Stock Market Investment Research
and the Tricky Tricks Used to Trick You
Stock Market Investment Research Trick #1 -- The Tautology Trick
Have you ever heard anyone argue that you should invest in index funds because, when costs are factored in, it’s impossible for the majority of investors to beat the index? Well, duh!
The index is the market. For every investor who beats the market, there has to be one who does worse than the market. Otherwise, the market price wouldn’t be the average of all the gains and losses experienced by the companies comprising the market. In other words, the market price would not be the market price.
The claim that index funds beat investing in individual stocks when costs are factored in is a tautology. This claim tells us precisely zero about what we need to learn to become effective investors. Incredibly enough, there are people who have put together investing research to prove that it is so. It’s like proving that water is wet. The point was never disputed by any serious person.
The point of this “research” is to bully you into accepting that indexing is the superior investing strategy.
I like indexing.
But I don’t like some of the ham-handed arguments I have heard put forward in support of it. The question that you need to answer in determining whether indexing is for you or not is: Do I possess the skills needed to
beat the market?
One is tempted to say that those who fall for the tautology trick are better off indexing since indexing is the simpler approach to investing. That’s not entirely so, however. For many of us, the best thing to do is to learn about investing by indexing and then to advance to picking individual stocks when we have a good bit of learning and experience behind us.
So I don’t like the tautology trick. Investing research that proves a tautology is not investing research at all. It’s hand waving. I come over time to lose confidence in investing experts who refer to studies supporting a tautology as investing research. Yes, that means you, John Bogle!
Stock Market Investment Research Trick #2 -- The Ignore-the-Marketing-Realities Trick
The highly paid and highly skilled managers of most mutual funds fail to beat the indexes. This proves that the market is efficient and that it is impossible to pick stocks effectively enough to beat the indexes. Right?
Uh, no. Not right.
Say that you were the stock-picker for a big mutual fund. What would be your top priority? Generating strong returns for your those holding shares in your fund? Or getting people to invest in the fund?
The top priority is getting people to invest in the fund. That’s how the fund makes money. Generating strong returns helps attract people to the fund. So that’s viewed as a good thing too. But getting people to invest in the fund is the paramount concern.
Say that stock prices have gone so high that the best strategic move is to move to safer asset classes for a time. Say that the reason why stock prices are so high is that the majority of investors has gone temporarily bonkers for stocks and will punish any mutual-fund manager who sells them by taking their business elsewhere. What does the fund manager do? He sticks with his excessively high stock allocation.
He opts against making the move that will increase shareholder return in favor of the move that will allow him to keep his high-paying job a bit longer. You’d be surprised how persuasive even the smartest mutual-fund managers find the arguments of their tummies telling them to do whatever it takes so that they will be able to continue to have something to put on the table indefinitely into the future.
There is investment research showing that most mutual fund managers cannot beat the market. The idea is supposed to be that, if these smart people cannot beat the market, no one can. It doesn’t follow. Such research does not tell us what a smart person who did not need to make marketing concerns paramount could do.
Leaving out the marketing reality is a tricky trick designed to trick you. Don’t let it happen.
Stock Market Investment Research Trick #3 -- The I-Don’t-Understand-What-You’re Talking-About Trick
Timing works. Long-term timing, that is. If you change your stock allocation in response to price changes thinking that you are sure to see a payoff for doing so in one year or two years or three years, you’re kidding yourself. Short-term timing doesn’t work. If you fail to change your stock allocation in response to price changes thinking that you won’t experience a penalty for failing to do so within 10 years, you’re kidding yourself in a different but just as serious way. The price you pay for the stocks you buy always affects the long-term returns you obtain. Long-term timing always works (and failing to engage in long-term timing always hurts you).
There are “experts” who want to con you on this point. There are people who would prefer that you not consider prices when investing in stocks (it’s of course a wonderful thing for the stock-selling industry if all price resistance is broken down). These people will tell you that we know that timing doesn’t work because there is an impressive body of investing research showing this.
When you look at the studies, you will see that they examine short-term timing, the kind of timing that does not work, instead of long-term timing, the kind of timing that does work. Surprise! Surprise!
What happens when you point this out? They cite the same studies again. The ones that show that short-term timing does not work. As if saying it a second time would make it so.
Hey! The term “short-term timing” has the word “timing” in it, doesn’t it? Is there some reason why studies showing that short-term timing doesn’t work should not be cited as evidence that long-term timing doesn’t work?
I can think of a good one. The reason is that to cite investment research in that way is a trick.
Stock Market Investment Research Trick #4 -- The Idiot-Switching Trick.
John Walter Russell coined the term “Idiot Switching.” It’s a keeper.
Not all long-term timing strategies work, of course. It is possible to imagine long-term timing schemes that would fail. Some of the people who engage in investing research have put their considerable intellectual talents to the task. They’ve produced some compelling “research.”
The fair-value P/E10 value is 15. If you lower your stock allocation when the P/E10 value goes above 20 and increase your stock allocation when the P/E10 value goes below 10, you’ll earn greater long-term returns from your stock investments and will attain financial freedom years sooner.
What if you sell all of your stocks each time the P/E10 value goes to 16 and go to a 100 percent allocation each time the P/E10 value goes to 14? Isn’t it possible that by following this idiot’s approach to switching that you could generate some data showing that long-term timing does not work?
Yes, it’s possible. People with big brains and getting paid big salaries have done this sort of thing. They refer to the work product they put forward as “investing research.”
Stock Market Investment Research Trick #5-- The Impossible-Hurdle Trick.
