AUTHOR’S NOTE: This post about investing is out of the ordinary for this blog. It is prompted by the recent stock market “crash,” and the subsequent volatility. Over many years of observing coworkers and friends in the midst of stock market “crashes,” like the one underway now I’ve witnessed people doing very unwise things. Hopefully, this post will reduce the likelihood that my readers will make those mistakes in the future.

Rely on the following observations and comments at your own risk. I have no formal training in stock trading and have never been a stock analyst. I have, however, read and thought about the buying and selling of publicly traded stocks a great deal over the 50 years since I graduated high school. More important, during my long career and since, I’ve observed co-workers and friends reacting to “crashes” in ways I believe were monumental missteps—with no apparent ability to learn from their prior experiences. I have done reasonably well with my own investments using a different strategy, but that is largely because I have studiously paid little attention to my stock, bond, or money market holdings and have not paid people to guess what securities or when I should buy or sell. [Past performance is not necessarily indicative of future results.] Let’s sort out why paying little attention and not paying people to guess which or when you should buy or sell stocks or bonds can make sense.

🙛

First, the obvious: Saving and investing what the guessers would have charged for making guesses for me, rather than wasting the money on investment analysts, adds up to real money over time. Now let’s move on to sort out the less obvious, but very valuable other reasons not to pay for those “services.”

Consider these headlines about the “crash” that started on February 21, 2020:

“The S&P 500 is now 12% below the all-time high it set just a week ago. This is now the stock market’s worst week since October 2008…,” intoned the AP on February 27, 2020. [Yet, the recent low (3167) was 4.7 times higher than the low in 2009 (677), which was 6.3 times higher than the S&P 500 in 1980 (106). See charts below.]

“Long-term stock investors still shouldn’t buy the dip, says El-Erian…” That’s economist and investor Mohamed El-Erian updating his previous blanket call to refrain from the previously tried-and-true strategy of reflexively buying stock-market dips.” [Note: The “tried-and-true strategy” is often tried, but not always true. Such is the hallmark of every investing strategy. One should be wary of people who say that their previous “tried-and-true” strategy should not be followed.]

“Coronavirus stock market crash may have created a once in a lifetime buying opportunity: strategist.” [“May”? Why can’t they say, “did” or “didn’t”? Note: Using the word “may” is an admission that the author doesn’t know whether the crash created a “lifetime buying opportunity.” The reality is that the author does not know whether or not it even is a buying opportunity, much less a once-in-a-lifetime opportunity.]

The U.S. financial industry employs about 8.5 million people. A goodly percentage of those employees hold themselves out to be (and appear to believe they are) people who can reliably predict whether a publicly traded stock or bond will be worth more or less tomorrow (or next week, quarter, year, or decade) than it is now. The number of analysts that actually have that skill is zero. The fundamental reasons for this fact are (1) not all of the facts that need to be known to accurately predict the future value of any security are knowable, (2) the impact of the unknowable facts can overwhelm the impact of the known facts, and (3) excrement happens.

Evidence of the unpredictability of individual stock and bond prices over time is abundant. In a Forbes-conducted 14 year, 100 round contest between stock “experts” and dart-throwing monkeys, the stock “experts” eked out a statistically insignificant win (51% to 49%) concerning Dow Jones Industrial Averages (“DJIA”) predictions, before brokerage fees and expenses were applied (on average, people lost money paying analysts). On average, stock “experts” won 61% to 49% concerning predictions of individual stocks (before fees, etc.), but from one round to the next, individual “experts” sometimes won and sometimes lost,^[i] i.e., their clients got wins and losses over time, which brought their average return closer to 50/50 (which was what the monkeys were achieving). That result is also skewed because some of the “winners” obtained advanced notice of soon to be published articles that artificially and temporarily boosted individual stock results (which cannot be consistently obtained by individual “experts”).^[ii] Another indicator is that Morningstar, a “highly respected” mutual fund performance predictor” regularly publishes ratings of mutual funds that, it is reported, that do not correlate with how the rated funds perform.^[iii] (My, perhaps faulty, recollection is that, during at least for some periods of time, Schwab’s rating system produced palpably poor results for investors who relied on it.) [I don’t know if Schwab paid Google to bury those stories or my memory is faulty, but I’d bet on my memory on this one because I was delighted at the time to see my theory validated.]

