Should average Joe invest like George Soros? NO, NO, NO!

George Soros Bet $1.3 Billion The Stock Market Will Fall

The above headline is from a news story a client of mine wanted me to comment on. The story basically says that George Soros has bet $1.3 Billion that the US market will drop this year:

From my client: 

Mike,

 

Give me your comments after reading the following article,

http://www.huffingtonpost.com/2014/02/18/george-soros-stock-market_n_4810434.html?1392759577&icid=maing-grid7%7Chtmlws-sb-bb%7Cdl3%7Csec1_lnk2%26pLid%3D444081

My Response:

I wish the press did not sensationalize these types of stories. It is very bad for the average stock market investor. It makes the average investor feel that they should follow in some form. They ask themselves "if the smart money is getting out, shouldn't I?"

Soros has made his wealth by taking extreme bets that have high risk but a high return if they succeed. This time, he is betting a portion of his wealth (11%) that  the market will decline. But it is only a portion of his wealth. He can afford to take this bet.

The problem for the average investor is that 3 factors reduce their ability to do what Soros does:

1. Getting the timing correct. There is nobody (including Soros) that has successfully designed a system to get the timing in and out of the market correct. If there was a perfect system, we would just let the computer run our stock portfolios. What makes us think that Soros has a crystal ball. he isnt always correct.

2. Emotional behavior usually scares the average investor out of sticking with the types of extreme bets Soros will make.  We know from studying investor behavior that emotion trumps rationality.  Most investors will bail out before the bet pays off. Soros has the emotional fortitude to stay with his bets. In addition, he can afford to make the bets. If he loses he still is a billionaire - what is $1.3 Billion when you have $11.8 Billion?

3. Taxes can take a big bite out of the returns - even if the timing is done correctly. All the buying and selling may result in taxes that exceed 30%. Will the bet return greater than 30% versus staying in the market for the long haul.

The average investor needs to keep in mind that over the last 50 years holding the total US market and not jumping in and out of the market has resulted in an almost 10% return. Over an 11% return when international stocks are included into the portfolio.
 

Remember this statistic:  Since 1970 an investor who was out of the market on 15 best days over 52 years would have seen their return go from 9.94% to 7.47%.

So unless selling portions of your stock portfolio this year are consistent with your long term investment plan, don't try and follow Soros or any other prognosticator, stay to your plan.
And remember: Those who live by the crystal ball eat glass!

Why Smart People Make Stupid Financial Decisions

I recently received an email question, printed below, asking why do smart people make bad investment decisions?

The question:

Mike,

I am wondering if you read the front page story in the Buffalo News (2/15/2014) about the investment broker 'bilking" people out of over 7.1 Million dollars. 5 were took for $5,600,000.

What really blew me away was the belief that a number of these investors were considered "sophisticated" investors.......

I read he was offering "quick turn - around" and profits anywhere from 4x to 15 x the original investment, w/o much risk

So...here is my basic question to you. How can someone who knows how to accumulate enough of the type money they gave this guy, also be foolish enough not to "smell trouble" when promised amazing returns, absent the type risk one would associate with those type returns ?

Returns like that do exist.....at the casino...the racetrack...high stakes private poker...

Do you actually find people that lost  in your investment work ?

It amazes me....

From Ed out in Amherst NY

Response:

Great question Ed.

I think it comes down to a combination of three things:

1.  People's lack an of understanding of capital markets: how they work, their history, characteristics, and risks. In addition they don't know the first thing about the tenets of Modern Portfolio Theory, Efficient Market Theory and Behavioral Finance. There are libraries of materials, studies, and research devoted to these topics.

Yet:

2. We have a culture: movies, books, TV shows, that ignore the evidence, and science, and propagate the idea that if you are sharp enough, or hire the right person, you can beat the market or gain large returns with little risk. That is not even close to the findings of academic research and /or financial history. People have no idea that the theories and rules mentioned in item 1 above exist. All they see are the few stories (fiction and non-fiction) of those who made easy money in the market by picking the right stock or investment.

Then there is:

3. Greed: We know from MRI studies of the human brain, that the brain on cocaine looks just like the brain of a gambler. Emotion trumps rationality. The smart person falls for the promises of the  silver tongued salesman.

So, simply, many people (many of them very smart) believe that excess returns can be gained in the market by outsmarting the market. Very few learn, or can conceptualize, that beating the market is a near impossible task.

They are hard wired to chase possibilities (emotional brain) not probabilities (rational brain). 

They forget this maxim from the great economist, John Maynard Keynes: 

"Its better to be approximately right than precisely wrong"

An earlier blog post of mine emphasizes the point on how hard it is to beat the market:

Next time you think you, your mutual fund, your broker, your stock picking software can beat the market; scan the graphic below and read this short excerpt from Business Week July 16-21, 2013, "The Hedge Fund Myth"

"Hedge funds are built on the idea that a smarter guy (and they are almost all guys; only 16.8 percent of managers are women) with a better computer can make miracles possible by uncovering inefficiencies in the market or predicting the future. In pure dollar terms, there are more resources, advanced degrees, and computing firepower devoted to chasing this elusive goal than almost any other endeavor, and that may include fighting wars. Yet traders face the immutable fact that every second, each megabyte of information, blog post, one-line rumor, revenue estimate, or new product order from China has already been taken into account by the efficient market and reflected in a security’s price. This means that trying to gain what traders call an “edge,” at least legitimately, is almost impossible. As the financial incentives on Wall Street have become enormous, so have the competition and pressure to gain an advantage at any cost."

Full Article: http://www.businessweek.com/articles/2013-07-11/why-hedge-funds-glory-days-may-be-gone-for-good#p2

Posted by AWM BLOG