Beware of those peddling certainty.
A large majority of investors have seen their portfolios underperform simple buy-and-hold strategies, despite having followed the stock-picking and market-timing advice of so-called experts.
These “experts” include pundits, gurus and forecasters such as Bill Gross, John Hussman, Nouriel Roubini, Meredith Whitney and, yes, even Jim Cramer. Investors confronting subpar returns are left wondering, “What went wrong?” The answer is that following the advice of “future tellers” disguised as experts is the wrong strategy.
David Freedman, in his outstanding book, “Wrong,” shows that experts are often the reason we get into big messes—whether the expert advice is in the field of medicine, investing, science, psychology, raising children, dieting or business management. With often-frightening examples, he exposes the biases and career pressures that lead to the often-dangerously distorted ways in which experts arrive at their advice.
Freedman explains how biases and corruption play a role in expert recommendations. He explains: “Most of us think of scientists as being devoted to uncovering truths, not pumping their career prospects. Less formal experts don’t enjoy that sort of halo. To win promotion or even simply keep their jobs, law-enforcement officials have to wrestle with the sometimes vicious politics racking the administrations they serve and stockbrokers desperately struggle to corral new customers lest they not survive the next round of pink slips. For such experts, actually being right isn’t always the best path to career success. There have been endless accounts of doctors ginning up unnecessary or overpriced tests for patients carried out at labs in which the doctors are investors, of government officials who receive favors and kickbacks, or brokers churning accounts to raise commissions and so forth.”
As presented in my book, “The Quest for Alpha,” there is an overwhelming body of evidence that clearly demonstrates the vast majority of those attempting to outperform appropriate risk-adjusted benchmarks fail to do so with great persistence. There is no persistence of outperformance beyond the randomly expected. In other words, past performance is not prologue.
Yet, despite the evidence, as Freedman noted, “many of us still put our faith in, not to mention bet our life savings based on, the advice of, say a screaming, bouncing, bell-ringing television personality who claims to have special insight into the movements of stocks, is, I think, a sharp illustration of how some experts can ride straight-out irrationality to great personal success.”
Freedman went on to explain why this happens: “We seem to have an insatiable appetite not just for unhealthy foods but for gimmicks that claim to make it easy to live without such foods or to eat without gaining weight. In other words, experts sometimes just give us the implausible advice we want, apparently without much regard for whether it will do much good or not.”
Freedman adds: “The simple fact is that most informal experts can spew out conclusions without much fear of being intercepted by wiser or more careful parties. Who’s filtering the recommendations of investment gurus? In the short run, most informal experts can get away with quite a bit, and do all the time.”