More Tips from Your Money and Your Brain
My Oct. 19 Yahoo!Finance column reviews the book “Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich” by Money magazine’s Jason Zweig. The full story can be found here. Jason had a host of great tips to offer in our interview — here are a few more that didn’t make the column:
Don’t go with your gut. “We worship intuition in America – we love stories about people who acted on their gut feelings and turned out to be right,” says Zweig. “Your gut can be a really good guide to lots of decisions – which person to trust in a negotiation or a social setting. But gut feelings about which stock to buy are almost certainly lousy, and have to learn to distrust them and become more mindful about how you’re investing.”
You are not smarter than the market. “I think that there’s a real ideology in this country that gets people into trouble — that you can and should beat the pros at their own game,” Zweig says. “The idea is: The people on Wall Street are trying to beat the market all day long, they measure their progress minute to minute, and they aren’t good at it, so why don’t you try to beat them? Most of that is true. Professional investors are trying to beat the market over the short term and they’re not very good at it. But the fallacy is anybody can win this game. Just because the professionals are no good at it doesn’t mean the rest of us are.”
Focus instead, Zweig says on winning your own game – and don’t worry about who else is losing their game. Determine your long-term goals are, put a solid financial plan in place and follow it. “The worst imaginable thing you can do is listen to Pied Pipers who tell you ‘here are seven tricks to beat the pros at the game,’” says Zweig. “That game will make you miserable.”
Here’s how to win your game: Be reasonable about your forecasts. Set realistic goals based on historical evidence – you’re kidding yourself if you expect to earn more than 10 percent a year in U.S. stocks. Calculate your risk – remembering not only how much you might gain if you’re right, but how much you might lose if you are wrong. Keep expenses under control, by minimizing trading commissions and holding your investments for at least a year to minimize capital gains taxes.
Rule out any mutual fund expenses higher than 1 percent for U.S. stock funds; 0.75 percent for government bond funds; 1.25 percent for small stock or high-yield bond funds; and 1.5 percent for international stock funds. As Zweig writes, “Hot returns come and go, but expenses never die.” He also advises dollar-cost averaging your way into an investment to smooth out the investment’s ups and downs.
Play before you buy: At Yahoo!Finance you can set up a “portfolio tracker” to set up an interactive list of your imaginary investments. By monitoring all your buys and sells, and then comparing them to an objective benchmark like the S&P 500, you can gauge your decision-making skills before you put your money where your mouth is.
“Never confuse brains with a bull market,” Zweig writes. If someone boasts about how good his stock picks are, remember to check whether the segment of the market he invested in performed even better. (A technology investor, for instance, might brag that he earned 48 percent in 2003, but the Goldman Sachs tech-stock index rose 53 percent that year.)
Beware forecasters who claim they can accurately predict the direction of the market. Financial marketers have such an immense volume of data to slice and dice, they can “prove” anything, Zweig notes. He gives the example of a money manager who tried to find one statistics that would have best predicted the performance of U.S. stocks from 1981 through 1993. He found one that predicted the market with 75 percent accuracy: the total volume of butter produced each year in Bangladesh. Those who tout statistics, Zweig says, will never reveal the theories they tested and rejected in the past.
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October 19th, 2007 at 8:54 am
“If someone boasts about how good his stock picks are, remember to check whether the segment of the market he invested in performed even better. (A technology investor, for instance, might brag that he earned 48 percent in 2003, but the Goldman Sachs tech-stock index rose 53 percent that year.)”
What a daft comment. If he got 48%, he’s beaten the overall market, and he should be rather happy, independent of how his or any other segment of the market did. The trick was to be in the right segment in the first place. We might as well conclude that an investor owning the second best performing stock on the exchange isn’t doing very well because she didn’t buy the best performing stock.
“Beware forecasters who claim they can accurately predict the direction of the market.”
Well, while short term behaviour of the “market” is certainly stochastic, the overall direction over the decades has certainly been “up”. It is the expectation that this trend will continue that makes people invest in the first place.
Perhaps we should instead beware self-styled financial gurus plugging books by other self-styled financial gurus. Or even better, maybe we should make up our own misleading half-truths and vacuous advice, write a book, and declare ourselves financial gurus too.
Dear GW: Well that wasn’t very nice. But I appreciate your taking the time to comment and am big on free speech, so I’m happy to publish it. Perhaps I should have pointed out that that 48 percent return, if all in tech stocks, required taking a high amount of risk versus investing in the market as a whole. You can’t compare returns without also comparing the beta for the portfolio.
As for self-styled gurus, well, I’ve never called myself that. I’m just here to help people get a handle on their money. And maybe you should take the time to read Zweig’s book before you accuse him of giving vacuous advice.