Can You Beat the Market on a Consistent Basis?

Interview with Spencer Jakab

Can you beat the market consistently? Which index fund should you get into? How frequently should you trade? Spencer Jakab, from The Wall Street Journal, shares his insights on these questions and more.

Douglas Goldstein: I’m very excited to be talking with Spencer Jakab from The Wall Street Journal. You’ve probably seen the Heard on the Street column, which he edits, and he also just wrote a book called Heads I Win, Tails I Win: Why Smart Investors Fail and How to Tilt the Odds in Your Favor. Spencer, I would like to tilt the odds in my favor, but people often tell me, “You know, there’s nothing you can do because you can’t control the market, and we all know that no one can beat it on a consistent basis.” Can someone beat the market on a consistent basis?

Can You Beat the Market on a Consistent Basis?

Spencer Jakab: It depends on how you look at it. Let’s think about it this way. There are dozens of books out there, and thousands of people out there, literally, who are trying to give you an edge, and as you point out, they generally don’t succeed.

People who try to get an edge don’t succeed, which is sort of a positive advice. This is what you need to do, this what you need to buy, this is how you need to invest, this is how you need to think about the market.

I think that at the margins, some of those can be useful, but they’re mildly useful, and even then, they’re only useful to people who are extremely disciplined in and smart about employing them.

On the other hand, there is a huge amount of low-hanging fruit out in the market because the typical investor is actually very bad.

People don’t realize, even about themselves, that if they look at their own investment performance how bad it is, compared to a completely passive strategy.

When I say to people, “If you are a typical investor and you follow this advice, more or less you could double or triple your NASDAQ over your saving life time,” it sounds pretty good, but it is really the avoidance of errors and mistakes that are key to it.

Douglas Goldstein: What are the low-hanging fruit? Does it mean that there are some really good bargains out there?

Spencer Jakab: It doesn’t mean that. There could of course be, and I don’t know what the bargains are, and by the way, no one else does either.

Pundits are generally useless, or slightly more than useless, in terms of following specific advice; do I buy Apple, do I sell Apple, and whatnot, but the low-hanging fruit is clearly there and it really boils down to two things. One thing is the thinking that investors do when they zigzag, the way that people invest, and the way that people psychologically and practically approach the market.

The other thing is the amount of money that people pay to be invested and some of the costs they’re not even aware of, that they incur upon themselves in taxes and transaction fees, and things like that, that are absolutely unnecessary, like a true waste of money.

If you look at that, then let’s say, Doug, you are working in finance, and you and your brother both inherit a large sum of money, and the person says, “Doug, you obviously know what you are doing. You can take this money. You can’t spend it, but you can invest it however you see fit, in any mutual fund you want, and in 30 years, you can touch the money. But your brother can’t touch it. He has to put it in the absolute lowest cost passive index fund, 60% stocks 40% bonds rebalanced, and can’t do anything.

Your brother probably would have something after 30 years, and this is a bit exaggerated because we’re starting with the lump sum, and this is not how most people invest. He would get something in the order of four to five times as much money as you. If you are merely typical, not bad, really typical, and that’s just tracking...

Douglas Goldstein: It’s funny you’re saying that, and of course the numbers do play out. We do see that when people play real hard to try and beat the market they just don’t.

You started your career as a pundit. You were one of these geniuses that people turn to, and you are still a genius that people turn to. You were doing work; you really were adding value to the equation.

It seems to me that the problem is people don’t know how to deal with all the information out there, and maybe the answer is, if you don’t know how to deal with it, just go with a basic index fund, and you have to choose which one, but that’s a different question.

Should You Trust the Experts?

Spencer Jakab: I was an analyst, and now I write columns and edit columns in The Wall Street Journal that people take as investment advice, and the people here obviously do a great job on their correspondence.

You look on TV, and there’s the occasional bozo that you see on CNBC, or Bloomberg TV, or whatever.

The vast majority of people who are interviewed for their knowledge about some subject, let’s say the next iPhone or their investor prowess, what they’re saying makes sense if the facts are correct.

