Financial Folklore: Tales from Wall Street to Main Street
April 22, 2011
SAN DIEGO (ETFguide.com) – Throughout the ages, financial folklore has been handed down from one generation to the next as so-called wisdom. And our generation has been brainwashed with its fair share of folklore.
Let’s consider some examples.
“Buying a home is the best investment anyone can make.”
The pummeled housing market should have put this particular fairy tale to rest, but there are a few holdouts that haven’t gotten the message.
People, for example, that bought their home decades ago are often cited as proof that buying a home is still the “best investment anywhere.” But before we count their profits, don’t forget to deduct their insurance premiums, the cost of home maintenance, improvements and property taxes. Including these real life expenses into the equations portrays a far more realistic picture about the true investment value of home ownership. It’s not as good of a deal as you’ve been sold.
But the real test of truthfulness behind this is to ask anyone that’s purchased a home or condominium within the past 10 years. Ask them how profitable their foray into housing market has been and they’ll tell you.
“Max out your 401(k) plan.”
Overstuffing your 401(k) plan with lots of money – is a good savings habits – but won’t necessarily help you you’re your investments more profitable. Why? It’s because most 401(k) plans offer a diverse menu of rigged investment choices with unnecessarily high fees. It’s the mutual fund industry’s best kept secret.
What about the wonderful benefits of tax free growth and employer matches? Unfortunately, these 401(k) features are undermined by consistent underperformance by mutual fund managers, poor asset allocation decisions by plan members and compounding fees.
Unless low cost index funds and ETFs are investment choices inside your 401(k) plan, overstuffing your 401(k) retirement plan with bloated contributions is probably not a good idea.
“Only invest in funds with managers that have a good track record.”
There are countless examples of how this piece of advice has been proven false more times than true. But since we don’t have countless time or space, let’s consider just one recent example – Philip Jabre.
Jabre is one of Europe’s best known hedge fund managers and after posting a tranquil 3% gain during 2008’s financial crisis, he followed it up with a handsome 46% gain in 2009. Surely investing money with Jabre - a seasoned professional with an impressive track record - was the smart thing to do, right?
In March, Jabre bought Japanese stocks (NYSEArca: EWJ) on news of the earthquake but got clobbered when the Nikkei Stock Average tumbled. Instead of staying calm, Jabre panicked and sold his shares before Japanese stocks bounced back, which netted his firm $300 million in losses. Hardly anyone could’ve foreseen this sort of meltdown from a guy with an amazing track record!
For anyone confiding in the false comfort of past performance, beware!
“Buy whatever Warren Buffett is buying.”
In the 1960s and 70s, youthful groupies would follow their favorite musical bands from city to city. Today, these same folks have graduated to following the financial moves made by investing legends like Warren Buffett. Are there guaranteed profits for those who ape the “big money?”
Reuters looked at five recent acquisitions made by Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A) to test out this theory.
Someone who bought 100,000 shares in stock in each of Berkshire’s acquisition targets 70 days before Buffett announced a deal, would have made money in just three out of five tries. Not bad, but hardly a sure thing.
In this simplified case study conducted by Reuters, the reward for aping Warren Buffett’s past five deals – or should we say, beating him to each deal by 70 days – was a complete wash. The profitable trades amounted to a gain of $3.256 million whereas the losses were $3.268 million.
So much for the false theory that copying financial titans delivers market beating results.