Friday, April 04, 2008

Stupid Financial Advice Revisited

Back in November 2007 - a mere 5 months ago - I wrote a post about some really stupid financial advice that I heard a financial commentator utter on TV. The advice related to Google stock, which at the time crossed the $700 mark. The commentator advised her viewers that even though Google stock was expensive, buying a single share of Google stock was a better investment than buying many more shares in "weaker companies".

Let's see how that clear case of performance chasing advice panned out. On November 4, the day this brilliant piece of advice was inflicted on the population at large, Google stock hit an intra-day high of $730 per share. As of the market close yesterday, the same stock was worth $457. It turns out that if you had taken that steaming pile of financial advice you would have lost 37.4% on your money within a few short months.

What does this story teach us? Well, here are a few lessons:

1. Don't trust financial advice from unqualified sources - there are plenty of people spewing financial advice left and right (this blog included). Don't trust it. If you want serious financial advice look for reliable sources and do your own research.

2. Don't chase performance - the reason the illustrious TV commentator graced us with her disastrous piece of financial wisdom is that Google stock has been on a tear for months prior to the date of the recommendation. Not being a particularly bright individual, the commentator simply extrapolated the past trend into the future. Well, if it has gone up this quickly in the past, shouldn't it continue to climb indefinitely? Nope.

3. Performance tends to regress to the mean - if an asset class did really well in the past, and is now becoming the common wisdom, "can't go wrong" investment (see real estate until last year), chances are that it is about to take a major tumble at some point. Don't get cocky, however, irrationally buoyant asset price increases can last long after the rational voices start calling a bubble. If you try to bet against a bubble you may well find yourself losing money hand over fist, before the bubble eventually pops.

I am sticking to my index funds, thank you very much.

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