which stocks would outperform and which ones would lag.

The only way to determine that is to look at business fundamentals. Companies that are doing all the right things – increasing sales, compounding earnings at high rates, growing market share, improving operating margins, paying down debt, buying back shares – will post superb returns, regardless of what the economy or stock market are doing. And those that are doing the opposite – experiencing flat or negative sales, lackluster earnings growth, small margins, high interest costs and diluting existing shareholders with new stock issues – will be laggards.

In short, stock market success is about analyzing businesses not investing in some self-styled expert’s macroeconomic forecast. Yet that’s exactly what the mass media and much of the investment advisory industry encourages people to do every day.

The media does it to attract viewers – and thus advertisers. The advisory industry does it sometimes out of ignorance but often just to justify its fees. This is especially true when you have a transaction-based relationship with an advisor where the more you trade the better he or she is compensated. Trust me. That doesn’t generate satisfactory long-term returns.

Every time you hear a pundit talk about “the new normal,” the rally just ahead or the prolonged economic slump we’re likely to endure, understand that you’re listening to opinions that are no more helpful than a weather forecast for three weeks from Sunday.

Both pieces of advice are worthless. But one is a lot more expensive – and harmful – than the other.

Good Investing,

Alexander Green