Johnny Carson as Carnac the Magnificent

In investing discussions you will frequently get some debate about this or that asset. Will prices go higher? Will the prices crash? Someone gives a good narrative for why the asset must continue to go up and someone counters with an equally convincing narrative against. Both sound reasonable and, depending on what narrative most matches your own feelings, you respond positively or negatively.

Here’s my take: Market narratives may provide the emotional framework people want to see in life to explain events, but they mean nothing (a point made very clear in Nassim Taleb’s book The Black Swan). The future is not predictable no matter how plausible someone’s narrative about it may sound.

We hear this stuff all the time in the news. Some market guru says that such-and-such must happen because of some inevitable series of events that will take place. Well there’s an old saying I like that sums up my feelings on this:

“No matter how thin you slice it, it’s still baloney.”

I don’t listen to or care what a single financial guru has to say on anything about the direction of the economy or the markets. I don’t care what degrees they hold, what awards they’ve gotten, what books they’ve written, or what they predicted in the past. The future is just not knowable and it doesn’t matter who is predicting it. In fact, it has proven to be a consistently profitable maneuver to ignore every single prediction about the market I hear and hold a balanced and diversified portfolio instead.

There’s another saying I really like as well about investing:

“Never confuse the unlikely with the impossible.”

For instance, not a single mainstream financial guru I know of was talking about deflation in early 2008. In fact, many thought it simply couldn’t happen here due to our modern banking system. This is the meaning of confusing the unlikely with the impossible.

Yet here’s what I said when the question of deflation came up in March 2008 on an investing forum:

http://www.bogleheads.org/foru….ary#176337

The one thing I’ll say is I’ve read analyses that have made convincing cases for inflation and those that made convincing cases for deflation. Someone will be right and someone will be wrong, but that’s how markets work.

Inflation and deflation are opposite sides of the same coin. Conditions that cause high inflation can lead to deflation as bankers attempt to control the problem and vice versa. The markets are too unpredictable to rule out any possibility, even those that seem unlikely right now.

The Japanese are certainly not inept and if it can happen there it can happen here (again). The market is one big social psychology experiment and can’t be modeled or predicted. Solutions that economists say should work may not work depending on how people feel collectively. So I’m not predicting deflation will or won’t happen. I’m simply saying that I don’t know (and neither does anyone else) and structure my portfolio accordingly.

I don’t say this as a way to bolster my ego. Simply that this represents the correct attitude of “I don’t know and neither do you.” This is the attitude you need as an investor.

Now, that was written over two years ago and what happened since?

In Spring 2008 TIPS were predicting high inflation as they went negative in yields. In fact, there were many market narratives about inflation roaring in. Yet, by December 2008 interest rates collapsed due to deflation and Long Term bonds (which do very poorly under inflation) posted 30%+ gains and even gold posted 5% gains. TIPS funds by the way posted around -10% losses for the year. No guru saw that one coming. In fact, many gurus were telling people to stay out of the market in 2009 with frightening sounding bear market narratives about it going lower. What happened? The total stock market posted around 30% gains that year.

What’s the lesson? Simple: The markets are not predictable and we simply don’t know how people are going to react to future events.

So if you’re going to listen to narratives, make sure it is in a fiction novel and not with your investments.

I am seeing recent books from old authors touting this or that new investment idea. Their previous advice may have been off the mark, but this time they’ve got it all figured out.  And just think, they are willing to sell you their wisdom for the low price of $12.95 in soft cover or a low monthly subscription fee.

No thanks.

People should be absolutely ruthless when it comes to assessing investment advice. An attitude of guilty until proven innocent will serve them well.

Be ruthless when looking at what an investment guru is saying. Maybe they did change their tune, but what is to say the new tune is right this time either? How did their advice work in the past? Was their economic thinking sound? Did they tell you to do things with your money that in hindsight were very risky? Did they make predictions and how did they turn out? Don’t rely on what they said their predictions were, go back yourself and read what they said and compare it to what actually happened. Be ruthless about the accuracy.

Also, don’t be lulled into “Aw, schucks…” apologies about how off they were before and how much they’ve learned their lesson. Those kinds of statements don’t get your money back. Early in my investing career I learned this lesson the hard way. Following a popular investment guru cost me money that didn’t need to be lost. I wasn’t ruthless enough in questioning the advice I was getting. I am now.

Investing is not a popularity contest and investors are not graded lower for coming off like a skeptical jerk. Be a jerk. Be ruthless. Question everything a guru says and why they are saying it. Make them prove what they are saying is true – Every last word of it.

Investors that are ruthless in assessing where to put their money put the odds in their favor. Unleash the ruthless investing jackass that is deep inside of you. You’ll be better off for it.

Why do people freak out so much when you tell them you own some gold in your portfolio? It’s as if you had just told them you killed a dozen people before lunch. The hyper-ventilation you hear from some when you even mention this topic is just nutty. It usually starts with some juvenile comment involving tinfoil hats. Then they pull out some quote from an economist (usually one that loves inflation to solve all problems) about how useless gold is. They may even hit you with the ol’ “gold is not a form of wealth but just a shiny metal” lecture (ignoring the bulk of human history, and all major central banks, that disagree with them). Then they tell you how “risky” gold is when their own portfolio may be loaded to the hilt with junk bonds, emerging market debt or other complicated investment products. They must think the Nigerian stocks they hold in their Frontier Market fund are a sure thing (assuming they even know what’s in the funds they own).

Well, I own gold and I admit it. I feel comfortable owning gold in my portfolio. I sleep well at night knowing I own gold even though it could drop in value. I understand that in a balanced portfolio gold is a useful tool. I trust gold to protect me in high inflation more than indexed linked bonds (TIPS) ever will.

