Easy Money – Yes, But Not Where You Think.

I was watching CNBC (the financial network) the other day (I’ve got to kick that habit, this kind of TV really is bad for you). Up came a viewer survey: How many of you are beating the Dow Jones (Industrial Average) in your investing?

38% of the respondents said they were beating the Dow. Another 30% or so were performing at “about the same level” as the Dow.

Wow! Really? The ability of people to go Rah Rah about their investing is astounding. It must be a psychological thing that people want to remember only their good investments, or want to show that they are good investors because that is the easy achievement that Wall Street is touting.

On the same financial channel we now have a daily hour-long segment on making money through Options trading – there’s a trader sitting there telling you how to establish Butterfly spreads or what naked options to write to maximize your “take” from this market. Then there’s this ad for Day Trading. A serious, fast-talking guy is earnestly telling you to “Just call and we’ll rush you a packet of Day Trading strategies that are right 86% of the time”. Many of his clients have retired in just three months of using his method, working just 15 minutes a day from home. Presumably they’ve quit their jobs, exchanged their wives for younger, sexy starlets and sit all day on some beach sipping Mai Tais! Capitalism is so great!

Truth is that most investors lose money on professional advice and almost everything you see on CNBC, The Wall Street Journal etc. is financial pseudoscience designed to lure you into a crooked Wall Street casino. A great recent article in Scientific American documents the flimflammery that goes with Wall Street experts claims of beating the market. It cites a well publicized incident where, in a dramatic visual demonstration on TV, John Stossel (who had a television special on skepticism on Fox Business News) threw 30 darts into a page of stocks and compared the results with the picks of the 10 largest managed funds. Results: Dartboard gain 31%, Managed Funds – 9.5%.

The article goes on to say:

A study in the journal Economics and Portfolio Strategy that tracked 452 managed funds from 1990 to 2009, found that only 13 beat the market average.

Wall Street is selling Main Street on the belief that experts can consistently  beat the market. They can’t. No one can. Not even professional economists. If they can’t the average CNBC viewer has zero chance.

Truth is that to beat the market you need specialized information. The stock market is a giant poker game where short term winners can only persistently exist at the expense of losers. Specialized information, available to a few insiders, need not be illegal, although, as evidenced by the recent Galleon Hedge fund conviction of Rajaratnam, it often is. But you can have specialized information through sophisticated “quant” models or data mining or as in the case of large firms like Goldman Sachs through a vast, private inflow of deals and client activities data. There are about $3 Trillion  in Hedge funds in the U.S. today and most of them operate in a private, unregulated trading environment. I highly recommend reading Sebastian Mallaby’s book, More Money than God: Hedge Funds and the Making of a New Elite about this secretive subculture of the financial industry that is in the zero sum game of moving large amounts of money from one pile to another and making huge returns in the process. Guess who the counterparties are to these zero sum games – yes, the ordinary Joe who tries investing himself or gives his money to professionals to manage.

By the way 85% of all trading on Wall Street is done by computers with direct access to the trading “floor”. The efficacy of these systems is often dependent on their “latency” measured in microseconds as the lag time between order placement and receipt by the trading floor computer. So if you’re operating on a longer lag time than a few microseconds you might be losing the edge!

But before you despair there is a winning strategy for you. It is simple, takes less than even the fifteen minutes a day, and even though you won’t retire in 6 months or even 5 years, over the last 30 years it has yielded 40 times the original investment with low fluctuations and risk. It beats California real estate and virtually every other stock buying/selling strategy no matter how sophisticated (not grounded in fraud or exceptional luck).

Three years ago, in a blog titled, An Almost Unbelievable Investment, I talked about this investment. Yes, we are talking about investing in the Dow Jones Industrial Average – the index itself. Since I wrote the blog there has been a severe market crash and the Dow saw its biggest decline in more than a generation. It’s time to revisit how this investment would do, so here’s a current chart showing its performance since 1977.

The Dow has returned a compounded return of 11.75% over the last 34 years. $10,000 invested in the index in 1977 will have grown to over $450,000 today! This beats the portfolios of everyone I know. How did yours do?

I will write more on the Dow and its amazing, simple-to-implement investing potential in a detailed follow-on blog. But for now please read my original article – much of what I wrote is still applicable – you can’t beat a simple index like Dow with all the flimflam in the world that Wall Street gurus will sell you.