Even the Pros Get It Wrong

In the past few years, financial experts have made lofty proclamations about everything from the imminent collapse of the Eurozone economy to an impending free-fall in the U.S. stock market. The good news is that these predictions simply didn’t pan out. The bad news is that these so-called financial experts have shrugged off their wrongheaded warnings and moved on to weighing in on today’s issues in the financial world.

The fact is, even high-paid Wall Street veterans can’t predict with any certainty which way the financial markets are headed. Consider that last year, highly touted hedge fund manager John Paulson last year predicted an economic collapse in Europe. The collapse never happened: Eurozone officials—including the European Central Bank—were proactive in dealing with the region’s debt issues. Meanwhile, Morgan Stanley predicted the S&P 500 would tumble in 2012. Instead of tumbling, the index flourished: By the end of the year, it had gained 16%.

These Wall Street pros all share a common goal: to beat the market. As a result, they routinely make moves to exploit perceived weaknesses in the market or to take early advantage of what they believe are opportunities in the market. Unfortunately, these moves don’t always pan out. In fact, this chart clearly shows that most actively managed equity funds failed to beat their benchmark indexes over the five years through 2011.

So if the investing pros continue to get it wrong, why do individual investors think they can do any better? After all, the average investor doesn’t have teams of analysts and reams of proprietary research and investment models to guide their decision-making. (And even these resources offer no guarantee that they’ll help beat the market.) Yet individual investors continue to follow the lead of those Wall Street pros who aim to outsmart the market. And unfortunately, they often end up with sub-par long-term returns.

Fortunately, there’s a different approach that doesn’t require investors to scour the Wall Street Journal or obsessively watch cable news for the next can’t-miss investment: A passive investment strategy, which primarily aims to keep pace with the broad investment markets. When the markets do well, you’ll enjoy the gains. And when the markets tumble, a passive approach will make sure you don’t fall farther than, say, the S&P 500. And compared to an active investment strategy, a passive approach will cost less for such things as trading fees, investment management fees for funds and other expenses. The result: More of your assets are protected.

Finally, you may want to re-consider how closely you listen to the so-called Wall Street experts. Whether it’s the talking heads on CNBC, the soothsayers in the Wall Street Journal or Barron’s, or the stock market whiz you meet at a cocktail party, your best investment move just may be to tune out the bulk of what these folks say. It’s not that they’re guaranteed to be wrong. Instead, it’s the risk that they’ll be right just once—enough to make you believe that it’s possible to consistently stay one step ahead of the financial markets.

In his most recent annual report to Berkshire Hathaway shareholders, Warren Buffett noted that the stock market is incredibly resilient, and that the Dow Jones Industrial Average has moved ever higher despite wars, recessions and even the Great Depression. “Since the basic game is so favorable,” he writes, “Charlie [Munger, Berkshire’s vice chairman] and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of ‘experts,’ or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.”

Amen to that.

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