The Best Argument Against Stock Picking Experts

by Jason Unger

You know that there’s no such thing as a stock picking expert and that most actively managed mutual funds can’t even beat their indexes.

So if you’re being sold on investing with a broker or in a “proven” mutual fund, there’s a legitimate question you have to ask yourself: why?

Obviously, the salesman is trying to make money off of your investments. But think about that for a second. If he’s selling you on his expertise or how well his fund has performed, why does he need you to pay him for that?

In his book, The Dirty, Filthy Lies My Broker Taught Me and 101 Truths About Money & Investing, abundance coach Mark Matson lays it out perfectly:

If They Knew What Was Going to Happen Next, They Wouldn’t Need Your Money

Some fund or stock is always making double or even triple digit returns. If brokerage firms had any real knowledge of which stocks were going to take off, they wouldn’t need to invest your money. They would invest their own and keep all the profits for themselves.

‘Nuff said.

(photo: rednuht)

{ 6 comments… read them below or add one }

Aaron @ Clarifinancial January 6, 2010 at 10:03 am

Jason, great site. And I like the way you have powerful, digestible bits that promote thought instead of going on about everything. However, I have to disagree with you about investment brokers.

First of all, just because the average actively managed fund doesn’t beat its index doesn’t mean there are some that don’t do so consistently. Almost by the definition of “average”, a lot of these are going to be dogs. You can’t judge an entire group by the average of that group.

Secondly, comparing an investment broker (most of them like to feel fancy by saying they are financial advisors) to an actively managed mutual fund is ridiculous. A mutual fund must maintain a certain investment style and stay consistent, or the fund manager can get fired because of “style shift”. Why? Because if all your funds chased gains instead of following their goal, you could no longer diversify among them confidently.

An investment broker, on the other hand, has to follow the wishes of their clients. They can, and sometimes they must, change styles as trends change. They follow an entirely different set of guidelines than a fund. See how they are different? One can’t change and the other almost has to change.

As for the argument about why you would need to pay for their expertise, this might apply to large companies, but not individual investment brokers. Let’s say they make $70,000 a year giving investment advice and they invest $20,000 of their own money each year. Along the way, they may have learned how to consistently make 15%. That is incredibly useful information to that broker’s clients – I want to know how to do that. Still, investing $20,000 a year at 15% would take a while to replace the $50,000 the broker is actually living on, not to mention adjustments for inflation. They might as well do something they are good at until then.

I’m not saying actively managed funds are good for anyone, or even worth the extra cost. In fact, I’m not giving investment advice at all. I am only saying you can’t dismiss an active investment style based on these two arguments. Thanks for a thoughtful topic.

Jason Unger January 6, 2010 at 11:03 am

Aaron – Thanks for the great comment. You bring up a good distinction between brokers and managers – a broker who simply buys the stocks you tell him to is simply doing what he’s told, whereas an advisor who tries to pick stocks based on his “expertise” is the guy hoodwinking you.

I understand your point about mutual fund managers needing to stick to certain allocations and diversification, but they are still attempting to pick the winners and, when appropriate, time the market with allocation adjustments.

The reminder here is that most stock picking experts are not in the business of giving investment advice — they’re in sales. And that means the customer’s interests are not always at the forefront.

Great discussion!

Robert J. Fischer January 6, 2010 at 11:15 am

Jason,

You are half right. The truth is that expertise is over rated and that people pay to much for it. This is because many financial sales people over sell their expertise. What financial salesmen are great at is asset allocation, explaining tax laws, and financial planning. What they suck at is predicting the future. In this way, they are like other professionals, doctors and lawyers for example, that may be experts in their area, but they still can’t predict how long a patient has to live or how a jury may rule. What people need is a simple set of rules for managing their portfolios. If the financial advisor provides these and helps the client implement them, they will avoid the disastrous results that occur when they listen to the news and let their emotions drive their investments. That type of financial advisor is well worth paying for. One who predicts what stocks will do best, will frequently be wrong.

In essence, its like Texas Holdem. An expert poker player can tell you what hands you should play pre flop. He can’t tell you if you will win the hand, but he gets the odds in your favor. Great financial advisors do the same thing. Mediocre ones try to make predictions.

Aaron @ Clarifinancial January 6, 2010 at 11:16 am

Expertise is definitely worth paying for sometimes. But I absolutely agree with you – be fearful of people who give advice and only make money if you follow it. Seriously.

Even though we disagree some, it sounds like we’re on the same page. Here’s a true story from the life insurance field: http://www.clarifinancial.com/articles/why-anonymous-competition-works-for-life-quotes

Jason Unger January 6, 2010 at 11:29 am

@Robert – completely agree with you. A fee-only financial advisor who doesn’t get paid by selling stocks or mutual funds can definitely be worth the money.

I like the Texas Hold ‘Em analogy – just because all of the odds say one thing doesn’t mean that the result is a given.

@Aaron – what a story. I’m not at all surprised, unfortunately, and I’m sure things like that are happening almost every day.

Monty Loree January 16, 2010 at 3:26 pm

Hey Jason,
I used this post in my blog entry today… http://www.cma1.ca/146

My comment is this: I agree that nobody can predict the future. I trust that “stock pickers” are trained, and they’ve got expertise… It goes with this logic… who would you like doing heart surgery on you, a trained expert or some untrained individual off the street.

My feelings are.. do your due diligence and make sure the stock advisor is pretty well seasoned..

Leave a Comment

{ 1 trackback }

Previous post:

Next post: