Lately, I’ve been pouring through some of the latest academic studies, and just shaking my head. Now, if you know me, you know that I am all about academic research, but academic doesn’t necessarily mean good.
Gene Fama, who won the Nobel in 2013 for Economics and Investing, talked a lot about how tough it is to get valid research. He told a story of how he went to a foreign country to get away and focus, and he was just holed up doing research and writing papers. Fama came back and brought his work to Merton Miller—another Nobel Prize winning economist—and as Fama said, “Merton Miller just looks at my paper and he’s going, okay, that one’s good, that one’s good, that one’s junk, that one’s junk, that one’s junk, that one’s pretty good right there. That one’s junk.”
Fama says that valid research is rigorous. Good academic researchers want somebody to look at their work and say, “Is this any good? Does it hold water? Is it worth pursuing?” Because if the work doesn’t have any validity to it, you want to know so that you can just abandon the idea and walk away from it. Otherwise, you get people that will actually invest based on ideas that haven’t been proven.
The Factors of Investing—Are They Data Mining?
For example, there are something like 400 factors of investing. Factors are what academics call the different variables that affect investment returns. Mutual fund companies will use all of these to market their funds. There are only six factors, however, that have been proven to work. The rest of them are just a bunch of data mining. What happens is, somebody looks for a factor that would have worked in the past over a specific period of time, and then they go and put a mutual fund out based on the idea.
An example of this is the idea that people spend more money at various ages. You know, when you’re in your 20s you might buy your first house, so you spend a lot of money, and then later you are earning more, so you spend more there, etc. But researchers found that you spend the most money between the ages of 43 and 46, and they said, “Hey look we can figure out when people were born, and then we can look for birthing peaks, and then we can add 43 to 46 years to that, and then we can tell at what points in the future people are going to spend the most money.”
The researchers say, “The boys came back from World War II and we had a birthing peak in 1946. Then after the Korean War there was another one. Let’s add 43 to 46 years to that.” They took this data and created a new chart, and voila! The data matches up with the S&P 500. And then the researches said, “I’ve figured out what drives the stock market!” And, of course, investment advisors jump on the bandwagon wagon, and they are making money selling their seminar program. This kind of thing is happening all the time, and the advisors don’t know any better.
My Turning Point
I used to be a broker, and I came to a turning point when I started digging into the academics and realizing how the products these companies push are really not good for people. Selling annuities—I realized that was most often horrible for people. I was selling life insurance as an investment vehicle. I couldn’t justify it. And I couldn’t justify the mutual funds or the investment products that they pushed at the broker-dealer meetings, or things like Limited Partnerships and private equity funds—all horrible investments.
Unit investment trusts were also big back in those days. It looks like a mutual fund—talks like one, walks like one—but it expires. And then as a broker you can sell it again and make another commission each time it expires.
One of the main things I did as a broker was sell a bunch of bonds. You would buy the bond from the inventory, mark it up, and sell it to the investor. That’s how you made money. So I’d have people who would come in on a regular basis, every time their bonds would mature, and they would go, “I’m wanting a new bond.” And I would just sell it to them because they wanted it, whether it was in their best interest or not.
At this time, I had all of the securities licenses, Series 6—it was the first one I passed—Series 7 was the next one, then Series 63. I had all the licenses to sell, and believe it or not, I even had a financial planning degree, but I didn’t really understand how these things work. That’s why I always tell people that you can’t stop with financial planning degrees.
The Starting Point for Financial Education
Most people in the investing industry don’t even have financial degrees. They’re not even chartered financial consultant professionals or certified financial planning professionals. I tell people that it’s kind of like when you get a black belt in karate, and they tell you, “Congratulations! You’ve just begun. Now your education really starts.” It’s the same thing in the investing industry. When you finally get your financial planning degree, now you’ve got a cursory understanding of taxation. You’ve got a cursory understanding of investments, social security, risk management, estate planning, and all the areas of financial planning. Building on your education starts from that point on, but I always tell people how that’s step one.
So I was selling bonds, but I didn’t understand how economic activity—interest rates, currency swings, etc.—could affect their value or default risk. I had all the licenses and some degrees to sell this stuff, but not necessarily the knowledge of how it all worked together.
Once I started understanding these things, I started telling my regular bond clients, “I cannot, and will not, do this anymore. I’m dropping my licenses.”
It’s kind of funny because I’ve had competitors on the station say, “Oh, you know what, the reason Paul Winkler doesn’t like annuities is because he can’t sell them.” No, Paul Winkler has every ability to go back and quickly grab an insurance license. I wouldn’t even have to study to go get it again. It has nothing to do with that. I dropped the license because I didn’t want to sell that stuff anymore.
The Story of Carlos
During that time, Carlos, one of my regulars, came in, and I told him I wasn’t selling those bonds anymore. So I gave him some other recommendations, and he said to me, “Yeah, I know, I just really want to buy bonds. Can’t you refer me to anybody?”
I said, “I can refer you to 100 people that’ll sell you bonds and junk like that.”
“Well, just do that, I just want to do that,” he said.
So I pointed him to an investment advisor in town that did that kind of stuff, and Carlos went and started working with that person. But then Carlos married a woman who just happened to be a client of mine. Years went by and they never mixed their money, so she didn’t know what he had. He ended up passing away, and she brought in his portfolio for me to look at.
The bonds had gone from hundreds of thousands of dollars to basically zero. I just shook my head. That was why I was trying to warn him, but the industry is so bent on selling things. And it can be hard to get out. It was because of all the academic research I studied, which made so much sense to me, that I couldn’t do what I used to do anymore.
There’s a lot of different research out there saying conflicting things. It can be hard for an investor to know who to believe, until you realize that there’s Nobel Prize-winning research that’s been empirically tested and verified. While the actual research is complex, understanding the basic implications is quite easy. That’s what we do here at Paul Winkler.
This post is a transcribed and edited excerpt from The Investor Coach Show with Paul Winkler. Subscribe on Apple Podcasts here to get regular episodes.
Written by Paul Winkler
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