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.
Ashok, I am so glad that you are writing about this again. As you know, I am a firm believer in the dow index as a good investment – and have held it for years. But, as you say, it isn’t very glamorous, and you just don’t hear about it as much as the new gimmicky investment strategies. I am thrilled to have you spell it out again – and will be sharing your blog with my daughters.
Thanks, Sue
It is indeed an investment that is not pushed too much by the “specialists” because they wouldn’t be able to charge exorbitant fees. In a way that’s a blessing because if everyone tried to buy it it would be driven up to a point where it wouldn’t be a hidden gem.
Ashok
Read the entire article:-
Apart from the finacial insight found the below intersting:-
“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”
On an average whats the lag time and how can an investor know that?
Saurabh,
Unless you are trading directly using a computer connected to the Exchange’s computer you have, for all practical purposes, an infinite latency compared to the professionals. Only the pros have access to the floor computers and you have to pay heavy fees for it.
Many instant pro traders have moved physically closer to the NYSE or other exchanges to minimize their latency. So if you live in Los Angeles and are trading in NY you have a latency disadvantage as your trades will be behind in the “queue” to closer computers.
Computerized trading uses algorithms that sense big moves in the market and try to take positions ahead of them. This can result in instabilities when all computers instantly want to buy or sell at the same time. On May 6th 2010 at 2:45 pm, for example, the Dow Jones Industrial Average fell 900 points in a matter of 2 minutes. Read the full account here: http://en.wikipedia.org/wiki/May_6,_2010_Flash_Crash.
This was caused by a large mutual fund firm selling an unusually large number of E-Mini S&P 500 contracts that first exhausted available buyers, and then high-frequency micro-second trading started aggressively selling, accelerating the effect of the mutual fund’s selling and contributing to the sharp price declines that day. The Market recovered in a few more minutes as traders realized that the machines had gone amok and unwound the positions.
The damage was done, however, for a lot of people who got stopped out of positions at the artificially low prices.
The point is that a non-professional trader is at the mercy of the big cats with specialized access who are betting against you in a zero-sum game.
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Many thanks Ashok. I had actually seen the first article, shows you have many secret admirers following secret tips. Some comments and thoughts –
1. You bought your first house in Orinda, California in 1977 for $112,000.
Could that be a bit steep? I almost bought a house in Grizzly Peak (one of my many mistakes of not doing something!) for $35,000 in 1971, but may be prices shot up between 72-76?
Then you say – It represents a growth to 8 times the original investment in 31 years less costs detailed.
But I also presume – you had a mortgage – leveraging your investments and some tax deductions, so your capital plus costs grew much more than 8 times.
Usually similar leverage is not recommended in the DJIA.
Or do you think that the latter, not leveraging investments in the DJIA, is the mistake?
2. I agree, fully with the point on how the bulk of talk is how “experts can beat the market”. They can’t normally and do not most of the time.
But then there is the question of imperfections and specialized information. One is Rajaratnam, another is Buffet. A third, is what you, and friends we know, were able to do with “specialized information” – not a insider trade, but deeper knowledge about a sector allowing one to make a bet, as Paulson did with the mortgages.
Finally, always the lure in the housing market, are location specific imperfections, given its lumpiness, as well the leverage and until recent madness, greater stability, no?
Keep up the blog and cheers.
Amitav
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