How The Financial Press Misleads Investors

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
August 10, 2004

IN THIS ISSUE:

1.  Financial Press Does Investors No Favors

2.  Are Stocks In A Trading Range Market?

3.  Some Strategies For A Sideways Market

4.  Why Most Investors Can’t Use These Strategies

5.  Why You Need (A Free) Financial Plan

Introduction

The stock markets have fallen back to the low end of the trading range that we haven’t seen since the peak in March.  Investors are frustrated, really frustrated.  No one likes trading range markets, except for the rare and nimble short-term traders and the small cadre of successful options writers.  Everyone is wondering and speculating when the markets will come out of this sideways conundrum.

Meanwhile, the financial press continues to serve up advice for individual investors on how to beat this market on their own.  Unfortunately, most individual investors are not skilled in doing the kinds of things the talking heads in the financial press and on cable TV are suggesting.  This week, we look at some of these ideas and why most people should avoid them.

Also, don’t forget that in frustrating times in the markets, there is an abundance of crooks out there who prey on investors with new scams to separate them from their money.  Remember, if it sounds too good to be true, it probably is.

Finally, if you are disappointed with your investment portfolio, if you are not getting the returns you think are reasonable, or if you’re just not sure what you should be doing, maybe it’s time to get a professional financial plan.  In this issue, I will tell you how you can get a thorough and objective assessment of your investments and a professional financial plan at no cost.  

Financial Press Does Investors No Favors

What has the financial press learned after going through the most recent market cycle – the bear market of 2000-2002, the bull market of 2003 to early this year, and now this trading range?  The answer: NOTHING.  Their mantra continues to be that individual investors can beat the markets on their own, and they continually roll out new advice on how to do so – including some strategies that they denounced just a few years ago when we were in a bull market.

The problem is, most investors are not experienced in executing most of the strategies we have seen touted this year.  Most investors don’t have the time to monitor the markets at least several times a day, and they certainly don’t have the wealth of research and quantitative tools needed to follow some of these strategies.  Yet the financial press keeps rolling them out, from one investment strategy to the next, regardless of whether or not most investors can really implement those strategies on their own.  They advise moving from one hot investment to the next without looking back.   

And investors are hungry for ideas that sound good.  The three-year bear market that ended in 2003 dealt serious losses to most investors.  Based on mutual fund money flows, many investors bailed out of the market either partially or completely in late 2002, very near the bottom.

We also know from those same money flow numbers that most of the investors who bailed out near the bottom did not get back in to catch the huge recovery of apprx. 45% in the S&P 500 Index from March 2003 to March 2004.   So they are very frustrated at this point, and this includes millions of Baby Boomers who don’t have that many more years to build their portfolios for retirement.  They are anxious to find something that works.

The Trading Range Market

Right now, the dilemma for investors is what to do in this sideways market we appear to be stuck in.  The sideways market is causing a lot of second-guessing on the part of the financial press and confusion on the part of investors who listen to them.

While the equity markets are under renewed pressure as this is written, the markets are pretty much where they started the year.  It appears we may be at the bottom of a trading range with the S&P 500 at around 1060.  The high side of the trading range appears to be around the 1160 mark.  Therefore, the S&P 500 is down about 9% from its high for this year.  Again, considering that the S&P 500 was up about 45% from its March 2003 low to its March 2004 high point, being down less than 10% from the peak doesn’t seem too bad to me. 

Of course, most investors don’t look at it that way.  They are very frustrated and eager to hear about any strategy that can work in a trading range market.  And the financial press has all kinds of  ideas, regardless of whether or not most investors can use them successfully.   Here are some examples.

Sector Rotation

In a July 16 “Managing Your Money” column in USA Today, an article dealt with how to play a sideways market.  One piece of advice was to target winning sectors.  All you have to do is just pick the winning sectors, ride them up until they are at a peak and then sell them before they fall.  Sounds easy enough, right?  WRONG.  The problem is identifying these sectors before they get hot and in time to make a profit. 

There are some professional portfolio managers who track the market day-by-day and use the “sector rotation” strategy successfully.  Some of the professional Advisors we recommend have used this strategy successfully for many years.  However, we’ve also seen a lot of professional managers who were not successful (at least by our definition) in using sector rotation strategies, especially during the bear market.

If professionals struggle with identifying winning sectors, how many individuals looking at the market in their spare time can possibly pick the sectors that are going to perform well in time to get in and make the big profits the pundits tout?  Who is going to blow the whistle and tell them when to get out so they don’t ride those winning sectors down? 

And when was the last time anyone in the financial press told you when it was time to sell something that they recommended earlier? 

Usually the press has moved onto the next hot investment for today and fails to follow up on the advice they gave yesterday or last month – especially if that advice didn’t turn out so well.  After all, they are in the business of selling the latest news.   Yesterday’s hot investment or strategy is now old news. 

