Caveat Emptor By: Gabriel PotterMBA, AIFA® 2013.05.30

“Who is more foolish?  The fool, or the fool who follows him?”  - Obi Wan Kenobi, Star Wars

There is a phrase often used in finance: “don’t chase the hot dot”. In other words, don’t make your investment selections based on what is doing well today.  The goal instead is to find out what is going to outperform tomorrow.  I’ve originally heard the phrase applied to investment styles; for example, if defensive managers who favor dividend yields over capital appreciation are currently outperforming, then it may be time to rotate a portfolio towards a more aggressive style. An unsophisticated investor may hire a manager because their style is in favor, but when the market favors a different style, the investor suffers.  More broadly, the lesson can be applied to an entire asset class; for example, real estate has had a fantastic rebound lately, so an unsophisticated investor may be convinced to over-allocate to the asset class without an appreciation for the unique risks.

Those of you who read our monthly newsletters know we recently put forth recommendations of entertaining economics.  Specifically, we recommended the Planet Money podcast from NPR.  The series started in reaction to the financial crisis of 2008 and I’ve been methodically going through the podcasts of the era to remind myself of the pervasive fear (particularly important for balance given the new bullish sentiment in the current market) and reflect upon the lessons of the crisis.  During the crisis, the most bearish market observers - like Peter Schiff, Nouriel Roubini, Meredith Whitney - were portrayed as the new experts by the podcast and others in financial reporting circles.  Certainly, these bearish experts provided great value to understanding the causes and likely effects of the financial crisis, but their calls in the recovery have been equally as inaccurate as the most bullish commentators were prior to the crisis.

So, I would like to extend the meaning of the “hot dot” adage: don’t chase the hot dot when it comes to advice. 

In a cyclical market, both the bears and bulls will find plenty of anecdotal evidence to support their beliefs, but there sometimes exists a lack of rigor between analysts of any stripe – bullish or bearish – in favor of hyperbole.  Entertainment can rely on shock value for effect.  The most extreme points of view, based on supposition and little else, make the most compelling headlines.  Realistic, evidence-based modeling is often more nuanced, harder to follow, and it can honestly be a little boring. Herein lies the danger of presenting entertainment options in economics.  We are delighted to recommend entertaining options for learning about economics and finance, but we must also warn that ideology and exaggeration can find their way into the information you receive.

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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