Primitive Rituals
Every Friday, investors across this great land huddle together in the great electronic village to celebrate a sacred primitive ritual. Anthropologists and economists are divided as to the motivation for this tribal rite. Many simply credit ignorance and superstition. Some attribute the gathering to man's eternal search for a deeper meaning - to know the unknowable or divine the intent of the gods. Whatever the reason, the ritual has assumed importance to the participants and viewers far beyond any actual value.

The ceremony, almost as old as television itself, proceeds in strictly defined order. The high priest, resplendent in imported hand-tailored Italian robes, gives a short invocation. The invocation always ends with the introduction of a visiting priest who has journeyed from the village of lower Manhattan to pay his respects to the great one. The two then engage in a highly ritualized duet ending with the high priest clutching and choking the visitor while chanting "names, please" and "what do you like?" When the visitor has disgorged enough names he is temporarily released.

The high priest then turns his attention to a panel of elders and lesser priests. At least one lesser priest must always dress as a bull while another poses as a bear. Each makes appropriate noises for his role and offers his reading of the entrails. (Under an agreement with the Society for the Prevention of Cruelty to Animals, no animals are actually sacrificed on camera.) While the lesser priests never agree on the portents, they are not allowed to actually physically attack each other, this being considered bad form.

The remaining priests all fill familiar roles. One must mutter and fret about market volatility while another advises the faithful to buy where their wives shop. Yet another endlessly intones, "Don't fight the Fed, don't fight the tape." The high priest gives each his blessing equally, bestowing a knowing smirk upon every remark, no matter how inane.

The high priest maintains a private collection of pet elves, which on a weekly basis attempt to divine the will of the gods and share their rapturous insight through a "sentiment poll." The gods must be crazy, or at least fickle, because the result has become a contrarian's delight. So poorly have the elves interpreted the omens that several years ago the high priest had them all slaughtered in a fit of pique. He then replaced them with new and improved elves. Unfortunately, the new elves have become an even sorrier lot and must be severely concerned with their own fate.

Still smirking - after all, nobody is catching on, everybody is eating it up, and he is actually still getting paid for this nonsense - the high priest offers a final benediction. After the benediction, a very minor priestess magically appears, silent as Vanna White, and leads the group into a spotlight where they all pretend to chat as the light flickers and fades from the television. A soothing voice offers to send transcripts of the sermon to the faithful.

As the light dies across the global village, each member of the congregation finishes his communion martini and begins to meditate. Under the spell of this powerful, mind-altering drug, each becomes convinced that the gods have transmitted a unique and startling insight to him alone. Armed with this sacred "insiders" knowledge, the villager expects to trade invincibly on the following Monday, extracting economic rents from the heathens.

What's Going on Here?

We have seen the dismal results that American investors endure. While we know that the economic and human consequences are severe, we also know that reasonably simple tools and techniques are available to dramatically improve investors' returns over time. We know that the average investor is intelligent and successful in most other aspects of his personal and professional life. Though few investors are intent on self-destruction, they often behave as if they were. This is a very disturbing paradox. What in the world is going on here? Why haven't investors caught on? Why don't they get it?

If you have been wondering why the average investor hasn't got a clue as to how to meet his financial objectives, Wall Street Week may provide some interesting insight. Funded by Public Television (which should set higher standards!) and under the guise of sophisticated commentary, Wall Street Week is just about everything that can be wrong with the popular financial media.

The show is not only several magnitudes worse than a total waste of time, it is very dangerous to your financial health. The Surgeon General should require a label similar to the one on cigarette packages and advertising warning that "Exposure to this drivel has been shown to cause self-destructive behavior, loss of cognitive power, and serious depletion of financial resources."

Wall Street Week, and similar shows, begin with the assumption that "insiders" can explain and predict market behavior. Further, it assumes that these insiders would generously share their knowledge with a hundred million of their closest friends.

We know that everybody is entitled to his own prediction. Mine, yours, and your dog's all have an equal chance of coming true. But I am going to tell you a little secret. If I absolutely knew what the market was going to do next week, next month, or next year, I wouldn't share it with you. Instead, I would go out and mortgage my house to buy options and then sail away. You would never hear from me again. I wouldn't even finish this book. I'd be history!

It's nuts to believe that these guys have any idea what the market is going to do, and even more crazy to think that they would share it if they did. The show does give them a stage for shameless self-promotion, and a big ego boost. An appearance on Wall Street Week is the ultimate public relations coup for a fund manager.

