I sat down to speak with Doug Goldstein of the Money Tree Investing podcast to discuss whether it’s realistic to expect to beat the market with any consistency and the media’s role in spooking or exciting investors. He asked smart questions and I tried to give smart answers based on the findings in my book and other personal finance sources. Check it out!
(This excerpt originally appeared as a post on my LinkedIn feed).
Whoever first said that “life isn’t a popularity contest” probably needed to get out more, but he or she had one redeeming quality: being a good investor. My new book, Heads I Win, Tails I Win, shows that most of us are lousy.
Think back to your high school. If it was anything like mine, the student body voted to decide which of their classmates was cutest, best-dressed, funniest and most likely to succeed, among other categories. The last of those was often the easiest to guess: a kid who had it all figured out and was well on his or her way to an Ivy League university followed by medical school or some other solid, lucrative path.
There isn’t a vote for least likely to succeed. The point of these contests isn’t to hurt people’s feelings, even if they sometimes do. But if there were then the recipient would be equally obvious: that good-for-nothing stoner who was late for every class and barely graduated or didn’t at all.
Now imagine being able to buy a share in the future earnings of Mr. or Mrs. “Most Likely” and “Least Likely” as if they were a company. The market prices would be sky high for the former and a pittance for the latter, with good reason. Everyone else would fall somewhere in-between. That’s exactly how the stock market works, though the vote occurs every minute of the day.
Whether you rely on conventional wisdom or actual surveys such as “America’s Most Admired Companies,” picking out the corporate crème de la crème isn’t hard. But investing in them exclusively happens to be a bad idea. In fact, the least admired companies on such lists tend to outperform the best ones as measured by stock market performance.
Think back on the high and low achievers in your graduating class. Some of the bad eggs probably turned things around and, while they may not be fabulously wealthy, are doing fine. Meanwhile, some super-achievers never really lived up to expectations. Likewise, we pay too much of a premium for respectability in the corporate world. Once a company is a blue chip, it’s priced not only appropriately but at a premium. Translated into stock selection, going with less popular, less obvious choices is likely to be profitable. Finance professors Meir Statman and Deniz Anginer combed through several back issues of Fortune Magazine’s ranking of respectability and created a “most admired” and “least admired” portfolio. Shares of the latter outperformed the former by nearly two percentage points a year.
Favoring Wall Street’s redheaded stepchildren can be done systematically. One way is to buy companies that essentially are being dumped by larger corporations. Unable to sell them or unwilling to pay a big bill to Uncle Sam in the process of doing so, companies frequently “spin-off” subsidiaries to existing shareholders in a tax-free transaction. The thing is, though, professional investors act strangely when these brand new companies land in their portfolios. Suddenly a fund that owned, say, a large bank, also has the same exact stake in a small or medium-sized insurance company. They already owned it before, of course, but it didn’t have its own name and stock ticker. In a value-destroying disservice to their clients (hey, what else is new) , they decide that keeping it in their portfolio is more trouble than it’s worth so they’re likely to sell their shares in the near future, putting downward pressure on its price early on.
Meanwhile, a middle-level corporate manager at the former insurance subsidiary suddenly finds himself as the chief executive of a listed company with his or her very own stock options and an even stronger incentive to do well. It may take a while, but the results usually are surprisingly good. The phenomenally successful value investor Joel Greenblatt wrote about his strategy of buying spinoffs in You Can Be a Stock Market Genius. Other investors have taken note. There are exchange traded funds that buy spinoffs exclusively. A $100 investment in an index tracking their performance has grown to $319 in the past year compared to just $170 in the broad stock market
Another long-running, well-known, yet still successful way to profit from what’s out of favor on Wall Street is to buy the “Dogs of the Dow” each January – the ten highest dividend-yielding stocks among the 30 Dow Jones Industrials. These usually were relatively poor performers in the previous year, allowing their dividend yields to rise (as price falls, yield rises as long as payouts are unchanged). A $100 investment at the start of this century in the Dogs turned into $313 compared to $233 in the broad market.
Far worse than investing in the most-admired companies is having a preference for the most glamorous or exciting ones. The very first investing book I ever read, Peter Lynch’s 1989 bestseller One Up on Wall Street, warned investors away from companies with flashy names. It specifically said companies with an “x” in their name were to be avoided.
