May 1, 2012
Academics Question Stock Investing
The Standard & Poor’s 500 index has soared 27 percent since October! These times of strong market gains are the brass ring for a large swath of well-educated, well-off Americans.
But recent academic research on three topics – value investing, the record of individual investors, and the usefulness of investment advisers – raises serious questions about buying individual stocks or actively invested stock funds.
The upshot of this research, it seems, was neatly summed up by Nobel Prize-winning economist Daniel Kahneman’s bestseller, “Thinking, Fast and Slow:” stock picking “is more like rolling the dice than like playing poker.”
The papers are complex (though not difficult to read), so here are synopses and links to them:
- A paper by four finance professors at Goethe Universität in Frankfurt is brutal to individual investors, who “exhibit negative skill.” Analyzing nearly 9,000 online brokerage accounts in Germany, they concluded that most investors don’t outperform the stock market – “and if they do it is mere luck.” Enough said.
- Wisely, you may think, nearly three out of four investors consult an investment adviser. It’s well-known that advisers who earn commissions based on what they sell face a clear conflict. The issue is: how do they handle it?
Harvard professor Sendhil Mullainathan, special adviser to the federal Consumer Financial Protection Bureau, sent research “auditors” into the field to impersonate prospective customers and evaluate the investment advice they received. Mullainathan and his co-authors concluded that such advice “is not in the best interest of the clients.” Further, an adviser sometimes “pushes clients towards funds with higher expected fees with little change in portfolio diversification.”
- “Value investors” are the “grown-ups,” buying stocks “for less than they are worth” and unswayed by irrationality. But is that enough?
Aswath Damodaran’s paper analyzes value investing – passive, contrarian, and active – an area of expertise for which the New York University professor is a minor celebrity. He doesn’t say it’s a failed strategy, but he does warn that success, for the contrarians, “may prove illusive.” And he makes clear that “beating the market is always difficult to do, even for a good value investor.” Here’s the rub: the paper is written for investment managers.
Note, however, that the paper is probably a value investors’ dream reading material. It is replete with history, interesting observations about Warren Buffett, nifty charts, and qualifiers.
Amid this tepid, even damning, research, Squared Away invites readers to explain why the investing craze never dies. Do readers go for active investing or for passive mutual funds – and why?