Each year around this time, the headlines blare about what you should do with your cash. Click around any of the usual financial media sites, and you will find all manner of experts detailing the “must own” stocks you should be buying right now if you want big returns in the year ahead.
In the year ended June 30, 85 percent of large-cap stock funds, 88 percent of mid-cap funds and 89 percent of small-cap funds failed to match the major stock indexes they track: S&P 500 Index, the S&P Midcap 400 Index and the S&P Smallcap 600 Index. The numbers for five and 10 years were slightly worse.
Mutual funds with an international tilt fared somewhat better. Over the past year, 75 percent of global funds, 55 percent of international funds and 42 percent of emerging market funds failed to match indexes. Over 10 years roughly 80 percent of the funds trailed indexes.
I looked at three ways that investors might try to forecast current-year earnings: 1) Use analysts’ estimates; 2) Assume results will approximate last year’s earnings, and 3) Calculate an average of the last several years’ worth of earnings.
Over all, the study found that most Americans have “relatively low levels of financial literacy.” It included the results of a six-question quiz on fundamental financial issues that may be taken online. The questions were intended to be very basic and thus easy. Yet the average person got only about half the answers right.
An alarming aspect of the study is that although most people knew very little, they felt great about what they knew — or thought they knew. “Americans tend to have positively biased self-perceptions of their financial knowledge,” the study said. And the positive bias has been increasing.
Money managers, at least, are paid to make investment bets. But why do amateurs believe they can outperform the professionals — or even identify those pros who will outperform? (Performance of individual mutual funds cannot be predicted with any greater degree of accuracy than individual stocks or bonds.) Many biases and cognitive errors contribute to this costly behavior, but a few deserve mention.
In interpreting the week’s news, it’s also worth remembering that a few days or even a month of stock returns will not tell us much about where the market will be a year or more from now. In fact, although everyone would like to know where the current gyrations will take us, the unpleasant truth is that there is simply no reliable way to foretell the short-term path of the market.
You might not know that from the forecasts of major Wall Street investment houses. The start of a new year is the season for prognostication, and many analysts have issued very specific predictions. The consensus on Wall Street is that the S.&P. 500 will rise 7 percent for all of 2016.
Every few quarters, we find ourselves running through the same muster drill. Something happens somewhere in the world, the markets go a little nutso, and they sell off a dozen percent or so of their value. The usual suspects panic. Eventually things stabilize. And everyone wonders what the hell just happened. Post-mortem explanations come along that seem reasonable (after the fact, of course, never before).