It seemed like a throwaway line but it stuck in my head years later. Just for fun I decided to test it out for an investing column in 2010. The results were surprising. I found 109 stocks in the Wilshire 5000, the broadest U.S. stock index, that began or ended with an “x,” including a few that did both. Right away I could see that Lynch was onto something. Only 49 of them had been profitable in the previous year. Even weeding the money-losing ones out, the remaining stocks were far more expensive on measures such as price-to-book or price-to-earnings than the broad market and also a lot more volatile. In other words, they were both riskier and less desirable on average.
Why would there be a connection? As any Scrabble player can tell you, few words have an “x” so that letter, probably along with “z” and “q,” lend themselves to made-up, snazzy-sounding names. By my calculation, an “x” appears in company names 17 times more frequently than in actual English words.
The same warning could have been given about companies with a “dot-com” in their name 15 years ago. A quarter century earlier, in the swinging sixties, it was anything with the suffix “tronic” or the word “scientific.” Hot companies included Vulcatron, Circuitronics, Astron and the gratuitously snazzy-sounding “Powerton Ultrasonics.” In his classic A Random Walk Down Wall Street, Burton Malkiel tells the story of a company that sold vinyl records door-to-door. Its stock price surged 600% when it changed its name to Space Tone.
The fact that boring stocks are better seems to be a lesson that each generation has to learn anew. Superior bang for the buck from dowdy, out-of-favor companies was discussed as early as 1934 in Security Analysis, the investing classic by Benjamin Graham and David Dodd. Graham was the teacher and has served as the inspiration for the most-successful investor of all time, Warren Buffett, so it’s safe to say that his theories have worked pretty well in practice.
Each generation may make the same mistakes, but individual experience seems to matter. When my son’s high school had a stock picking contest I asked if I could see his classmates’ portfolios. The most popular choices were highfliers such as Tesla, Facebook, and Apple. Not a boring company in sight. Most of his classmates lagged the market.
A company called Openfolio that anonymously aggregates results and holdings from thousands of individual investors showed the same thing. Some 77% of Tesla shareholders were 49 or younger while 73% of Exxon Mobil owners were over 50. But younger investors’ love of flashy companies hurt them. During 2014 the portfolios of 35 to 49 years olds lagged 50 to 64 year olds by 2.3 percentage points. Those below 25 lagged the older group by a whopping 6.4 percentage points.
Maybe we do live and learn.
I have a soft spot for Barron’s Magazine, the investing weekly. When I was a kid my dad would always have a folded copy in his briefcase. A little over 13 years ago, when I decided I wanted to be a financial journalist, one of the first things I did was apply for a job at Barron’s. They weren’t hiring but I wound up writing a couple of dozen freelance pieces for them anyway.
I’m happy to say that they, or at least their book reviewer, have a soft spot for me too. The review that appeared of Heads I Win, Tails I Win was very flattering. I like how it starts:
Spencer Jakab comes off as a reluctant financial guru. You might expect a Wall Street Journal columnist and editor (Heard on the Street, Ahead of the Tape) to stress his investment prowess in a book on investing. But not until page 249 does Jakab confide that he rescued his mother’s stock portfolio from the dot-com bust of the early-2000s, persuading her to sell her Nasdaq-related holdings in the fall of 1999 and park the funds in “boring Treasury bonds.” Her circle of middle-age Hungarian immigrants ignored his advice and lived to regret it.
Anyway, read the whole thing and then read my book if you haven’t already.
My book was featured in a nice article by Ron Lieber in The New York Times. It starts out mentioning an alleged Fidelity Investments study that showed a surprising finding about investor success. Here’s a transcript from Business Insider of Jim O’Shaughnessy discussing it with Barry Ritholtz:
O’Shaughnessy: “Fidelity had done a study as to which accounts had done the best at Fidelity. And what they found was…”
Ritholtz: “They were dead.”
O’Shaughnessy: “…No, that’s close though! They were the accounts of people who forgot they had an account at Fidelity.”
Except, as Lieber found, the study had never been conducted. For what it’s worth, I bet that’s what they would have found since, as I note from two actual studies in the book, frequency of trading or even checking your brokerage account correlates negatively with returns. Rip Van Winkle would’ve been an awesome investor.
In addition to being a nice piece on investing, the article has a photo credit (the pic above) by none other than little old me – surely a first for a Wall Street Journal reporter in our rival paper! It’s a snapshot of my collection (well, part of it) of bad investment books that I mention in Chapter One.
