Bad Advice Detection
Following the Main Money Media will typically leave you more confused than enlightened. Responding to the amped-up assertions of most weekend or late night money show hosts can be downright dangerous. Add the sheer volume of financial information available today and distinguishing valuable investing information from all the bad advice bandied about can be overwhelming.
1. Run a Simple Safety Test
The most common investment promise is high return with little or no risk. One of the primary rules of selling says (and a recent article in Inc. magazine include this phrase in its title); “give customers exactly what they want.”
Ask any random person what they want from their investments, and inevitably the top two answers will be “high returns” and “low (or no) risk.” I cannot count the times I have been asked, “What’s the best investment if I don’t want to lose any of my principal?”
The right answer is a bit complex, as it depends on liquidity needs. However, the short answer is, “practically nothing.” Here’s what I mean:
On July 22, 2014 a 10-year U.S. Treasury Inflation Protected Security (TIPs) was offered with an annualized yield to maturity of 0.25% (plus inflation). This means that after accounting for the decreased value of your money from inflation, you make a very safe (but illiquid) 0.25% per year. Invest your $1 million nest egg for absolute safety and you’ll make a whopping $2,500 per year (you can’t even buy groceries for year with that).
Here is where we set the safety test bar: 0.25% annually plus inflation. To illustrate: A 5-year bank certificate of deposit (CD) currently yields about 2%. Subtract inflation and you will probably end up netting nothing on this very safe investment.
So, any investment being offered with a return of greater than 2.25% must have risk. The market is too big and efficient to allow, what amounts to, free money to lay around for more than a few seconds. If there really were totally safe investments yielding 12%, 8%, or even 4%, you can be sure Goldman Sachs or JP Morgan Chase would have sniffed them out before you ever had a chance.
This simple fact can save your future: The higher the promised return, the greater the potential risk, period.
2. Consider the Source
Whether a piece resembles a television infomercial or an academic treatise, first discover who is behind the work. With today’s search engines, it’s usually easy to find out more. In fact, if it is hard, that’s a red flag in itself. Google the author’s name and see what else comes up.
- What are his/her credentials? Does she have a consistent, credible, seasoned platform from which to be a voice of authority on the subject?
- What are his/her motives? Is the information purely academic, a thinly veiled sales pitch, or somewhere in between?
- Has the work been rigorously peer reviewed? No matter how convincing an assertion may seem, if it has not withstood the gamut of respected, peer-reviewed scrutiny, it’s best to take it for what it is: one person’s potentially fallible opinions.
3. Consider Whether It’s Information or Knowledge
Let’s say the information and its sources pass the safety screen and credibility hurdle. An equally important question is: Can you benefit from it? To quote financial author and CBS MoneyWatch columnist Larry Swedroe: “When it comes to investing, there’s a major difference between information and knowledge. Information is a fact, data, or an opinion held by someone. On the other hand, knowledge is information of value.” [Source]
Given the never-ending deluge of financial news, this is no small question. Pick any day, throw a dart at its current events, and you will hit information that seems important to the market. Sometimes it tempts you to jump on a fast-moving band wagon, lest you miss out on promising profits. Other times, a gloomy outlook may frighten you into losing your resolve. Either way, the implication is that you can improve on your outcomes by taking advantage of the information.
There are several problems with this logic.
- By the time you’re aware of good or bad news, the rest of the market knows it too, and already has incorporated it into existing prices.
- It’s unexpected news that alters future pricing, and by definition, the unexpected is impossible to predict.
- Any trades, whether they work or not, cost real money.
Rather than try to play an expensive game over which you have little control, a better way to position your life savings is according to market factors that you can expect to control, such as:
- Minimizing costs
- Forming an investment plan to guide your way – and sticking with that plan
- Capturing returns available by participating in expected long-term market growth
- Maintaining diversified holdings to dampen market risks
When you read dire predictions of impending doom (i.e., market risk), you can rely on planning and diversification to carry you through that risk. Likewise, when you read forecasts about happy days ahead, you can feel confident that your portfolio already is positioned to cost-effectively capture a portion of those gains commensurate with your goals.
Applying these handy guidelines to the financial information you receive can save both your money and sanity. Eventually it might also save you some precious time, as you learn to stop listening and reading most of the drivel that passes for money news and advice.