Gold has no interest or dividends. I admit these things and acknowledge that this is one area that makes gold different than stocks and bonds. However, this does not make gold useless for diversification.

Gold maintains real purchasing power over time and it’s really good at doing this. No other asset on this planet has such a long history. I don’t worry about politicians printing trillions of dollars of gold. This is because politicians can’t print gold. Gold can also be owned directly without any obligations attached to it. These are unique attributes for an asset class when used properly in a portfolio (and properly does not mean 100% gold).

While gold does not have the interest or dividends of stocks and bonds, it has other benefits that can work at certain times to protect a portfolio that does hold stocks and bonds. Gold for instance does very well under high inflation when stocks and bonds do not.

Gold has risks just as stocks and bonds have risks. I understand what these risks are and how they fit in a diversified portfolio. Yet, I do not rely only on gold in a portfolio. I also own stocks and bonds to drive returns when gold is performing poorly. In diversification there is safety which is why I own all these assets and don’t get religious about it. I accept gold’s quirks because I know when it comes time for it to perform it will do so better than all its contemporaries.

The empirical evidence says that owning some gold in a portfolio is not the death sentence academic literature would suggest. In fact, at certain times having gold can be a tremendous help. So, either reality is wrong or the academic theories are. Given a choice between the two, I’ll take reality. That reality is that all portfolios should hold some gold for diversification against stocks and bonds despite what critics state. That’s why I own gold.

I just saw an ad on TV talking about TDAmeritrade’s new options trading tool. They had some hipster guy walking in with a bag full of groceries in his hand. He was very serious and lecturing about the need for strategy in trading. They then cut away to some other beautiful people talking about keeping up with the market first thing in the morning and watching some blinky lights on the computer monitor giving them information.

One lady looked intensely at a “heat map” that showed where the money was going that day. I thought she was playing Tetris but the commercial says this is part of the trading strategy. It looked more like a video slot machine, which I suppose it actually is in some respects, but it certainly wasn’t investing.

Well, it was just too much to bear so I took a quick look at what other pretty charts their software can make from their website above.

The “Heat Map” feature. Here you can see where the hot money for the day is going in the market so you can be the chump jumping in after everyone else and be left holding the bag:

TDAmeritrade's "Heat Map"

This chart is a representation of your money being sucked down a black hole by doing options trading:

Options Black Hole

The website says: “See a clearer picture of the potential profit or loss of your options trades.” Is this chart clear to you:

Options Huh?

Here’s a chart they left out:

Bad Option

That’s my projected returns on $100 for most options traders.

If the information in TDAmeritrade’s “heat map” and other technical indicators was worth anything, why would they be telling it to you? Why wouldn’t they use their secret insight into the markets and make a killing themselves? They’ll just have to be happy with their per-trade commissions while their options trading customers are pulling down the big bucks. I guess they’re just being nice guys.

I know people who lost their life savings trading options. Stay far away from this stuff.

]]> http://crawlingroad.com/blog/2010/01/25/strategize-analyze-optimize-and-lose-money-all-with-one-tool/feed/ 0 http://crawlingroad.com/blog/2009/06/07/soothsayers/ http://crawlingroad.com/blog/2009/06/07/soothsayers/#comments Mon, 08 Jun 2009 02:34:19 +0000 craigr http://crawlingroad.com/blog/?p=1901

Market Gurus

I do get tempted from time to time to listen to an investing show even though I follow the Permanent Portfolio. Some shows feature investment advisors who have some neat strategies or ideas I hadn’t considered before. Further, I believe that some investment advisors can be useful for things such as informing you of more tax friendly ways to invest, estate planning, etc. Unfortunately, it seems many investment advisors are in the market predicting business and this type of advice should be ignored. 

I was reminded of this today when a well-known market prognosticator was being interviewed and he rattled off all sorts of predictions about stocks, bonds, precious metals, currency exchange rates, etc.

I thought to myself: “How does this guy know these things before they’ve even happened?” Of course he can’t possibly know. He was just good at sounding confident that he knows. 

After hearing this, I came inside and dug up a quote about market prognosticators from Harry Browne that I thought you’d enjoy. I found this quote in a great e-Book collection of his newsletter writings called: Investment Strategy in an Uncertain World:

…a prediction implies a certainty, a precision, that doesn’t exist in the real world. It encourages you to place a bet that can pay off only if the prediction turns out to be correct. Such betting is no wiser in the investment world than it would be elsewhere. The strange thing is that most people aren’t concerned with predictions in other areas of life. One sets goals, rather than predictions, for his income, personal relationships, and living conditions — and tries to satisfy his goals. But only a foolish individual places bets on the future — such as making a purchase based on a prediction of a higher income that will pay for it.  

And yet, when one enters the investment markets, the first thing he does is to look for a fortune-teller, someone who can predict next year’s gold price. In other areas, the fortune-teller is an object of amusement. But nine out of ten economists and investment advisors attempt to make their reputations as soothsayers — and nine out of ten investors spend their lives trying to find the soothsayer who’s genuine.

Harry Browne’s Special Report – March 2, 1982

As quoted in: Investment Strategy in an Uncertain World

When people ask me what asset X, Y or Z are going to do my answer is always the same: “I don’t know.” This isn’t a very exciting answer, but it’s an honest answer.

My advice is to ignore fortune tellers in the investing world the same way you ignore them in other areas of your life. Instead, build a balanced and diversified portfolio and get out of the market predicting game. Your investment portfolio will be far better off and you’ll be a lot less stressed about your finances.