The popularity of the show can certainly not be based on the accuracy of its predictions, which have been a dismal failure. There is really an undeniable entertainment value to schmoozing and kibitzing with movers and shakers. This is the Wall Street equivalent of Lifestyles of the Rich and Famous. The real problem is that people take it seriously. If you think that watching Wall Street Week is a shortcut to forming an investment philosophy or modeling an efficient portfolio, you are unlikely to be tempted to delve into a tedious and challenging study of finance.

The show dedicates itself to the highly questionable (even suspect) proposition that market timing and individual stock selection drive investment performance. Today, almost nobody on Wall Street with an IQ over room temperature really believes that, yet this proposition is still shamelessly peddled to anybody who is still buying.

In show business, of course, there is never a reason to abandon a proven formula. As long as ratings and market share stay up, you can count on next week's show looking remarkably like last week's. Notwithstanding its public funding and high-sounding purpose, PBS is just as interested in ratings as any other enterprise. Wall Street Week is a hit, so PBS isn't likely to screw it up with a dull and boring discussion about how markets work. Success in terms of ratings and market share are not related to the value or validity of the investment information and content.

So, Wall Street Week studiously avoids any discussion of the last forty years of academic research, pretends that markets are hopelessly inefficient, bans discussion of Modern Portfolio Theory and banishes heretics who promote buy and hold. Unfortunately, the popularity and longevity of the show give the impression that it must be doing something right. This success continuously validates a brain-dead investment philosophy. The net result is a Public Broadcasting (dis)Service.

Financial Pornography

If Wall Street Week were an isolated phenomena, no one need be concerned. America is, after all, notoriously tolerant of crackpots. But an examination of the rest of the popular financial media turns up little else of value, little intelligent life at all. In fact, most of what the popular financial media puts out could properly be called financial pornography! It's not only bad for your wealth, it has no redeeming social value.

We must be clear about what the media are up to. It would be a mistake to believe that they are on a collective mission to educate the American public. Rather, their mission is to sell papers, airtime, or magazines. Any educational value that might result is just a happy coincidence. Anyone who has ever watched television, listened to talk radio, or browsed the newsstand at the check-out counter might reasonably conclude that the media have a very low opinion of the American intellect.

Their general credo is that "No one ever went broke by underestimating the American public." Contrary to popular belief, Lowest Common Denominator is not a mathematical term, but a programming director's working philosophy - give 'em what they want, don't make them think, dumb it up as much as possible, and stick to winning formulas.

The media have another problem too: the relentless pressure to come up with new stories every day, every week, or every month. When I finish this book I can just stop writing, but such is not the case at Money Magazine. Next week they have a whole new magazine to fill. While there is a limited number of good ideas to explore, there is an unlimited demand to fill air time or column inches.

The media solve this problem by carefully selecting the themes they wish to cover. For instance, Modern Portfolio Theory (MPT) is considered too complicated for the great unwashed American public to follow. Not only is it sort of dull, it has a limited number of things that can be said about it and it lacks a human interest angle. All in all, it's not a subject likely to sell a lot of airtime. Worse yet for radio or television, it takes a little thought and can't be reduced to twenty-second sound bites. It shouldn't surprise you that the airwaves aren't full of stories about MPT.

On the other hand, because there is a new market closing every business day, there is an unlimited number of guys that would just love to go on television or radio to give their slant on why the market did what it did. These sources, often standing with the trading floor or even a ticker tape in the background to add color, spew catchy sound bites provided by their public relations departments. It doesn't matter whether the source is right or wrong, or even has a clue what's going on. It fills time and gives the impression of juicy tidbits and maybe even insider knowledge.

And not just any bland comment will do. Imagine if you will a source who made the following comment, "Who knows why the market went down today? Markets do that every once in a while. It's really not important to long-term investors. Investors should buy a properly balanced diversified portfolio and forget about it." How many times do you think that man will be invited back? Where is the excitement? Where is the pizzazz?

Every business day the government announces a few new economic numbers. Often these are just revisions of previously announced numbers. Each number, however, is treated gravely, as if the entire future of capitalism depended on it. Each demands minute analysis and generates the required sound bites by a highly-regarded (by whom?) source. Since no report can be considered complete without speculation, it would be unthinkable to simply report the number without an "expert" who could also provide the appropriate spin.

Hero worship is a favorite media subject. Interviewing a "successful" mutual-fund manager has all the ingredients the media loves: human interest, insider tidbits, deep insights, and pithy quotes. Unfortunately, we are going to need quite a number of heroes to fill all that time or space. If we confine ourselves to managers who have "beaten" the market for over ten years, we have pitifully few.

But, if we lower our time horizon to ninety days, the number of potential candidates expands enormously. Each will be hand-delivered in a new Italian pinstripe suit, starched shirt, and power tie with properly blow-dried hair by a suitably humble public-relations flunky. They all know the rules: pithy quotes, deep insights, groundless speculation, and insider knowledge, or you don't come back.

