Blame the Media!
By: Robert DeVries
Fake news is all the news these days. Accusations fly about the veracity and bias that exists in today’s media.
Regardless of which side of the political aisle you are on, the financial media is not on your side. The financial media does a disservice to the investing public in several ways, including the following:
- Making statements like… “If you had invested in MegaStock when it went public, you’d have Ten Bizillion Dollars today…”
- Using the phrase…“The market was down 1% today…”
- Being on the air 24 hours
I’ll dive into each of these individual topics over my next three blogs. In this blog I tackle:
If you had invested in…
This notion is akin to a lottery ticket mentality, that if one could just pick the one right stock or hedge fund manager, and stay invested forever, they would be rich. There are several flaws with this notion. It ignores diversification, promotes a home run philosophy, undersells the difficulty of identifying a single winner, and most importantly, ignores the issue of when to sell a position.
Diversification is an important tool to help participate in average equity returns while reducing individual position or sector risk. Diversification can be achieved by low cost, global index funds. Warren Buffett has repeatedly said that most investors would do best by using low cost index funds as their investment strategy rather than picking individual stocks. He has even left a note to the future trustee of his estate to do the same, despite making billions in investing in individual companies.
The ‘hit it big’ philosophy is probably best seen in the Initial Public Offering market. Two large studies show that IPOs generally underperform the market. Jeremy Siegel’s study reviewed over 9,000 IPOs from 1968 until 2003. The IPOs underperformed the market average by 2-3% per year, and four out of five stocks did worse than a small cap index.
Even during banner years like 1986 when Microsoft, Oracle, Adobe, and Sun Microsystems went public, the IPO portfolio barely outperformed the small cap stock index. Indeed, for every IPO success story, there are many more that have underperformed.1
Another study by Jay Ritter, where IPOs from 1980-2014 were bought and held for three years, showed an average three year return of -17.8% when adjusted for market returns.2 Why might that be? Think of it this way, if the people who know the company best are selling, should you really be buying?
Hedge funds are also difficult to pick. Going back to the Oracle of Omaha, Warren Buffet put up a $1 million challenge to any asset manager who could pick a hedge fund or funds that would outperform the S&P 500 over 10 years. Through nine years, the return of a low-cost S&P 500 index is up 7.1% annual return vs. 2.2% for the average for five hedge funds picked.3 Buffet’s high profile bet demonstrates the almost impossible task of picking which active investment or hedge fund manager can outperform the S&P 500 or the stock market for long periods of time.
Finally, the statement ‘if you had invested in…’ ignores the disposition decision. If one had bought $10,000 of Microsoft at its IPO, whose adjusted price is approximately $0.10, it would have grown over the next 10 years 60 times to nearly $6 and the initial investment to $600,000. For most, that would have been more than enough return and money (in 1996). Some would have been tempted to sell their allotment at the peak of the first day, earning 40% in that first day!
But the media using grandiose statements like the one at the beginning of this blog ignores the more important decisions, such as how much money do you need to lead the financial life you dream about? What is the required return? What dangers, such as being invested in only one stock, prevent you from achieving your goals. If you need help with those important decisions, contact our wealth services firm in Satellite Beach, FL – Melbourne/Brevard area at (321) 773-7773 to schedule your complimentary consultation.
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