Traditional Market Timing

After decades of claiming that traditional market timing could not be done successfully, more and more pundits in the financial press are now recommending that individual investors try it in this sideways market.  As you well know, I believe market timing can be done successfully, but is best left to professionals such as those we recommend. 

But just as with sector rotation, we’ve seen many more professional managers who don’t do well with market timing than those who have been very successful.  Very few can do it consistently over time, even with all the quantitative tools and research at their disposal. 

Market timing isn’t something that most individual investors should attempt on their own.  Most don’t have the time for it.  They don’t have all the quantitative tools and research.  Even worse, most investors tend to be too emotional and can end up buying high and selling low.  This can be a disaster.  Yet some in the financial press, who loathed market timing for years, now embrace it and make it sound easy.

Chasing The Latest Hot Funds

The amount of information and data available on mutual funds is nothing short of mind-boggling. With the Internet juggernaut, there are now dozens of large organizations that track and analyze mutual fund performance.  There are hundreds of websites that offer information on how to pick the best mutual funds.  Almost all of these outlets focus on one thing: past performance.

With only limited knowledge of a computer, an investor can find the top performing funds over any given period with just a few clicks on a keyboard.   You can “slice-and-dice” mutual fund performance information endlessly – if you have the time, that is.

Even if you don’t use a computer, you can find mutual fund rankings in a host of different magazines.  There are dozens of newsletters that focus only on mutual funds. And there is an endless stream of “experts” on TV who will tell you about the hot mutual funds.

The problem, as always, is that today’s “hot” funds may go cold tomorrow.   Many investors make the mistake of buying the hot funds of the day, and then when they underperform or go down, they sell and go look for the latest hot funds.  I call it the “Mutual Fund Merry Go-Round.”

If you are on the Mutual Fund Merry Go-Round, and want to get off, read these three articles I wrote in early 2003.  Find out how you can get successful professionals, with the quantitative tools and research, to select the most suitable mutual funds for you.

Buying Only The Best Stocks

Another piece of advice I read recently was to concentrate your portfolio by buying only the 10 stocks with the greatest potential for appreciation.  Can anyone reading this tell me which are the 10 best stocks to buy?  If you can, we need to talk!

This article assumed, apparently, that most investors know how to pick the 10 best stocks.  And why only 10 stocks?  I don’t know.  Anyway, the writer advises (almost casually I might add) that we should all be able to identify the 10 winners, invest only in them and make a bunch of money.  Is this writer naïve, stupid, or both?  

If it were that easy, professional managers would never have any losers in their portfolios.  Do you really think a professional manager goes out purposely to buy stocks they expect to underperform?  If managers could identify the losers in advance with any certainty, they wouldn't buy them in the first place.  How much more difficult is it for amateurs to avoid losers while selecting the 10 best stocks?

Finally, if the people who write these articles could actually do what they suggest, do you think they would be working for columnist pay?  I don’t think so!

Portfolio Rebalancing Is Not The Silver Bullet

In a July 28 column in the Wall Street Journal, an article dealt with how to make money whether the market goes up or down.  The article says that in reality you don’t need to guess the market’s direction in order to profit from shifting valuations.  All it takes, the writer says, is a little self-discipline.  Considering that it is very difficult to forecast the market’s short-term direction, he suggested that all you have to do is annually “rebalance” your portfolio. 

Here’s how it’s supposed to work.  First, you initially construct a portfolio that is made up of the various asset classes, such as large company stocks, small company stocks, international stocks, various bonds, real estate investment trusts, etc.  Next, you determine the best weighting (allocation) to give each of these asset classes.  Then once a year, you sell the profits from your winners and use that money to buy more of your losers, to bring everything back into balance with your original allocation. 

The idea is to force self-discipline by buying into depressed sectors that may be due for a rebound, while lightening up on high-flying sectors that could be set to tumble.  It’s called portfolio rebalancing.

I agree that it is important to diversify your portfolio with multiple asset classes and especially with different investment strategies.  And I agree that it is a good idea to rebalance the portfolio periodically. 

Most People Don’t Know How To Do This

The problem I have with so many of these investment articles in the financial press is that they assume their readers already know how to allocate their portfolios; they know which asset classes are appropriate for them; they know what percentages should be allocated to each asset class and/or strategy; they have the software and quantitative tools to identify the top performing funds in each asset class; and finally, that they know their own level of risk tolerance. 

Yet my 28 years of experience in this field tells me just the opposite, that most investors DON’T really know these things.  Most investors need a professional to help them with these decisions.  They need a professional financial plan designed specifically for their needs, risk tolerance and financial objectives.

What Is A Financial Plan?

There are different types of financial planners, and thus different types of plans.  For the purposes of this discussion, I will be referring to financial planners who specialize in investments, rather than other professionals who may specialize in insurance and/or estate planning.

A good financial planner will start by learning about you, your current financial situation and what your goals are.  He/she will need to know about your income (all sources), the amount you have in savings, your living expenses, any debt that you may have (any kind), ages of your children (for college planning), any medical conditions, etc., etc.

