Snake Oil Salesmen

In the last few days, mid and small cap stocks have virtually been on fire based on hope of a dramatically changed India. Stocks which were seen as having no future are going up as if its been virtually assured of a place in the heavens. Infra and Real Estate stocks which had been beaten down pretty badly are now up and running with a speed that maybe even Ussain Bolt cannot match.

Its one thing to expect companies that are performing good but have been bogged down due to overall slowdown in economy and credit crunch to try and reclaim their previous peaks and quite another to see companies, many of which are under Credit Restructuring mode to double or more. But then again, a rising tide lifts all boats. As Warren Buffet wonderfully put it and I quote

“A rising tide lifts all boats. It’s not until the tide goes out that you realize who’s swimming naked.”

The tide is rising and its carrying both good stocks and bad (bad doing in may ways much better than good stocks). While this would be a ideal time to unload from the portfolio the bad stocks, what usually happens is that good stocks are sold to buy bad stocks since good stocks do not move as much as bad and why have a portfolio that doesn’t move in such markets providing the right excuse to do the worst possible thing.

This also seems to be the time for both Paid and Free advisers to cherry pick their winners. After all, if one had recommended a well diversified set of stocks, it would be difficult to not have recommended some stock that has emerged a winner in recent times. Since I myself do not subscribe to any such services, I am in the dark as to whether they in addition to recommending a stock also recommend the portfolio weight or is it left to the discretion of the client concerned.

But unless the portfolio size is small (10 – 12 stocks?), its difficult to actually reap the rewards of picking a few winners since with a large portfolio (equally weighted), one’s investment is too small that returns, no matter how wonderful they are on the percentage scale, pale when calculated for the total portfolio.

In fact good friend Kiran tweeted as much today where he said (Link)

A company I know sells multiple newsletters with total portfolio size of nearly 100 stocks (max). Since the subscription is not expensive, I do believe that the number of subscriptions will be big. What I wonder though is, with such a large portfolio, how much can a investor hope to beat the market returns since the law of large numbers applies here as well as it applies elsewhere. While the risk of a strong hit to the portfolio due to one or two dud stocks is reduced to a very large extent, if a stock doubles in price, the swing it makes for the total portfolio is still just 1% which is negligible to say the least.

The biggest issue in my opinion with many of these stock advisors is the fact that their portfolio’s are high beta and strongly correlated to market. During good times, the returns are strong to make one not worry about the risk being taken, but as and when the tide turns around, easy to lose much more than what a simple index ETF would lose in the same period.

To me, stock markets are the only field (other than maybe Sports) where you really do not have to sell anything to make a living out of it. Using one skills is all that is required. Yet, this is a field that is filled with snake oil salesmen who clamor to help you in your goal to riches.

With there being no requirement of track record, no public audit of returns and very little interference from authorities, this is one field that seems immune to bear markets or bull. Claims of clients made X amount money after attending my 2 hour seminar / buying my newsletter is becoming common. I really wonder why the same guys need to sell their wares (products, what ever it may be), if making money was so easy. After all, all you need to do is press F1 (Buy) and sit while profits stream to your account. Why spent time writing mails on the great achievement their clients made and indirectly calling for newbies to come, learn and make big money.

The reason unfortunately is pretty simple. Very few actually make reasonable (in percentage terms) money trading the markets. Markets is a very harsh area where evidences seem to point out that survivor ratio (especially among the trading community) is less than 5%. Since traders / investors who lose money never fault themselves, they are easy feed for those who promise them untold riches only to be duped again and again.

Like any other professional activity, becoming a successful trader / investor requires one to be dedicate time and energy to the goal. Malcom Gladwell in his famous book Outliers talks about the fact that on an average, it takes about 10,000 hours of dedicated practise if one really wants to be successful. I wonder how many put in even 1000 hours before they decide that short cuts are the way to go (and 1000 hours of staring at the screen doesn’t count 🙂 )

I for one continue to believe that the best way to take advantage of the market for the vast majority of the population is via ETF’s and low cost mutual funds. No newsletter or tip giver will ever beat them on the long run (if they exist till then being the million dollar question).

And before I conclude, the following quote by Fred Schwed Jr in his Classic book “Where Are the Customers’ Yachts?”

“Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little.”