Few decline to play by the rules. An interview on television or radio, a comment in the Wall Street Journal, or a picture on the cover of Money Magazine, Forbes, Fortune, or Worth validates the "expert" as a real player in the business. Phones begin to ring and cash begins to flow in her direction. Careers can be made in just a few seconds. So, now is not the time to be humble. Of course, we know which way the market is going next quarter, and you can be sure our shareholders will benefit greatly. Our research (our proprietary indicators) shows that.... This market has no where to go but....

One of the dirty little secrets of the news industry is that most reporters don't think up their own stories. Instead, they are fed a constant stream of ideas and stories by the public relations flacks. All reporters and writers are showered with press releases, backgrounders, briefings, and BS by public-relations agents hired to make their clients rich, famous, and powerful. A lazy reporter can just change a few sentences in the information provided him by the public-relations agent and then hit the bar with his day's work done.

The public-relations industry isn't exactly a repository of virtue. Their mission isn't truth, it's spin. Their interest is in getting their client's story out into the media, with enough media coverage able to validate almost any loony idea. For a price, they will tell you that tobacco is good for you, citing plenty of "evidence" and "research" produced in North Carolina colleges located in little towns with names like Raleigh and Winston-Salem. Though the media and the public-relations folks generally have a well-deserved low opinion of each other, their relationship is symbiotic. Neither one could survive long without the other.

You have got to have money to afford a public relations campaign. That kind of talent doesn't come cheap. Think for a moment about who has the deep pockets on Wall Street. What kind of behavior do you think the brokerages want to encourage? Are they the organizations that will profit from low cost, low turnover, buy and hold strategies? Is their interest necessarily the same as yours? Do you think that maybe you are being had?

For a variety of reasons, bad advice is far more profitable than good advice. Take a look at who pays for advertising on television, radio, magazines, and newspapers. You don't really expect the media to savagely maul the hand that feeds them, do you?

Not all reporters are rocket scientists. It's perfectly possible to be a financial reporter without ever having taken a course in finance or economics. It's perfectly possible to be successful in the trade without having read a book on the subject within the last ten years. Financial theory has evolved rapidly in the last few years and many reporters haven't done their homework. Then again, they don't need to; it's too easy to interview heroes and put a little spin on yesterday's market close or tomorrow's number of the century. Today's reporters just need to follow the formula.

Of course, the really bright reporters quickly find that financial theory isn't newsy. There are lots of reporters out there who could teach college-level courses in finance. But they are trapped into covering the same old stories the same old way. That's what the people want, expect, and pay for. That's not only what sells, it's what advertisers pay for. In an atmosphere like this, is it any wonder that Luis Rukheyser is a household name while Harry Markowitz, Merton Miller, and Bill Sharpe are not?

Sloppy reporting and fuzzy thinking aren't just the province of a few small-town rags. I thank Weston Wellington of Dimensional Fund Advisors for sharing a few gems from his immense collection of Financial Pornography. Here is an assortment of thoughtful and useful offerings from some of the best known papers in the country.

Each of you could put together your own outrageous collection from tomorrow's papers. If millions of people didn't take this garbage seriously, it would be funny. Unfortunately, the continuous rain of dreck from television, newspapers, magazines, and radio creates a climate where investors get the impression that this is how smart players ought to plan their strategy. It's hard to ignore the most highly visible "prestige" players in the media. They must know something, right?

These kings have no clothes! There is a whole industry of hacks out there that get paid very well for filling your head with merde! Investors have got to realize that this type of commentary is worth far less than zero! You and I aren't going to reform the media, nor do we have to go on that mission. They have their program and we have ours. Their program is to sell advertising, ours is to learn something. While we don't have to buy into their agenda, we do have to understand it.

The Big Lie

One of the earliest and most successful (for a while) spin doctors was credited with the idea that if you tell a big lie often enough, people will begin to believe it. The financial advertising folks have taken that interesting concept one brilliant step further. By taking a number of absolutely true facts and mixing them with a little innuendo, they have been able to create big lies.

We don't expect advertising to be fair, objective, or impartial. In that regard advertising seldom disappoints us. While the Securities and Exchange Commission complicates the lives of financial advertisers by requiring documentation and fair disclosure, advertisers have found that they can live with this while still conveying a distorted message. You will be hard-pressed to find one outright lie. While each fact has been extensively researched and verified, it is the emphasis and spin that manages to pass on an absurd image.

For instance, suppose you advertise yourself as having the highest total return since the crash of 1987. That sounds pretty good, right? You tout your Morningstar rating and paint yourselves as the toughest managers on Wall Street, as if managers should somehow carry Uzis and have black belts to be effective. (Or, maybe they are just nasty to their office staff. Who knows?)