More fundamentally, however, if your stock analyst could predict rises and falls in stocks, your analyst would always advise you to withdraw your investments in stocks and bonds before they fall. Do you know anyone whose stock analyst consistently prevents their clients from ever losing money? I don’t. After crashes, analysts usually say something like, “No one saw that coming!”—as if that is an acceptable excuse for being not giving you the advice you needed, i.e., predicting future stock prices so that you can make money.

The mistake I’ve seen coworkers and friends make is this: They become frightened by sudden drops in the stock market and pull their 401K or other investments out of the market after the drop. Even when the market starts to rise, they remain too scared to put their money back in—lest they are burnt again. Only after an extended period of the market going up, they regain the confidence to put their money back into the market. Of course, at that point, the market has not only recovered all the previous losses it is on its well on its way to the next crash. Worse, when they muster the courage to get back in, they dump all their money back in all at once or over a short period of time. Sadly, that usually coincides with other people gaining similar confidence, i.e., the herd is arbitrarily increasing demand and pushing stock prices higher than is warranted. One would be hard-pressed to identify a worse strategy, but it is as common as it is bad.

Consequently, there is no “right time” to put all your money in the market. Even if there were a right time, there is no way to confidently know when the right time is. That, however, does not mean that people should not put money in the stock market. Quite the contrary. Let’s sort out that apparent contradiction.

The following charts reveal what is as knowable as anything can be known about stock prices.

The charts reveal that, at least in the past, stock prices go up over the long haul. There is no guarantee that the broad markets (e.g., DJIA, S&P 500, and NASDAQ) will continue to go up over the long haul, but the history of the U.S. markets provides reasons to believe they likely will. [With the looming risk Americans might elect more socialistic governments across the country, the likelihood is significantly less than it would otherwise be.

Sidebar: If the trend toward socialism is not turned back, no investment strategy will work and much of your gains, if you get any, will be confiscated anyway. Not investing and making less money between now and then will not save you. They will take from you whatever they determine you don’t need as much as others (especially the politicians and bureaucrats) need it—no matter how much you have.]

The huge short-term swings in the markets shown in the above charts also reveal that there is no way to predict when to invest or when to sell. Nevertheless, they do suggest a strategy (described below) that can work.

Investing in individual stocks is vastly riskier than investing in funds that track broad markets. Individual stock prices are much more volatile than averages of many stocks and the value of market indices going to zero is practically impossible. Which companies might go bankrupt is not easily predicted. Consider these companies that went bankrupt: General Motors, Chrysler, Braniff Airways, Enron, WorldCom, Conseco, Sears, ToysRUs, Kmart, CIT Group, Washington Mutual, Lehman Brothers, Circuit City, Sports Authority, and Kodak. Some of those companies are still in business but, upon bankruptcy, their stock and bondholders were wiped out or nearly so (sometimes unfairly so^[iv]). In short, unless you have inside information, are into rolling the dice, or want to support a company for non-financial reasons, investing in individual stocks should be kept to a minimum.

The supposedly “sage” advice is to “diversify your investments.” A truly diversified portfolio of investments is impossible for at least two reason: (1) Many investment opportunities are “private” investments, i.e., not available to the ordinary investors (and even if they were, it is impossible to know enough to invest wisely in a wide array of ventures—so people tend to have too many eggs in any private investment basket, which is the opposite of diversity), and (2) The best mix of each kind of available investments is unknowable and unpredictable as well. For example, how much of your portfolio should be invested in South African Krugerrand coins, Russian icons, or the thousands of other esoteric possibilities? Absent some of each, you are not diversified. Nevertheless, more diversification is better than less. Shooting for (much less paying for) a perfect allocation is a waste of time (or money).

On the other hand, the charts above show that the DJIA, S&P 500, and NASDAQ have had a very good track record of increasing in value over the long haul. That streak might come to an end but predicting what might have a better chance of rising over time is unlikely to succeed and is almost certainly a riskier strategy. To reduce risk more, one would buy shares in multiple EFTs or mutual funds (carefully consider the charges of each to find ones with low fees and charges) for each of the broad market indexes. One would also not put all of her eggs in stock index funds. One would buy some bond indexes as well. (That is currently hard to do given the low yields they now create, but you will be glad you did when the stock market crashes from time to time.) I go even further and keep a very noticeable percentage of money in the even lower-yielding money markets.

