Investing Lessons from 2010

Here’s what you should have learned from 2010’s stock market volatility.

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Assume you invested $100,000 on Jan. 1, 2010 in a portfolio that tracked the Russell 3000 index. The Russell 3000 measures the performance of the largest 2,000 U.S. companies, representing approximately 98 percent of the U.S. stock market.

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Right after making that investment, you were injured in a car accident and were in a coma until Dec. 31, 2010. You open your eyes and ask about the major events you missed. Here’s a sampling of the bad news:

  • New homes sales fell to the lowest level since 1963.
  • California unemployment reached 12.5 percent, which was the highest since tracking began in 1976.
  • The sovereign debt of Greece and Portugal were downgraded.
  • The BP oil spill in the Gulf was significantly worse than the Exxon Valdez disaster.
  • The famed Hindenburg Omen, a well-known technical indicator, flashed a sell signal.
  • Ireland had to be bailed out.
  • North Korea edged towards war with South Korea.
  • After hearing all this terrible news, you asked, “Is any of my $100,000 left?” You are stunned to learn the Russell 3000 index gained 16.93 percent.

    The clear signal from the financial news was to flee to safety: Dump stocks and buy bonds. That’s what many investors did, following the advice of their brokers and wealth managers. How could they be so wrong?

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    The fundamental problem is that much of the financial media and the securities industry are engaged in an elaborate ruse. They want you to believe that following every morsel of financial news is a productive way to increase your investment returns. It isn’t. There is no predictable relationship between the financial news and the direction of the markets, which are random and unpredictable.

    This irrefutable fact doesn’t stop financial experts from predicting the future. Here are a few examples of incorrect predictions for 2010: Eric Jackson, a senior contributor, predicted the DJIA would close at 10,500 in 2010. It closed at 11,577. Richard Russell, whose web page indicates that he “has made a name for himself as a fortune teller for investors seeking to stay a step ahead of the stock market”, predicted “a disastrous stock market crash that will render America unrecognizable by the end of 2010".

    Some of the bulls were also wrong. Eugene Perion of Advisor’s Asset Management predicted a Dow close at 12,700. Jim Stack of Inestech Research agreed. He also forecast the Dow to close at 12,700. Both were very wrong. Long-term predictions fared even worse. At the end of 1999, Edward Kershner, who was then with PaineWebber, predicted the DJIA would reach 25,000 in 2010.

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    Many of the investment pundits have no legitimate credentials qualifying them to make predictions about the economy or the markets. But even legitimate experts have a dismal record in predicting the future. In The Fortune Sellers, William Sherden studied almost all economic forecasts between 1970 and 1995. He concluded that the accuracy of these forecasts was “about as good as guessing”. He also noted a 1985 study by The Economist, which found that the predictions of sanitation workers about the future of economic growth in the United Kingdom were as accurate as the forecasts of the heads of multinational conglomerates.

    If you are investing based on your assessment of the effect of current events on the markets or the predictions of stock market professionals about the future, you are just gambling.

    Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.