Chapter 7 Excerpt: The Myth of Financial ExpertiseDocument Transcript
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THE MYTH OF
Why professional wine tasters and stock pickers
are clueless—and how you can beat them
f I invited you to a blind taste test of a $12 wine versus a $1,200
wine, could you tell the difference? I bet you $20 you couldn’t.
In 2001, Frederic Brochet, a researcher at the University
of Bordeaux, ran a study that sent shock waves through the
wine industry. Determined to understand how wine drinkers
decided which wines they liked, he invited fifty-seven
recognized experts to evaluate two wines: one red, one white.
After tasting the two wines, the experts described the red wine as
intense, deep, and spicy—words commonly used to describe red wines.
The white was described in equally standard terms: lively, fresh, and
floral. But what none of these experts picked up on was that the two
wines were exactly the same wine. Even more damning, the wines
were actually both white wine—the “red wine” had been colored with
I Will Teach You to Be Rich
Think about that for a second. Fifty-seven wine experts couldn’t even
tell they were drinking two identical wines.
There’s something we need to talk about when it comes to experts.
Americans love experts. We feel comforted when we see a tall,
uniformed pilot behind the controls of a plane. We trust our doctors to
prescribe the right medications, we’re confident that our lawyers will steer
us right through legal tangles, and we devour the words of the talking
heads in the media. We’re taught that experts deserve to be compensated
for their training and experience. After all, we wouldn’t hire someone off the
street to build a house or remove our
ALL OuR LIvES, wisdom teeth, would we?
wE'vE bEEN All our lives, we’ve been
taught to defer to experts:
TAugHT TO dEFER
teachers, doctors, and investment
TO EXPERTS… “professionals.” But ultimately,
buT uLTIMATELY, expertise is about results. You can
EXPERTISE IS have the fanciest degrees from the
AbOuT RESuLTS. fanciest schools, but if you can’t
perform what you were hired to do,
your expertise is meaningless. In our culture of worshipping experts,
what have the results been? When it comes to finances in America, they’re
pretty dismal. We’ve earned failing grades in financial literacy—in 2008,
high school seniors correctly answered a gloomy 48 percent of questions
on the Jumpstart Coalition’s national financial literacy survey, while
college seniors answered only 65 percent right. We think “investing”
is about guessing the next best stock. Instead of enriching ourselves
by saving and investing, most American households are in debt. And
the wizards of Wall Street can’t even manage their own companes’ risk.
Something’s not right here: Our financial experts are failing us.
When it comes to investing, it’s easy to get overwhelmed by all the
options: small-, mid-, and large-cap stocks; REITS; bonds; growth, value,
or blend funds—not to mention factoring in expense ratios, interest
rates, allocation goals, and diversification. That’s why so many people
say, “Can’t I just hire someone to do this for me?” This is a maddening
question because, in fact, financial experts—in particular, fund managers
and anyone who attempts to predict the market—are often no better than
amateurs. They’re often worse. The vast majority of twentysomethings
can earn more than the so-called “experts” by investing on their own.
THE MYTH OF FINANCIAL EXPERTISE
low-cost funds (which I’ll get to in the next chapter). So, for the average
reasons for this that I’ll detail below, but I urge you to think about how
you treat the experts in your life. Do they deserve to be put on a pedestal?
Do they deserve tens of thousands of your dollars in fees? If so, what kind
of performance do you demand of them?
In truth, being rich is within your control, not some expert’s. How rich you
are depends on the amount you’re able to save and on your investment plan.
But acknowledging this fact takes guts, because it means admitting that
there’s no one else to blame if you’re not rich—no advisers, no complicated
investment strategy, no “market conditions.” But it also means that you
control exactly what happens to you and your money over the long term.
You know what the most fun part of this book is for me? No, it’s
disbelieving e-mails I’m going to get after people read this chapter.
Whenever I point out how people waste their money by investing in
below-market returns, I get e-mails that say, “You’re full of it.” Or they
say, “There’s no way that’s true—just look at my investment returns,” not
really understanding how much they’ve made after factoring in taxes and
fees. But surely they must be making great returns because they wouldn’t
continue investing if they weren’t making lots of money . . . right?
In this chapter, I’m going to show you how you can actually outperform
the simplest approach to investing. It’s not easy to learn that reliance on so-
called “experts” is largely ineffective, but stick with me. I’ve got the data to
back it up, and I’ll show you a simple way to invest on your own.
THE MYTH OF FINANCIAL EXPERTISE
More Examples of How
“Experts” Can’t Time the Market
P undits and television shows know exactly how to get our attention:
with ﬂashy graphics, loud talking heads, and bold predictions
about the market that may or may not (in fact, probably not) come true.
These may be entertaining, but let’s look at some actual data.
Recently, Helpburn Capital studied the performance of the S&P 500
from 1983 to 2003, during which time the annualized return of the stock
market was 10.01 percent. They noted something amazing: During that
twenty-year period, if you missed the best twenty days of investing (the
days where the stock market gained the most points), your return would
have dropped from 10.01 percent to 5.03 percent. And if you missed the
best forty days of investing, your returns would equal only 1.6 percent—
a pitiful payback on your money. Unfortunately, we can’t know the best
investing days ahead of time. The only long-term solution is to invest
regularly, putting as much money as possible into low-cost, diversiﬁed
funds, even in an economic downturn.
USELESS NEWSLETTERS. A 1996 study by John Graham and
Campbell Harvey investigated more than two hundred market-timing
newsletters. The results were, shall we say, unimpressive. “We ﬁnd that
the newsletters fail to offer advice consistent with market timing,” the
authors deadpanned as only academics can. Hilariously, by the end of
the 12.5-year period they studied, 94.5 percent of the newsletters had
gone out of business. Not only did these market-timing newsletters fail
to accurately predict what would happen, but they couldn’t even keep
their own doors open. Get a life, market timers.
I’ll end with a couple of more recent examples. In December 2007,
Fortune published an article called “The Best Stocks for 2008,” which
contained a special entry: Merrill Lynch. “Smart investors should buy this
stock before everyone else comes to their senses,” they advised. They
obviously weren’t counting on it being sold in a ﬁre sale a few months later.
And in April 2008, BusinessWeek advised us, “Don’t be leery of Lehman.”
I’m not sure about you guys, but I’m leery of worthless risky advice
couched in cute alliteration. I think I’ll ignore you from now on, pundits.
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