Don’t Be Lured By Investment Pornography

While it may be entertaining, following the advice of financial pundits won’t help you to retire sooner.

By + More

It is particularly insidious that so much of what passes for financial journalism is really financial pornography. It’s dispensed by distinguished looking experts who give opinions on a wide range of investing subjects. Sometimes they are right and sometimes they are wrong. They have no accountability.

[See the 50 Best Funds for the Everyday Investor.]

Here’s the rub. Anyone making a prediction has a statistical possibility of being correct simply because of random chance. That doesn’t mean they have an expertise. There is no evidence that picking winning stocks is a skill. When stock pickers are successful, they are quickly anointed (or anoint themselves) as investing gurus, but they are really just lucky. Several studies have demonstrated this irrefutable fact. An exhaustive analysis of the performance of 2,076 fund managers over 32 years found that 99.4 percent of them showed no genuine stock-picking ability. Another study evaluated 819 actively managed funds over 22 years and found that 97 percent of them could not be expected to beat a risk-appropriate benchmark.

These studies don’t prevent purveyors of financial pornography from dispensing their stock picking views, in an effort to persuade you they have this non-existent expertise. A recent video on Yahoo’s Breakout is typical. The expert guest was Simon Baker, a hedge fund manager. Baker recommended four “recession resilient stocks to ride out the storm”. Viewers are led to believe that Baker has a stock picking expertise worthy of consideration. He doesn’t. If his stock picks work out, you can attribute his success to luck. If they don’t, I doubt Mr. Baker will do a mea culpa in a return appearance.

[See The Big Myth: Active Managers Shine in Volatile Markets.]

There are many examples of stocks highly touted by experts that tanked. Remember Bethlehem Steel, Eastman Kodak, Polaroid, Pan Am, Kmart, and Wang Laboratories? In their heyday, investing experts found them irresistible picks. In fact, Kmart, Polaroid, and Wang Laboratories were all cited as examples of excellent companies in the 1982 bestseller, In Search of Excellence.

Pfizer is another example. In 1998, Fortune and the Wall Street Journal extolled its virtues. Forbes featured Pfizer on its January 11, 1999 cover as “Company of the Year.” Since 1998, the S&P 500 lost 3 percent. How did Pfizer do? It’s down over 50 percent.

Purveyors of stock picking skill typically have big personalities, such as Jim Cramer. The host of Yahoo’s Breakout, Jeff Macke, described Baker as a “dapper Brit.” He seems very confident, polished, and articulate. But if he has discovered the secret to picking stock winners, I would expect him to publish his findings in a peer-reviewed journal.

Merton Miller is a Nobel Laureate. Here’s his view on stock pickers: “If there's 10,000 people looking at the stocks and trying to pick winners, one in 10,000 is going to score, by chance alone, a great coup, and that's all that's going on. It's a game, it's a chance operation, and people think they are doing something purposeful... but they're really not.”

[See How to Beat the Returns of the World’s Greatest Investors.]

Don’t be fooled. Relying on Baker or anyone else to pick winning stocks is a mug’s game. Yahoo’s Breakout would serve investors better by providing sound, academically validated advice about investing that would empower investors to achieve higher expected returns for a given level of risk. Instead, it’s a forum for investment pornography.

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 was released in September, 2011.