Next, a good financial planner will spend plenty of time with you discussing your goals and objectives.  This will certainly include when you want to retire, what kind of lifestyle you want to have in retirement, do you need to set aside money for kids’ college, buy a bigger (or smaller) house, etc., etc.

[Maybe this sounds too personal for you.  Maybe you are uncomfortable sharing this detailed information with someone you don’t really know.  Yet the truth is, all good financial planners have a “Privacy Policy” which states, in writing, that they will not share your information with others.  Always ask to see their Privacy Policy and read it carefully.]

Next, a good financial planner will have sophisticated software that can analyze all of your financial information and determine how much you need to save and what rate of return you need to make on your investments in order to meet your goals.  While this is not rocket science, very few investors know how to calculate this information on their own.

All too often, unfortunately, financial planners find, after running the numbers, that the client will have to achieve an unreasonably high rate of return on his/her investments, and save much more than they had expected, in order to reach their financial/retirement goals.

While it is not pleasant to learn this, it is absolutely critical when it comes to realistic financial planning.  And the good news is, the sooner you find out where you stand, the better – so you can start making the necessary adjustments to reach your goals.

The Hardest Part: Deciding On The Investments

Now we get to the really hard part: deciding on the investments and the allocations.  By this time, you and your financial planner should have decided on a realistic rate of return on your investments and how much risk you are willing to take to get there.

Since everyone’s financial situation is different, I cannot offer a specific list of investments I would recommend.  Generally speaking, however, most portfolios will include a mix of large, medium and small cap stocks, international stocks, a mix of bonds and perhaps some real estate.  Usually these asset classes are in the form of mutual funds.

A good financial planner will have sophisticated software for analyzing the mutual funds in each asset class and be able to recommend the top performers in each group.  He/she should show you the historical data on each fund, including long-term rate of return, worst losing periods (drawdowns), standard deviation, etc., etc.  He/she should also advise you if there have been any changes in the managers of the funds recommended.

Many financial planners will also recommend some “alternative investments” such as hedge funds, professionally managed futures funds, etc., especially for larger portfolios that can diversify more.  These types of investments are not suitable for all investors and should be carefully selected.

It may be that some of the investments you already have are worth keeping.  A good financial planner will not assume that everything in your portfolio is bad.  He/she should be able to analyze each of your current investments to see if they are comparable to any of those he/she would recommend.  If they are, keep them and perhaps avoid some transaction costs.

Once the investments have been selected, the next step is to fund the accounts and make the purchases.  A good financial planner will monitor your portfolio on an ongoing basis.  You should get an easy to understand quarterly statement with a detailed breakdown on how each of your investments is doing, as well as your overall portfolio return.

A good financial planner will also stay in touch with you with a periodic phone call to see if your financial situation has changed.  He/she should also call you if any changes need to be made in the portfolio.  As an example, maybe a fund changes managers and together you decide to move to another fund.  He/she should also call at least once a year (or more often if need be) to discuss rebalancing the portfolio as discussed above.

A good financial planner should also be constantly searching for better funds, better managers and better alternative investments.

Finally, when it comes to fees, there are several types of financial planners.  There are “fee-only” planners who charge a fixed fee for providing the service.  There are “commission-based” planners who are paid by the commissions on the products they sell (which, of course, can lead to conflicts of interest).  And there are “asset-based” planners who are paid a pre-determined management fee based on the size of the assets under management.  There are pros and cons to each fee arrangement, but I generally prefer the asset-based fee. 

Conclusions

I wish the press would stop telling individual investors that they can do all these complicated things on their own.  As discussed above, most investors don’t know how to do sector rotation, market timing, etc.  No one – not even Warren Buffett - knows which 10 stocks will be the best over any given period.  The press should be advising them to seek professional help in their investment selection and portfolio management.   

At ProFutures Investments, we provide financial planning.  We have three Investor Representatives with years of financial planning experience, including one Certified Financial Planner.  We are an asset-based planner, so there is no charge for the financial plan.  At no cost or obligation, and based on the information you give us, we will do a full analysis of your investment portfolio, and we will give you a formal recommendation including any changes we would suggest.

As noted above, we do believe that diversification is very important - both in terms of asset classes AND strategies.  Where we differ from most financial planning firms is that, in addition to mutual fund portfolios, we also have specific managers that bring you different strategies such as sector rotation, market timing, etc., as well as alternative investments. While not suitable for everyone, most investors who come to us want to add these strategies and others to their portfolio.

We do customized financial plans for clients all across the country.  Your financial planner does not have to live in your city or even nearby.  Some clients tell us they are more comfortable sharing their financial information with a firm that is not in the local neighborhood. We have a very strict Privacy Policy, so you can be certain that your information stays CONFIDENTIAL with us.

If you would like to take advantage of the financial planning services we offer, you need only to give us a call at 800-348-3601 to get started.   There is no cost to get a financial plan, tailored to your specific situation, and there is never any pressure to invest in any of the services we offer.

Very best regards,

Gary D. Halbert

 

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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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