How to Avoid Getting Swindled by Biased Investment Advice

Advertisement

Wouldn’t it be peachy if we lived in a world where all the investment advice you received came from totally objective and rational sources that had only your interest at heart? Yeah, it would be just loverly. But it ain’t gonna happen, my friend!

Fortunately, you don’t have to throw up your hands, dismissing everything you hear and read as “lies, lies, lies.” Let’s find out how you can recognize biased investment advice, protect yourself from it — and perhaps even profit from it.

Investment Advice to Beware 1: The Sales Motive

We might as well begin at the unsavory bottom. People who work in the financial field often feel a powerful tug to tell you a slanted story: They’ve got an investment to sell. Stockbrokers, of course, are the poster kids for this kind of behavior, along with some insurance agents, realtors and coin dealers.

I’m not implying everybody in these businesses is crooked — far from it. In fact, I sent a gift card to my crackerjack insurance lady, who saved me more than $5,000 on my 2011 health coverage.

However, it’s essential to remember that salespeople wrestle with an inherent conflict of interest. To earn their bread, they have to move product. And the stuff they move may, or may not, be what’s best for you.

Whenever a salesperson pitches you on an investment, ask yourself: What costs are built into this thing? Could I buy an equivalent product elsewhere with a smaller sales charge, or with lower ongoing expenses?

I’m especially wary of mutual funds that impose a “load” (sales charge). Loads can put a serious dent in your profits if you decide to exit the investment within the first few years. Say, for example, you buy a fund with a standard 4.5% up-front charge. The fund’s net asset value grows 7% annually for the next two years.

When you redeem, you net a 9.3% return on your money, versus 14.5% for a no-load fund with the same portfolio performance. On a sizable investment, that difference can really bite.

Investment Advice to Beware: Velvet Persuasion

Not all sales pitches come roaring in at 90 miles an hour. There’s also the velvety “free” advice that investment firms hand out to the public. My email box is cluttered, as I’m sure yours is too, with financial advertising disguised as research. Fund families offer to share their latest market insights with you in supposedly exclusive conference calls. Financial planners invite you to bring your portfolio in for a complimentary analysis.

Of course, the intent is always to get you to buy something — a product or service the adviser just happens to peddle. Did you ever read a “white paper” on emerging markets by a fund manager who thought it was a bad idea to invest in emerging markets? Did the financial planner ever conclude you didn’t need any planning?

The same subtle bias, by the way, still percolates through much of the stock research issued by major brokerage firms. True, the outrageous excesses of a decade ago are gone. We don’t have Henry Blodget at Merrill Lynch touting stocks in print that he trashes in private. (Instead, Blodget co-hosts a harmless, perennially bearish video interview site at Yahoo Finance.)

Even so, Wall Street analysts continue to be extremely shy with sell advice. Sells account for only about 5% of brokers’ ratings — a number that has barely increased in the past 10 years, despite regulatory censures and mammoth fines. Clearly, analysts are still afraid of angering their firm’s investment-banking clients.

One limited consolation: Buy ratings have shriveled to less than 30% of the total, from more than 70% in 2000. So a Wall Street buy signal means considerably more than it used to. But don’t expect them to tell you when to bail out. It’s not in the Street’s DNA.

Investment Advice to Beware: No Sales Pitch, But Still Deadly

Sometimes, outlets that may not appear to have any direct sales motive can deliver tilted advice. This type of bias is often hard to detect, unless you train yourself to be alert for it. Yet it can be fatal to your wealth. Here are three carriers of the virus to handle with particular care:

1. The Electronic Media: With the advent first of cable news and now the Internet in its myriad manifestations, it’s easier than ever for shrewd operators to stampede public opinion. Beware TV shows like CNBC’s “Fast Money” and “Mad Money,” which focus almost exclusively on fleeting short-term trends. Ditto for the avalanche of email communiqués that try to rush you into action, with titles like “Pocket $1,000 by Monday” or “Kick Up Your Profits Eight Times in One Quick Move.” For most investors, the way to make serious money is by riding long-term tidal movements, not by playing this morning’s market squiggles.

2. Government: Yes indeedy, your own government is a generous source of slanted investment advice, starting with the self-serving, everything-is-OK pronouncements of Treasury and central bank officials. Federal Reserve Chairman Ben Bernanke seems determined to go down as one of the worst offenders ever in this department. In July 2008, just two months before Fannie Mae and Freddie Mac collapsed, Dr. B told Congress the twins were “adequately capitalized” and “in no danger of failing.” In October 2005, as housing was teetering on the brink, Bernanke proclaimed, “There is no housing bubble to burst.”

Bernanke has admitted that one goal of his “quantitative easing” program was to push up the stock market. Beware! The prices on your screen include a sizable element of Fed fluff.

3. Bloviating Billionaires: Before the Sokol scandal blew up, cyberspace was crackling over Warren Buffett’s negative comments about bonds. Sure, we all know Buffett is a genius at investing in stocks. But has anybody bothered to ask why that talent necessarily makes him an expert on bonds?

Fact is, Buffett has never liked bonds (even though government bonds have logged almost the same return as stocks for the past 30 years). Billionaires don’t need bonds. Even if Buffett’s stocks dropped 99%, he would still be rich beyond the dreams of avarice. Not so most of us. For ordinary mortals, bonds play an important role in generating income and stabilizing our portfolios. Don’t let a billionaire’s prejudice blind you to the importance of a balanced investment strategy.

Investment Advice to Beware: It’s All in Your Head

A final species of investment advice bias may seem perfectly innocent. However, it can also hinder your returns if you’re not careful. I’m talking about your own psychological bias.

We all carry around preferences and preconceptions in our heads, built on years of experience (as well as a fair amount of genetic hard wiring). I have these biases, and so do you.

When it comes to investing, I’m a skeptic. Because I tend to doubt glowing promises and rosy scenarios, I lean toward assets that produce an immediate income. The same “not so fast, buddy” attitude has helped shape my contrarian viewpoint, too. For me, it’s second nature to gravitate toward investments the crowd may be overlooking.

These habits of mind have served me well as an investor. However, I realize there are many paths up Mt. Fuji, all of them rugged, and this isn’t the only one that leads to the top. So I encourage my Profitable Investing subscribers to tailor my advice to their own taste. You may find that in some areas of your portfolio, you want to be more aggressive — or possibly, even more conservative — than I am. That’s fine by me.

Just make sure you understand your own biases, as I’ve tried to spell out mine here in black and white. If you think of yourself as “more of a growth investor” than fusty old Richard Band, can you live with the sharper fluctuations in your wealth that such a strategy entails?

Many people say they can — until October 2008 rolls around, and the markets seem to be plummeting into a black hole. In the end, you’ve got to know yourself, truly and honestly. Only then can you cope with the sometimes crazy and even destructive biases of the financial noisemakers around you.


Article printed from InvestorPlace Media, https://investorplace.com/2011/07/how-to-avoid-getting-swindled-by-biased-investment-advice/.

©2024 InvestorPlace Media, LLC