They’ve put a lot of effort into learning it. They have an extensive education, and what they’re saying is not wrong.

They have a sophisticated understanding of it. What they don’t do - and this is insurmountably true - is they don’t add anything to security selection, because what they’re saying is more or less reflected in the market, and they don’t have a sense of what to do. When and if they did, they wouldn’t be telling you.

Those who say don’t know, and those who know, don’t say. Those people who are giving you explicit advice: “Buy this now, sell that now,” wind up giving you bad advice. They’ll excuse away their mistakes and most people who route their pundit business are not conmen.

A few are, but they sort of calm themselves into thinking that they’re better than they are, and some have decent track records. It’s very difficult to say if their track records are the result of luck or skill, but over a large group of people, you can see that pundits are just a coin flip.

If you, and studies have been done, look at the proclamations of well-known pundits in the market, there’s just no reason to follow them, and the fact that they’ve been right three times in a row or they already told you to buy Apple 10 years ago, doesn’t matter.

That doesn’t have any bearing on the next thing they’re going to tell you.

Douglas Goldstein: A lot of these people could be sort of a black swan situation. Spencer, I want dive into this question that a lot of people have on index funds, and frankly I’m involved in the index fund market too, as a financial advisor.

I work with people, trying to help them to put together portfolios.

One of the issues is that there are so many index funds today, and lots of them have a low cost, so it’s not an issue that you can put your money in and not pay a lot, but people end up messing themselves up.

However, even before they have the chance to mess up and sell low and buy high, how would you suggest that someone else choose, if they want to make a portfolio of index funds? How do you choose what index to get into?

How Do You Choose What Index to Get Into?

Spencer Jakab: That’s a good question. The broadest, most representative index in any category is generally the best choice.

You can buy the Vanguard Total stock market index, or the equivalent given by other providers, although I’m not really endorsing one product over the other.

You want in if you’re buying in exchange for this fund, especially, and it applies less to a traditional mutual fund.

You want the big liquid one that turns over a lot because your transaction costs, getting into and out of them, are the lowest, and you want that one that’s most representative of the market.

The S&P 500 is fine, and that’s about 86% of the value of your stocks, if you’re talking about the U.S., but you can go broader than that. A well-balanced portfolio should have those large capitalization stocks, but should have some stocks from outside the United States, should have some bonds, and some real estate. It should be diversified.

A robo-advisor will choose five or six in very low-cost index funds and then rebalance them, and that tends to dampen volatility, and volatility is what spooks people.

It makes people make bad decisions, so dampening that volatility month to month, year to year, has a positive side effect of making you less nervous and causing you to make fewer errors cognitively.

Douglas Goldstein: I think what also spooks people, and please don’t take this the wrong way, is the media. The media is out there with the headlines.

They’ve got professional headline writers meant to either frighten people or excite them. What role do you think the media plays in normal people making bad investment mistakes?

What Role Does the Media Play When It Comes to Investing and Decision Making?

Spencer Jakab: Guilty as charged. We’re not out to spook people, but there’s a saying that if it bleeds, it leads. You’re not going to say nothing happened today, or everything’s fine, or don’t read this.

You’re going to tell people why something is important, why something is shocking, why bad news prevails over good news.

There’s an interesting study done by a group called Bespoke Investment Group, where they looked at the Drudge Reportheadline.

If there’s a big headline, they’ll put it on top of the Drudge Report, and they looked at when Drudge had a financial headline, or didn’t have a financial headline, i.e. in finance. Generally the market going down five days in a row is not a headline.

When the market has gone down five days in a row or garners a thousand points in the last seven sessions, or something like that, then financial news is big, and there was a perfect inverse correlation in terms of when the Drudge headline indicator was at its highest.

When things were really scary and bad, that was the time to be investing.

That preceded very good returns in the market. It’s the scariest of times. It’s a time where people are least likely to contribute to a stock fund and in fact are quite likely to be withdrawing money from the stock fund.

Douglas Goldstein: They’re doing exactly the opposite of what they should do, based on the news, either frightening them or exciting them?

