Many people make resolutions at the beginning of each New Year. Some people focus on their health, some focus on their relationships and others focus on changing their financial situation. I can’t help you with the first two, I am not the picture of health, but my wife and I will celebrate our 25th Anniversary in 2018. It is the financial picture that I want to focus on.
I have been studying, analyzing, trading and writing about the market and economy for over 30 years. For the last 18 years I have been involved in the investment publishing industry. I have been the editor of numerous newsletters and trading services. I have to say that I haven’t always been comfortable with some of the promotional material that was used to sell my newsletters. The rosy outlooks, and while not promises of wealth, the expectations of turning a small amount in to a vast fortune are abundant in the marketing materials of investment newsletters. Unfortunately, not all of these newsletters are honest and even the ones that are may be touting the past performance where the editor went through a hot streak or picked one risky investment that paid off in a big way.
It is tempting for investors to look at the top performing newsletters each year and pick the one that did the best in the previous year. Studies show that this is not a good practice. There was an interesting article in the Wall Street Journal recently and it was talking about this very practice. The article was written by Mark Hulbert, the founder of Hulbert Financial Digest (HFD). HFD ranks investment newsletters and they have done so since 1986. The article in the Journal talked about how investors should avoid the top-ranked newsletters in the following year.
According to the article, “Consider the performance of a hypothetical portfolio that each January invested in the recommendations of the investment newsletter at the top of the previous calendar year’s performance rankings. According to a study by my company, this portfolio created from each year’s winners has lost almost everything—incurring an 18.0% annualized loss since 1991. So, $100,000 invested in this portfolio back then would today be worth just $471 today.”
That is an impressive feat. To take $100,000 and turn it in to $471 in 26 years is incredibly bad. You could probably do better by betting on individual numbers on a roulette wheel. At least every once in a while you get lucky and hit big.
I know with my own track record, I can get hot and cold, but I tend to stay consistent with my approach. I was running a live chat room last year and each day I tried to come up with at least one new option trade each trading day. I did this with listeners every morning and we used the same process every morning. We would look at the charts, and then look at the fundamentals and the sentiment toward a stock.
During one really great stretch from mid-September through mid-October, we had 14 winning trades out of 18. This was an incredible run considering we were buying options. The average gain was just under 70 percent while the average loss was just under 40 percent. What do you think happened after that streak? That’s right, my process cooled off and over the next 23 trades, there were only nine winners compared to 14 losing trades. While the total run with all 41 trades was still really good, I made sure to caution listeners about staying consistent with their trade allocations. The temptation is to bet more when you are hot because you feel like you can’t lose. When that feeling hits, it is usually the time the losing starts.
This same phenomenon happens with newsletters. Investors are looking to make changes at the beginning of the year and start researching ones that fit their investing style. They see an incredible performance in 2017 and jump right in. As was pointed out by Hulbert Financial Digest earlier, this is the wrong thing to do.
So what should you do? What you really want is consistency. I pointed out my own track record and how different it could be from one month to another. With options trading that can happen very easily. When I say you want consistency, there are two ways to seek consistency: through the annual returns or through the process. Many newsletters have been around for years and Hulbert likely has results for those that have been around for five years or longer. If the newsletter isn’t ranked by Hulbert, you at least want to know that there is a consistent approach being applied to analyze the opportunities.
After almost 20 years in this business I can tell you that an analysis approach can go through periods where it is in synch with the market and at other times it is out of synch with the market. If the advisor is constantly changing their approach, they may never be in synch with the market.
Another thing to remember is that we have been in a bull market essentially since 2009. There are some newsletters and editors that haven’t even experienced a bear market yet. Personally, I went through both the 2000-2002 bear market and the 2007-2009 bear market. My approach in both of those bear markets didn’t change. Yes, there was a time when it felt like I couldn’t get anything right as the momentum shifted from upward to downward, but once the trend was down the approach was back in synch with the market.
And just to be clear, I don’t have a newsletter that I am managing at this time, so I am not trying to sell you on me and my approach. I am sharing this with you as an experienced investor so that you understand that chasing the hot hand is the wrong thing to do.