The Edmond Sun

Business

November 16, 2012

THE ASTUTE INVESTOR: Looking for the smart money

EDMOND — Have you ever read an investment report that made reference to the “smart money?” You’ll hear comments how the “smart money” is going into certain stocks or market sectors. My favorite is “watch what the smart money is doing.”

Well, that sounds like good advice, but how do you know who is smart and who is not? More importantly, what is the standard for smart versus, well, not so smart? And where do you go to watch them? Maybe there is a look-out spot near Wall Street, or a favorite corner, where you can strategically place yourself for an afternoon of smart people watching. Perhaps it’s a lot like bird watching. Oh look! There’s one in a three-piece suit.

Usually it refers to what savvy corporate insiders, institutional investors, hedge-funds and other professional investors are doing at the time, in comparison to high or low levels of bullish investor sentiment. Unfortunately, the term “smart money” has led to increasing use of the term “dumb money” in some market writing, with the implication that non-professional investors must be dumb.

That is totally unfair and inaccurate. Individual investors are most definitely not dumb or stupid. That would be impossible just given the fact that they are able to be investors. Individual investors would have to be among the most intelligent, knowledgeable, successful people on the planet to have the success in their chosen careers that provide them with money that can be invested.

You don’t get to be a successful artist, attorney, doctor, engineer, scientist, business executive, salesperson, small business owner or whatever, by being anything but knowledgeable, intelligent and sometimes brilliant.

The term comes from the idea that the so-called “smart money” supposedly buys low, sells high and thrives from their investing. It also implies that most individual investors lose money over the long-term, or fail to match the gain they would make by simply leaving their money in the bank.

Numerous studies on the subject seem to verify this. Research firm Dalbar Inc. published a study in 2003 titled “Quantitative Analysis of Investor Behavior.” It showed that from 1984-2002 the average annual return on equities was 9.3 percent, while the average annual return of individual investors who invested in those equities was only 2.6 percent over the same period.

A similar Dalbar Inc. study of bond investors in 2006 showed that over the 20-year period from 1986-2005, the Long-Term Government Bond Index had an average annual return of 9.7 percent but the average annual return of individual bond investors was just 1.8 percent.

So what seems to be the problem for obviously intelligent and smart individual investors? According to other studies, the very fact that they are smart, knowledgeable, intelligent and successful — in whatever is their own field of expertise — may be the problem, as it may cultivate over-confidence when they step into money-management, a field that is not their area of expertise.

For instance, a survey by the Securities Investor Protection Corporation in 2001 revealed that 85 percent of U.S. individual investors were unable to pass a simple five-question investment “survival” quiz. In 2009, the Investor Education Foundation of the Financial Industry Regulatory Authority conducted a similar investor survey. Sixty-seven percent of respondents rated their own financial knowledge not just average but high. Yet by far the majority failed FINRA’s test of their knowledge of even the most basic of financial questions.

In 2012, the Securities & Exchange Commission published a report on financial literacy among non-professional investors. Its conclusion was that “U.S. investors lack basic financial literacy, and have a weak grasp of even elementary financial concepts.” Yet the majority rated their financial knowledge as high.

It’s obviously a potential problem for investing success when those suffering the consequences don’t even realize they have a problem. Thus, many keep investing the same way in every cycle, making the same mistakes over and over, while expecting the results to be different. (As I recall, wasn’t that Einstein’s definition of insanity?)

Gerri Walsh, president of the FINRA Foundation says, “There are a lot of people who think they’re good at handling their money, but their results tell you otherwise. Those people are going to be particularly difficult to reach and educate because they don’t think they have a problem.”

The market is a great teacher, but its lessons are often not learned. If this describes you, perhaps you need to seek the assistance of a good financial adviser to help you.

SIPC Vice President Robert O’Hara said, “We’ve been at this for more than 50 years, and we see the same problem over and over again. Investors are enticed in during bull markets, but then don’t know what to do when things turn sour later. People need to take the time to learn the basics about investing, and how to put them into practice.”

It sounds like a reasonable suggestion given the statistics. In the meantime, who wants to join me for a little smart money watching? Maybe if we hide in the bushes we can see some walking by. Thanks for reading.

NICK MASSEY is a financial adviser and president of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Securities offered through Securities Service Network Inc., member FINRA/SIPC.

 

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