The ad carries a strong implication that this single fund is probably right for all investors. A viewer could even be forgiven if he began to think that it might be right for his entire portfolio. After all, what a great track record! They couldn't lie on television, could they?

But, you might fail to mention that your fund got hit harder than just about any other fund during that same crash. Or you might forget to say that you invest in stocks of very small companies, which carry the highest risk in the stock market. Or lastly, you might fail to reveal that your expense ratio is one of the highest in the industry.

I must admit, I don't know how tough the managers really are, but in all other respects there is no sense quibbling with the facts that the ad presents. I also will tell you that I think the fund is pretty good for what it is. These guys buy little companies! They get down in the weeds where few other managers will go. Given the very small companies that the fund buys, and given the lack of liquidity in that part of the market, we would expect that the fund returns would be pretty good. We would also expect the risk to be very high, which it is. So, while this might be a good choice for two or three percent of a portfolio, a little part of your domestic, small-company, growth allocation, it hardly qualifies as an all-weather fund.

I'm not sure that what the ad conveys is everything that an investor should know before he signs up or sends money. The facts are all right, but the message is distorted. So, it must be a great ad! I am not going to burden you with a few hundred other examples culled from a typical day's media. But by now you should be asking yourself if you would buy a used stock from these guys!

Of course, there is a very direct link between advertising and new money flowing into the funds or brokerage houses. If advertising didn't generate a positive cash flow for the funds, you might correctly expect that they would shortly give it up. Frequent advertising gives the impression of dependability and strength.

By now you should suspect that there is no link between an advertising budget and future performance. To the extent that advertising expenses appear in the fund's expense ratio, they add a drag to performance. To the extent that existing shareholders get to pay an expense designed to attract other investors you might consider it a tax.

There does appear to be a strong link between past performance and advertising. A large fund family always is going to have a few winners. Strangely enough, these tend to get the lion's share of the advertising budget. The impression they would like you to give is that the fund family has only winners. Of course you may care to dwell for a moment on how infrequently these winners repeat. But that's not likely to be emphasized in the ad.

Usually you will see in tiny little print somewhere hidden among the charts the required SEC disclaimer, "Past performance is no guarantee of future performance." That is the only thing you should ever believe! As they love to say on Wall Street, "You can take that to the bank!"

The seeds of all this confusion and disinformation from the media and advertisers fall on fertile soil since our minds are already conditioned to believe it. Earlier we explored the tremendous impact that conventional wisdom has on our lives. When we grow up "knowing" something, it's a great deal harder to accept change than if we were starting from ground zero.

Finance is a science or art undergoing rapid change. Most of us with finance or economics degrees minted before 1990 have a lot to unlearn. While we were going about our daily lives, they changed the whole game on us! Our natural inclination is to want to play by the old rules. And you can rest assured that Wall Street wants to continue doing business as usual.

Back To School

Finance, investments, and economics are not required by American high schools or colleges. Somehow, like sex education, it is assumed that we will pick the subject up naturally. Even new graduates may never have been exposed to concepts that they will need in order to vote intelligently on economic policy or provide for their family's futures.

Given the importance of the subject to both the political process and to the individual, I have always found this a curious, costly, and disconcerting policy. Millions of Americans think that they know a great deal more about the subject than they actually do and go through their entire financial lives blithely acting on that assumption.

What's missing here is any concern or concerted effort to get us back up to speed. A whole generation of Americans is poised to retire without nearly sufficient assets to support them and no one seems at all worried. While there is some agreement on the need to invest more, there is very little effort aimed at helping Americans to invest more effectively. The entire subject has been treated with benign neglect.

The fault lies not with the schools. Educators are willing and able to teach whatever Americans want. But a political determination must come before the school system can devote its scarce resources to any project. This is not a decision that individual teachers or school systems can make for themselves. Until the American people demand a better fundamental economic and financial curriculum, it's not going to happen. And until they do, Americans will be shortchanging themselves in an area critically important to their success.

There is an antidote to all this BS. Get to your local university or college and take a course in finance. Go to your library and borrow some current books on the subject. Subscribe to the Journal of Finance. Download a few papers from the economics and finance departments of the world's major universities. Tear yourself away from the television and get yourself down to the local Barnes and Noble, Waldens, or Borders bookstores.

You are going to have to take responsibility for your own financial education. If you think you are going to get any useful information from Wall Street Week, Money Magazine, or The Wall Street Journal -- or the ads appearing in them -- that will help you build and administer a superior portfolio to meet your long-term goals, there is little hope for you.
Frank Armstrong