BAD ADVICE & THE CRASH

Sam Smith

Almost totally ignored in the coverage of the financial crash is the role of poor investment advice. Not the Bernie Madoff version, but run of the mill standard advice that left endowments of non profits and 401Ks down 40%.

At the heart of this bad advice was the absence of a single word: sell.

This is not unique to the fiscal crisis. Investment advisers hate that word. Try to find good discussions on when to sell a stock and you’ll be hard pressed. It’s there, but just not anywhere near as handy as its opposite: buy and hold.

Part of the problem may be a loyalty to the overall market as opposed to the individual investor. After all, if everyone played the market smart, it wouldn’t be anywhere near as good a place to put your money. If, say, everyone tried to sell a stock when it declined a certain amount, only the lucky early traders would be ahead of the collapse as the stock headed like a cigarette butt to the floor.

But as long as you have a huge constituency of the placid, predictable and permanent, traders can have their profits without the amateurs spoiling their fun.

Some of this is what Catherine Austin Fitts calls “pump and dump,” -“artificially inflating the price of a stock or other security through promotion, in order to sell at the inflated price,” and then making even more by short-selling.” In fact, Fitts thinks the whole American economy is being pumped and dumped.

But if you think about it, any form of gambling depends heavily on a large number of reliably gullible participants. The financial markets are no exception.

Where there is a difference is that the federal government does not pretend to regulate the rules of poker the way it claims to control the markets.

Let’s imagine that we were to turn over the regulation of markets to the EPA or FDA. One of the first things these agencies might do is figure out how to have average participants adequately informed of the hazards they face and what to do about it. This would be in contrast with federal market regulators whose first concern is the market itself.

There are, to be sure, some non-governmental sources of such information and while they are a bit hard to find, they are well worth pursuing.

One is the amazing Mark Hulbert who years ago decided to keep track of how well investment newsletters actually did their job. He follows over 180 newsletters and the results can be pretty glum. For example, in the past year only less than ten percent of the newsletters have made suggestions that have produced a net gain. Over five years, almost precisely half have made no money. Hulbert tracks both long term and short term results and parses them by different categories. Imagine if the federal government required every registered investment advisor to report their personal score with the same accuracy as, say, a baseball team.

Hulbert’s work also points to newsletters that have good records in dealing with timing such as Timers Digest, the Chartist and Cabot Market Letter. Timers Digest, for example, keeps close tabs on the timers with the best records and Cabot offers some good and simple advice on when and how to sell, such as

– When to cut losses
– Never let a solid profit turn into a loss
– Remember that you can always buy a stock back

How much and what sort of regulation there should be to allow investors to be better informed about dealing with bear markets and when to sell is a worthy topic for considerable debate, but what isn’t debatable is that, in the face of 40% market collapse, untold numbers of investors ended up in trouble because they had been taught to buy and hold.

To give an idea of the effects of such advice, consider two investors: one who sells a stock when it drops 20%, the other who holds on to the stock as it declines 40%. The first investors’ portfolio needs to rise 25% to get back to where it was; the second’s portfolio will have to go up by two thirds. This is not an insignificant difference.

As things stand now, the average investor gets neither good basic information about the reliability of their investment advice nor is the government interested in slightest in doing something about it. And so these investors buy and hold and while others, who aren’t called traders for nothing, make their profits.

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