In the book, The Number, author Lee Eisenberg features these sarcastic “rules of investing” that fabulously illustrate these common investor pitfalls:
#1) Only buy stocks that will go up, the others are a waste of time.
While preposterous, the author nails the fact that many investors (and mutual fund managers for that matter) are under the illusion that there is a magic formula to predict winning and losing stocks. And while E-trade’s commercials might lead you to believe otherwise, research shows that 80% of “day traders” who spend their time trying to buy winning stocks end up losing money.
And day traders aren’t the only ones that can’t outguess the market. Of the overpaid fund managers on Wall Street trying to pick winners for mutual funds, roughly the same 80% margin fail to do as well as low priced index funds that buy the whole market.
Lesson learned: Avoid the sales pitches of brokers and their Wall Street firms’ multi-billion dollar ad campaigns eluding that they have a crystal ball.
#2) Give your broker lots of business. By trading in and out he will become your best friend.
I know a lot of financial advisors who are paid some form of commission, which doesn’t make them bad people. It’s quite the opposite actually; I’d consider most of them to be among the nicest, most personable people I know. Where the problem comes in is when investors don’t realize all the ways that these advisors are financially benefiting from them.
When potential clients come to me for a second opinion, without fail the more money their advisor has been making from the relationship (unknowingly to the client), the closer that the client describes that relationship to be… It’s amazing just how charming someone can be when the kickbacks he gets from working with you puts a new BMW in his garage.
Lesson learned: If you’re short on friends, find a commission based financial advisor.
#3) Pay attention to Wall Street research. The people who produce it are intelligent, honest and really care about you.
The statement is partially true, there are a lot of incredibly intelligent people on Wall Street, but unfortunately that intelligence is rarely focused on doing what’s best for Main Street. Instead it’s focused on crafting products and marketing campaigns that are doing one thing: siphoning away your money.
Lesson learned: The CEO’s at the big financial firms are looking out for their bottom line, not yours.
#4) Read the papers daily and listen to TV financial reporting. Do exactly what they tell you.
CNBC and Money magazine aren’t out to deliver the advice that will be the most helpful to the their viewers, but instead to whip up the kind of greed and fear that boosts their advertising dollars. As so aptly summarized by the title of their recent article Gurus Achieve an Astounding 47.4% accuracy, Forbes magazine featured a study showing that so called market “gurus” like Jim Cramer are about as effective at predicting the market as the flip of the coin (if they’re lucky).
Lesson learned: The next time you hear someone “predicting” the market, and telling you what you should do about it, consider their motivation (and track record).
#5) Be nice to your barber, he’ll always have the best stock tips.
I’m sure you’ve probably run into a similar situation… You’re at a Christmas party and an acquaintance starts bragging about some investment that he tripled his money on and says that because he likes you he’s going to let you in on the secret of his latest hot pick. Even if he actually did double his money, what he’s neglecting to admit to you (and likely himself), are how many losers he had to pump money into before one paid off.
Lesson learned: Whether it’s your barber, brother-in-law, neighbor, unless they’re a CEO or hedge fund manager, I promise you they don’t have any inside information (and if they do, you might want to talk to Martha Stewart about how that worked out for her).