A nice article appeared today in Money Magazine by Kerry Close about my book: “5 Ways to Make Smarter Investing Decisions-By Outsmarting Yourself.”
Who doesn’t like a listicle? I’ll let you read it if you want, but here’s the intro:
The best thing you can do for your portfolio may be absolutely nothing.
A steady, mechanical approach to investing is a predominant theme throughout Heads I Win, Tails I Win, a new book released today by Wall Street Journal“Heard on the Street” writer and editor Spencer Jakab. The former Credit Suisse stock analyst emphasizes that the vast majority of investors are wired to think they’re better at making money than they actually are—and that we ignore all evidence to the contrary.
The solution? “Put into place a process that will stop you from sabotaging yourself,” Jakab recommended when we spoke to him this week. That means investing in a methodical—and even mechanical—way, rather than reacting to the ups and downs of the market and pundits predicting gloom and doom on TV.
An excerpt of my book appears in today’s Wall Street Journal (front page of the Money & Investing section). It explains, using “Back to the Future Part II,” why market timing is so futile.
What follows is an excerpt of the excerpt (is there a word for that … excerptlet maybe?).
Investors are way off in their estimate of how their portfolio has done, routinely guessing several percentage points a year too high. While that comes as a shock, they are even more surprised to be told that it is missing good times rather than suffering through selloffs that hurt them the most.
Like Biff, investors sit out on some really good days by trying to avoid bad ones. Nearly all of those happen around scary episodes such as October 1929, October 1987 and in 2008 following the collapse of Lehman Brothers. Pretend, for example, that you took your money out of the market following the choppiest episodes over the last 20 years and wound up missing the epic rebounds that made up the 40 best days. You actually would lose money. A couple of days a year on average produce all of the market’s return.
Read the whole thing or, even better, buy the book. It just went on sale.
I was thrilled to see that my upcoming book was reviewed this weekend in Fortune Magazine and even more so when I saw that the reviewer was none other than Roger Lowenstein. He’s one of the most accomplished financial journalists around, the author of several books I’ve enjoyed, and also a former Heard on the Street columnist like me.
I was perplexed when I started to read the review, though. The first 264 words – as long as some entire book reviews – were about Benjamin Graham, the father of value investing, mentor to Warren Buffett, and a man I mention several times in Heads I Win, Tails I Win. After that he finally got to my book and said a couple of nice things.
He wrote that “Jakab has plenty of sensible advice” and that my writing is “anecdotal and witty.” But that’s where the praise ends. Lowenstein laments that the author, “a former security (sic) analyst … spends many pages debunking the idea that investors should try to time market breaks (he aptly likens this to astrology). He devotes not a paragraph to how one might estimate the future profitability of a business…One does not learn how to evaluate stocks. One learns that value investing has worked, but not why.”
While a more positive review would have made me happier, the weird thing was that Lowenstein really seemed to want to have read an entirely different book – one that taught my mostly mom and pop audience how to value stocks and beat the market. The premise of my book, though, is that this is mostly a wasted exercise, whether you try to do that yourself or pay some clever broker or stock picker to do it. My own work as a securities analyst and overwhelming academic evidence support this.
But the weird thing is that he invokes Graham. I guess Lowenstein isn’t familiar with the great man’s final interview in 1976 in the Financial Analyst’s Journal, the year he died. Here’s the money quote:
I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I’m on the side of the “efficient market” school of thought now generally accepted by the professors.
Amen.
I love making bets. The stakes are never high – usually a beer, a sandwich, or, if it’s with one of my kids or my wife, making the winner breakfast in bed. The real payoff is the smug satisfaction of having been right.
Of course there are lots of things people bet about. If it’s “what’s the capital of Burundi” then you really should be braced for the other person actually knowing it’s Bujumbura. Why else would they agree to a bet? But the winner of, say, the NBA playoffs is unknowable. With the Warriors up two games to none, though, the odds are pretty much tilted in their favor (nearly nine-to-one over the Cavaliers).
A year ago I made a bet with three colleagues at The Wall Street Journal and chose a side before they could. It seemed like a milder equivalent of wagering on the Cavaliers to win but without adjusting the payoff – even odds. I had just received a list of the stocks in the S&P 500 with the highest percentage of buy and sell recommendations from analysts. I guessed that the list of sells would do better than the buys.
