I constantly marvel at the massive amount of information available to the investing public today. Low cost and in most cases, free, information is readily available at our fingertips. Why then, do individual investors still struggle to not damage themselves in the financial markets? I recently came across two items in my reading that illustrate why the vast majority of individual investors should have some type of competent professional help in managing their investments and why a blind reliance on technology and information available online is not only not sufficient, but may be outright dangerous.
The first item comes from the Bloomberg News Service and tells us that “Investors Turn to Stocks at the Right Time”. The article states that stock mutual funds and ETF’s (exchange traded funds) took in $162 Billion in 2013, the most since 2000. What I find disturbing about this is that it occurs after stocks (the S&P 500) are already up 168% since 2009. As usual no one wanted stocks when they were relatively cheap (except Warren Buffett). Now that PE’s (how much you are paying for a company relative to the how much the company earns) are again approaching historical highs everyone wants back into the stock market. It is interesting that stocks have attracted the most money this year since 2000. 2000 was the last time PE’s were this high and the following year the S&P fell 46%. It appears that the greed/fear cycle that drives the stock market is still intact and the perennial recipe for disaster for the small investor is firmly in place. Wouldn’t it have been better to just have invested in an asset allocation that you were comfortable with long term and then just stuck with it and not worry about getting in and out of the market and costing yourself a great deal of money in the process?
This behavior is behind what has been termed the “Performance Gap”. It is a phenomenon so pervasive and so damaging to the investors that we offer to help that we illustrate it on the back of our business cards. For example, from 1982 to2002, the average stock mutual fund earned 11.5%. During that same time period the average investor in those funds earned only 4.3%.This gap is wholly attributable to investor behavior, particularly the tendency of individual investors to flee stocks when they are inexpensive and crowd into the market when they are expensive.
The second item comes from Rebecca Grant at Venture Beat, which tracks tech start-up companies. She reports on Robinhood, which initially launched as a mobile, social forum for stock trading advice, (apparently that didn’t really catch on). The site then morphed into an information source on “crowdfunding” opportunities. Now the site is redeveloping itself again into a commission free brokerage platform complete with financial commentary from its users. Normally I’m all in favor of anything that gives small investors better or cheaper access to the financial markets (Pilot Capital is fee only, no commissions –no product sales). What really bothers me here is the attempt to meld social media and financial advice, sort of a Facebook for financial advice. The idea, as I take it,is to allow small investors to harness the wisdom of the masses on investing. However, as we see in the paragraphs above, the masses have never really demonstrated any wisdom whatsoever when it comes to investing. The real danger here is that this encourages yet another generation of investors to view investing as entertainment and to follow the always wrong impulses of the crowd.