Why Smart People Can Be Poor Investors: Financial Advisors' Daily Digest

Summary

• David Merkel, CFA, looks at a 50-year-old case study in disastrous investing.
• Separately, Merkel hits his 20% cash ceiling, and knows not where to redeploy the proceeds from his stock sales.
• Ian Bezek suggests that emerging markets are among the best opportunities left in a pricey environment.

Numerous investors in our forum have questioned the wisdom of hiring an advisor. Commenting on last Friday's post, for example, User 28678235 writes:

I would say that by the time you know enough to distinguish a good advisor from a bad one, you probably know enough to manage your own money."

We've had this discussion before in a post one month ago called "DIY Investors Who Should Drop All Pretenses and Hire an Advisor," in which I referred to the selfsame User 28678235 - but the topic is worth reviewing because of what I think may be a common misjudgment.

The assumption made is that investing is primarily an analytical activity. Therefore, if someone is smart enough, he doesn't need an advisor's help. As noted in the above-linked article, in my long experience in this business, I have seen numerous times that it is often the very smartest people who make the worst investors. They know that comparing P/B ratios (or whatever) is kindergarten compared to their accomplishments in, say, medical school. But human nature being what it is, they are utterly blind to the underlying and deep-seated emotions driving their investing, often enough, over the cliff.

For an insightful and close-up observation of investor self-destruction in action, take a look at David Merkel, CFA's fascinating review of a little known, 50-year-old book he saw referenced in another SA article. Called "Wiped Out: How I Lost a Fortune in the Stock Market While the Averages Were Making New Highs," the author wrote his embarrassing self-revelatory account in hopes of making up his huge market losses. As Merkel tells it, the author gave his nest egg to a broker who actually earned very nice returns (in a rising market) on the portfolio:

Rather than be grateful, the author got greedy. Spurred by success, he became somewhat compulsive, and began reading everything he could on investing…he could never be satisfied. Instead of being happy with a long-run impossible goal of 15%/year (double your money every five years), he wanted to double his money every 2-3 years. (26-41%/year)."

That led him to shoot for home runs, increasing his risks and thus generating losses that were all but impossible to make up.

Not every investor exhibits greed of this kind. Some have the opposite a problem -- an exaggerated fear that prevents them from earning any kind of return on their money. The key point is that all investors risk being blindsided by the one thing that is hardest to analyze, comprehend and control -- their own behavioral biases and impediments to success. Having a "designated driver" to take the investment wheel can prevent a calamitous crash; and while you're paying the fees, you might as well pick the advisor's brain on the host of consequential financial questions you face.

Your thoughts, as always, are welcome in our comments section. And below please find today's advisor-related links:

• Kevin Wilson: U.S. GDP/capital growth rate below its 65-year trend line for first time since 1939.
• Indeed, for the first time ever, David Merkel, CFA, hits his 20% cash ceiling, and knows not where to redeploy the proceeds from his stock sales.
• Says Ian Bezek: In an expensive world, emerging markets are among the best opportunities left.
• John Lohr: At the end of the day, the new fiduciary rule won't change advisors' business that much.
• Russ Thornton explains the interaction of Medicare, Medicaid, LTC coverage and your IRA.
• John P. Reese: Tips for digesting financial information.
• Kurt Dew: Congress is considering a bill that would shield execs from liability for actions leading to banks' bankruptcy.
• Marc Gerstein: "Excellence" is an illusion - buying cheap is for real.
• Book review: "Phishing for Phools: The Economics of Manipulation and Deception," by George A. Akerlof and Robert J. Shiller.