What percentage of each kind of investment should you buy? It depends on your appetite for risk. The more money you put in stocks over bonds or bonds over money markets, the more money you will likely make over the long haul (if you live long enough), and the more likely you will have less investments to cash out if you happen to need to draw money out during a crash. Beyond that, there are nearly as many theories on what the mix should be as there are theorists. Rest assured, however, if you ask an investment adviser about investment allocation, she will likely give you the answer that creates the largest fees for her and/or her firm. [I’m not suggesting they are all unethical. Some surely are, but I believe most investment counselors who interface with the public do not know that the advice they have been taught to give is not worth the price charged for the advice or is unwise.]

Lastly, none of the above investing should be done all at once. Steady, consistent investing over time will result in you having bought stocks and bonds in up markets and down markets, i.e., you are likely to have a reasonably averaged purchase price, which, on average, will be lower than the price at which you will sell the investment (assuming the market continues to perform roughly as it has in the past).

The above advice may be worth exactly what you paid for it, i.e., nothing. If you look for them, you will find many articles that defend what stock analysts do. For the reasons above, I believe modern stock analysis for ordinary investors to be one of the biggest waste of human brainpower and talent (“human capital”) ever. Many will protest that some stock analysts have had long streaks of being at or near the top of stock analysts. That is true. It is also true that such streaks are a low probability occurrence. Here is a description of a similarly improbable event: “What is the probability of rolling a pair of dice 154 times continuously at a craps table, without throwing a seven? The answer is roughly 1 in 1.56 trillion, and on May 23, Patricia Demauro, a New Jersey grandmother, beat those odds at Atlantic City…”

In “Fooled by Randomness,” Nassim Taleb posed the following situation and question:

If one puts an infinite number of monkeys in front of (strongly built) typewriters, and lets them clap away, there is a certainty that one of them would come out with an exact version of the Iliad. Upon examination, this may be less interesting a concept than it appears at first: Such probability is ridiculously low. But let us carry the reasoning one step beyond. Now that we have found that hero among monkeys, would any reader invest his life’s savings on a bet that the monkey would write the Odyssey next?^[v]

In short, a normal “bell curve” of random events will include very unlikely events, and bell curves of streaks will produce very unlikely streaks. Those who happen onto a winning streak make the news and often truly believe and claim the random event was due to their diligence and brilliance. Only a fool would be fooled by such randomness.

On the other hand, please note that there is a big difference between stock analytics and investment services. Some people are unwilling or incapable of carrying out any investment strategy, including the one described above. For those people, the services of an investment firm can be very valuable. Those valuable services include:

• Construction of a financial plan;
• Basic investment advisory services [excluding picking investments], e.g., helping you identify which funds have the lowest fees;
• Tax-efficient investing consulting;
• Rebalancing portfolio investments to maintain the desired mix of stock, bond, and money market investments;
• Holding investments, which are in your name, in a secure and reasonably safe place; and
• Maintaining and providing access to good accounting and tax records concerning your investments.

As I said above, use these observations at your own risk. If nothing else, I hope they are food for thought.

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^[i] See “The Truth About Top-Performing Mutual Fund Managers.”

^[ii] See “Can Monkeys Pick Stocks Better than Experts?” for the source of the cited numbers and, for greater wisdom on the general topic, see or listen to “Taleb on Black Swans,” or read the mother loads, “Fooled by Randomness” and “The Black Swan.” See also, “Analysts Do A Great Job Predicting The Past. The Future? Not So Much.”

^[iii] “A plethora of studies have examined Morningstar, such as Blake and Morey (2000) who study the rating system to determine if they predict future fund performance for U.S. equity funds. They find no compelling evidence of significant outperformance.”

^[iv] See “Auto Bailout or UAW Bailout? Taxpayer Losses Came from Subsidizing Union Compensation.”

^[v] See, Part II, “Monkey’s on Typewriters – Survivorship and other Biases” Location 2320 Taleb, Nassim Nicholas. Fooled by Randomness (Incerto). Random House Publishing Group. Kindle Edition.