Be Mechanical in Your Investing

Spencer Jakab: That’s right. The news reflects what people in the market are saying, and they want to get quoted and they want to be dramatic too. We’re not manipulating people, but you’re absolutely correct.

I would say the perfect time to up your allocation to stocks would be when, not The Wall Street Journal, but when, let’s say your local paper has a headline that’s about the stock market.

That’s a great day to buy, when people who don’t pay very much attention to the stock market or are informed about how bad things are, that’s quite a good time.

I’m not suggesting any timing strategy based on news headlines, but you’re absolutely right that it does a disservice to people, to sort of invest on the basis of what’s in the headlines.

What I advise people to do is, to the greatest extent possible be mechanical, be kind of robotic about the way they invest because that will insulate them from making any kind of emotional decision, and on the flip side as well, when they think something is very hot and feel like a fool for not being in it or not chasing the trend, just ignore it.

Ninety five percent of people are going to be better served by just ignoring that stuff. It’s hard to do, though.

Douglas Goldstein: It’s much easier said than done, because the reality is you’ve been working and saving, and your $150,000 IRA all of a sudden drops to $85,000. So you’re like, “What was I doing here, and you want me to put more money into it?”

I think people get crazy.

I saw a little while ago a study, and I just don’t remember where I was. Maybe you’ve seen this, that they look at people who invested with the benefit of the news, and people invested without the benefit of the news, and it turned that those who weren’t looking at the news actually did better over time, even if it’s not true.

Trade Less Frequently for Better Returns

Spencer Jakab: There are many studies like that. There’s a famous study that, for example, looked anonymously at 33,000 brokerage accounts and it adjusted for taxes, and caused everything to look at who trades the most and who trades the least.

The frequency with which people traded led consistently to poor returns. The people that had the best returns were those who traded the least. There’s another study done by a professor at Columbia Business School that showed that people who check their portfolio more often do worse.

It’s funny. I asked my mom a couple of years ago, “Who does your taxes”? She said, “I pay some guy”. Then she told me, and note that she’s retired, “I got this letter that I owe some capital gains,” and there’s an Israeli company that is on NASDAQ, that she had bought many years ago.

So I asked her, “Can you even remember back when you could first trade online on stocks?” She said, “I opened an account. I put the money in my checking account into this account, but I forgot that I had it, because I just bought two stocks. They didn’t pay dividends, and I eventually forgot that I had that thing. They never sent me a letter, and then the Israeli company got bought. I can’t remember what the company was.” Then she got some capital gains.

I said, okay. This is like in the 90s, that she had done it. I asked her, “What’s the other company?” She’s like, “Amazon.com.”

She hadn’t invested a lot of money at the time, but it’s worth as much as her apartment or something. You think it went up several thousand percent, went down 90%, went up a ton, went down another 90%, all these crazy things, but she was oblivious to them.

I don’t recommend forgetting that you own something, but she was insulated because she was forgetful and had forgotten that she’d opened this account.

Of course, I don’t recommend buying two stocks and doing that because your chances are not too great doing that, but the more that you can insulate yourself, the better off you are because you’re giving yourself the gift of time and compounding.

The more you get into it, the worse you can do. Obviously, there are exceptions, but on average it will give you returns. There is no doubt.

Douglas Goldstein: I think Eugene Fama, who won the Nobel Prize in Economics, said that managing money is like soap. The more you handle it, the smaller it gets.

Spencer, the study that you cited a minute ago about the 30,000 brokerage accounts was done by Terry Odean, Terrance Odean, from the University of California.

He was a guest on my show, The Goldstein on Gelt Show. If anyone out there wants to watch that interview, they can see it on YouTube. He talked about that study, but that’s not the topic of our interview today.

Spencer, in the last few seconds, tell us how people can follow you and follow your work.

Spencer Jakab: I can be followed on Twitter, and I’ve an unusual spelling on my surname, so it’s @Spencerjakab. You can read my articles - I still do write a couple times a week - at The Wall Street Journal. Look for my bio line and then listen to things like this.

Douglas Goldstein: Spencer Jakab, thanks so much for taking the time.

Spencer Jakab: Thank you.