Based on what I write in my upcoming book, Heads I Win, Tails I Win, not only aren’t analysts very good at picking stocks but you can gain a slight over the market by going against them. I figured I had a slightly better than even chance of winning, putting a small amount of money where my mouth was.
I didn’t even look at the list before making the bet. After I did, though, I started to worry. On the “buy” list were Facebook, Google, and various microchip stocks. They actually did well. On the “sell” list were a bunch of energy stocks that did pretty badly since oil prices proceeded to keep falling for several more months. There were also a bunch of dull stocks, though, such as utilities and breakfast cereal makers. They were boring but beautiful.
The year has come and gone and, despite an awful showing by some energy producers, the sells did nearly two percentage points better on average than the “buys” on average. In fact, the “buy” list lagged the S&P 500 by almost four percentage points. Theory validated!
Burton Malkiel, who wrote a very nice blurb for my book, once quipped that blindfolded monkeys can do as well as stock pickers. One fascinating study shows they probably can do better. So, with all due respect to analysts (and I really mean it – I used to be one after all), you should never buy or sell a stock based on their recommendations.
I went on the WSJ Moneybeat podcast today for the first time and it was, um, interesting. For the first segment, Chris Dieterich of Barron’s, Stephen Grocer and Paul Vigna of Moneybeat, and Chuck Jaffe of Marketwatch and I discussed “smart beta,” the hottest trend in investment products. I talk about smart beta in my upcoming book.
In a nutshell, “beta” means stock market return whereas “alpha” is the extra gain that clever fund managers try and usually fail to generate. That’s why passive index funds are the best bet for most investors. But smart beta tweaks that by attaching allegedly smart criteria to a passive fund. These are getting more and more exotic, though they can be something as basic as equally-weighting stocks rather than using market value or favoring stocks with lower P/E ratios.
Some smart beta is a costly gimmick and other products are pretty sound, but beta can be as smart as a whip and not help investors who do dumb things. That tendency to buy high and sell low is hardwired into most of us.
It was a lively, respectful discussion. Then the gloves came off and we discussed the relative merits of Alexa, the Amazon.com talking speaker, and cheese. You see this week’s WSJ Heard on the Street podcast featured David Reilly’s very own Alexa. Stephen and Paul thought it was a cheap stunt to overshadow their podcast earlier in the week when they attempted to eat three pounds of cheese. You see there’s a big cheese surplus in the U.S. and every man, woman, and child in the country would have to consume that much of the stuff to deplete the excess.
Unfortunately, the lightweights on WSJ Moneybeat couldn’t eat all the cheese between them and had to leave plates of it in the newsroom for the rest of us to help polish off. Despite mild lactose intolerance, I bravely chipped in to whittle away at the surplus.
I cover a lot of investing errors in my book (coming on July 12th), but, sadly, the list of mistakes is way too long to fit in 255 pages. An interesting one I overlooked was what Vanguard calls “the procrastination penalty.” Now this is a little different than the old chestnut you may have heard about the awesome advantage of starting to save money early. One variant goes like this:
A young person begins saving at age 21, socking away $2,500 a year in a tax-free account until she reaches 30, after which she never sets aside another penny. The money grows at 7% a year compounded. Her brother starts at age 31 and puts away money the same amount until age 70, earning an identical return. In other words, he saves four times as much in nominal terms. Even so, his late start sees a nest egg grow to “only” $534,000 which is a little less than the $553,000 earned by his sister.
The effect highlighted by Vanguard is more modest but also far easier to avoid. They looked at their own company’s data for when people make contributions to IRAs (individual retirement accounts). Not surprisingly, since the deadline for the preceding year is on tax day in April, that’s the most popular month by far. For example, one could have made a contribution as early as January 1st of 2015 or as late as this Monday, April 18, 2016.
The stock and bond markets don’t always go up so waiting will occasionally work to your advantage (as it would have in spades in tax year 2008, for example). In the long-run, though, markets tend to rise. That small delay compounds over a saver’s working years into a not-so-small difference. Vanguard takes the example of an investor who contributes the maximum $5,500 over 30 years on either January 1st or April 1st. The “early bird contributor” would, at a 4% rate of return after inflation, earn $158,967 while a procrastinator would earn just $143,467 or nearly 10% less.
Spencer Jakab 