The “Idiot Switching” trick is too obvious for some. Some of the people doing investing research prefer a more subtle approach. The more subtle the trickery being done is, the more likely it is to trick you, no?
The subtle way to show that long-term timing does not work is to impose an impossible hurdle. If you can obtain an annual increase in your investment return of 1 percent, you will attain financial freedom years sooner. What if investment research were prepared in which the test of whether long-term timing works or not is that it must increase returns by 3 percent or 4 percent or 5 percent? Employing such a rule would make it possible to show that long-term timing does not “work.”
It’s been done.
Stock Market Investment Research Trick #6 -- The Ignore-a-Key-Factor Trick
The Old School safe-withdrawal-rate studies make no adjustment for changes in price levels. They report the same withdrawal rate as safe for retirements beginning at times of high valuation as they do for retirements beginning at times of low valuation.
That cannot be. Valuations affect long-term returns as a matter of “mathematical certainty,” according to
and many other of the best-informed
Lower returns obviously translate into lower safe withdrawal rates.
Why then do the Old School studies ignore the valuation factor?
Because they can. Because you do not demand better in the investing research you use to develop your investing strategies. Because at times of high valuations most investors want to hear fairy tales that make them feel good rather than genuine research and there are a good number of "researchers" willing to dress up fairy tales with tables and footnotes to meet the demand.
Do you remember that movie Network in which the guy screamed out that “I’m mad as hell and I’m not going to take it anymore!” I hope that the next time we lose a big hunk of our retirement accounts because of the trickery that is frequently passed off as “investing research” we give the sentiment expressed the consideration it deserves.
Stock Market Investment Research Trick #7 -- The Create-An-Imaginary-World Trick
The dominant investing model of today is something called the
Efficient Market Theory.
It assumes that investors are rational and that all relevant information is thus incorporated into the stock price that prevails each day. You cannot beat the market because the market knows all and all that is known is reflected in its price, according to this theory.
Has there even been a market in which the assumption in which this theory is rooted applied? Has there ever been a market in which investors set prices rationally rather than by getting caught up in a wild enthusiasm for stocks and then by an equally emotional disillusionment? No, there’s never been one.
So why do many of the people who prepare investing research act as if the Efficient Market Theory provides us a reasonable model by which to understand how stock investing works?
I answered this question up above. It’s because they can, it’s because we let them. If we investors were rational and concerned about pursuing our own self-interest, we would not let the people preparing investing research get away with this sort of thing. But we’re not. So we do. It’s not the Efficient Market Theory, really. It’s the Efficient Market Story. It’s something that we tell ourselves to help ourselves get to sleep at night. When stock prices are high, we like thinking that they are high for a reason, that it all makes sense somehow.
From one way of looking at it, the people preparing investing research that partakes in the Create-an-Imaginary-World Trick are doing us a favor.
That really is so from one way of looking at it.
For a time.
Stock Market Investment Research Trick #8-- The Undefined-Word Trick
Don’t worry too much about valuations. Stocks will do fine in the long term.
You’ve heard that one, right? This claim is based on investing research, don’t you know?
Stop giggling. Serious people did this investing research. They wear ties. They have nice smiles. You should sit up straight and pay attention when they speak.
Please take a brief look at The Stock-Return Predictor. At today’s valuations (this article was posted in September 2007), stocks are not likely to provide a return superior to far safer asset classes in 10 years. Nor are stocks likely to provide a return superior to far safer asset classes in 20 years. Go out 30 years, though, and stocks are looking good.
So it’s true that stocks are always best for the long term.
That’s what the investing research says, isn't it?
Stock Market Investment Research Trick #9 -- The Ignore-Dividends Trick
The biggest part of your long-term return from your stock investment is the dividends paid. Investing research that tries to persuade you that stocks are not the best asset class for the long-term investor often reports only what happens to the stock price while ignoring the fact that those owning the underling stocks were being paid dividends all the time that the price was going up and down.
Ignoring dividends makes as much sense as ignoring valuations. It makes zero sense. Investing research that ignores dividends is not science, it’s science fiction.
Stock Market Investment Research Trick #10 -- The Know-Nothing Trick
You are trying to come to a better understanding of how long-term investing really works. You have familiarized yourself with the various tricks played on middle-class investors by the “experts” purporting to put forward investing research. Their tricks don’t work on you anymore. You know what to look for. You’ve gone beyond the power of the con.
But wait. They find one last nasty trick way down at the bottom of that big nasty bag of them. It’s the topper of them all, The Know-Nothing Trick!
We really cannot know how stocks are going to perform in the future. We don’t have enough data. The future could turn out different than the past. None of the valuation assessment tools are sufficiently precise. Yada, yada, yada. Blah, blah, blah. Blee, blee, blee.
Pointing out the caveats that apply with all valid investing research is not a trick. That’s responsible reporting of the realities. It becomes a trick when the purpose is to cause the listener to give up hope of learning how stocks may perform in the future by looking at how they have always performed in the past.
We can’t know everything. We can know some important things. It is every bit as much of mistake to fail to inform yourself of what we can know as it is to pretend that we can know more than we really can. Anyone using the historical stock-return data to learn how to invest successfully for the long run needs to be aware of the caveats that apply. Anyone failing to become familiar with what the historical data says is investing blind.
When the stock market investment research is not tricking you by telling you things that are not so, it’s tricking you by telling you that it’s not possible to know what is so and what is not. Those who say they know nothing are wrong. They know enough to know that what they “know” is wrong. They just don’t want to know it. You know?
The historical stock-return data is our friend. No trick.
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