Swedroe: Be Wary Of ‘Experts’

Many individual investors have seen their portfolios devastated, despite having followed the advice of “experts.” They are left wondering, “What went wrong?”

As you may have already guessed, the answer is that following the advice of “future tellers” disguised as investment pros is the wrong strategy. As Jim Cramer once famously said to Jon Stewart of The Daily Show, “I got a lot wrong.”

Investment legend Warren Buffett put it this way: “A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting.”

Distorted Expertise

David Freedman, in his outstanding book, “Wrong,” shows us that experts are often the reason we get into big messes, whether they occur in the field of medicine, investing, science, psychology, raising children, dieting or business management.

With sometimes frightening examples, Freedman exposes the biases and career pressures that frequently lead experts to arrive at their advice in dangerously distorted ways. Since much of the book is devoted to the field of medicine, it can be a terrifying read that leaves you uncertain about what and who to believe.

Freedman notes how biases and corruption can 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.”

Freedman observes that a wide range of economists and even mathematicians—as well as many nonscientist financial experts—have demonstrated quite clearly for about a century that no matter what technique you use to pick stocks, you’re not likely to beat the market.

Despite that, “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.”

He also explains 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 goes on to add: “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.”

The Allure Of Certainty

Finally, Freedman provides a great example of how people react to advice. He presents the case of an individual with back pain. This individual visits two doctors. Each reviews the MRI. The first doctor states that he has seen many similar cases and that it’s hard to say exactly what is wrong.

After all, it can be difficult to predict what will work for any one person. This doctor suggests trying Treatment A first and then going from there. The second doctor states that he knows exactly what is wrong and what to do.

Which doctor do you choose? Almost always people will choose the latter. Yet that might very well be the wrong choice. While we want certainty, it rarely exists. And it certainly doesn’t exist in the investment world, where so much of returns are explained by unforecastable events, such as revolutions, earthquakes and tsunamis or terrorist attacks.

Later this week, we’ll explore the “Wizard of Oz effect”—or the desire to believe that there’s someone out there who can protect us from bad things happening to our portfolio.

Larry Swedroe is the director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.