Once you know the truth, you’ll want to adopt Edesess’s Ten New Commandments for Smart Investing, simple rules you can follow to invest, get a profitable return, and avoid squandering any more of your hard-earned dollars on bogus expertise.
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THE BIG INVESTMENT LIEWhat your financial advisor doesn't want you to know
By MICHAEL EDESESS
Berrett-Koehler Publishers, Inc.Copyright © 2007 Michael Edesess
All right reserved.
Chapter OneThe Beardstown Ladies versus the Professionals
The Beardstown Ladies would have had it made for good if they hadn't been so naive and honest.
In the early 1980s, Mrs. Betty Sinnock, a grandmotherly woman of homespun wisdom, formed an investment club with fifteen other women—also senior citizens—in the town of Beardstown, Illinois, population 6,200. They called their club the Beardstown Business and Professional Women's Investment Club.
They got together regularly to study public companies and to select some to invest in. They joined the National Association of Investors Corporation (NAIC), an organization of investment clubs. They researched stocks, looking for companies with a solid history of growth. They saved and invested diligently, contributing $4,800 a year to their joint portfolio.
They stuck to companies they knew. When one of them came to a club meeting and announced she had seen a lot of cars parked at Wal-Mart, they bought Wal-Mart. One member brought some Hershey Hugs to a meeting. The members decided they tasted good. They wound up buying Hershey stock.
By 1992, they had accumulated a substantial portfolio, making them one of the larger investment clubs in the NAIC. The Beardstown Ladies' discipline and hard work had paid off. They were proud of their achievement, accomplished through their own efforts without professional advisors.
They were so unlike the conventional image of astute investors, and so appealing as a human interest story, that they attracted media attention. They appeared on the nationally televised program CBS This Morning, performing so well that CBS asked them back.
What happened next will go down in history. As one observer's account puts it, "For the Beardstown Ladies, it was the deviation from their comfort zone—in an attempt to quell the fast-paced, number-hungry media—that got them into trouble."
In senior partner Betty Sinnock's own words: "In 1991, a producer of CBS This Morning called and asked to feature our club for the second time. They wanted us to be on the show January 2, 1992 and they wanted to know what our annual return had been and how we had fared against the Dow."
To respond to this request, the club bought the NAIC Accounting Software and received permission to use it at their bank, since Mrs. Sinnock didn't own a computer.
When Mrs. Sinnock finally got the data entered and read the results, the club had earned an average 23.4 percent per year for a ten-year period. The Standard and Poor's 500 (S&P 500) stock market index, a broader index than the Dow, had achieved only 14.9 percent per year.
The Beardstown Ladies had outperformed the stock market by a full 8.5 percent per year!
The mere human interest story of the Beardstown Ladies got a shot of adrenaline from that 23.4 percent ten-year return that Betty Sinnock had calculated with the NAIC accounting program. This was the stuff of big print on book jackets, a publisher's dream.
A book packager in New York asked to do a book based on the club. The book, The Beardstown Ladies Common Sense Investment Guide, became an instant best seller and soon was being published in seven different languages. Four more books followed, plus several audio and big-print editions and a video. The books touted in big bold letters the Beardstown Ladies' "23.4% per year return." The ladies were doing more traveling than they had ever dreamed possible. They were happy to share their knowledge to motivate others to save and learn about investing. They were constantly in the news, always in stories glowing with warmth and admiration.
In Betty Sinnock's words:
Television stations would fly us to New York or California for a four-minute segment. For us, coming from a small town, it was all the more exciting. Maybe a little frustrating and amazing, too.
In December 1994, Phil Donahue flew 13 ladies and our broker to New York to appear on his show to promote the first book. Six of the ladies had never been to New York City, and two of the ladies, in their 70s, had never flown before. It was a fantastic experience.
As we were being chauffeured around in limousines, I remember thinking, "we don't spend money like this." ...
As part of the book's promotion, we were scheduled to be in a different city every day for 14 days. We were doing several interviews a day, for the print, radio and television media. It got pretty exhausting.... I was traveling nearly four days a week....
It wasn't until the groups of people coming to hear us talk began to grow that we finally began to take in what was happening. At one point we were asked to do a program for the Smithsonian. Every time I talked to the people from the Smithsonian, the venue had changed because they needed more space to accommodate all of the people. Finally, we ended up in the auditorium of Washington University, where 1,500 people had made reservations to hear us speak.
For the first time, I felt that this must be how a celebrity feels.
And it was all because of their 23.4 percent annual return.
When I heard about this on the news I assumed the number was wrong—but not because the Beardstown Ladies were inexperienced and untrained investment professionals. No, I assumed it was wrong because I knew how easily accidental or trumped-up statistics acquire lives of their own in the investment field. The gullible public and the mass media that cater to it, wishing fervently to believe in investment Holy Grails, regularly swallow these unlikely but facile figures whole, without checking.
On March 2, 1995, the New York Times, usually known for careful reporting and fact checking, nevertheless published a long and thoroughly uncritical piece on the Beardstown Ladies, in which their 23-plus percent performance was cited not just once but several times. The piece included a recipe for "Shirley's Stock Market Muffins (Guaranteed to Rise)."
A Times editor would reread this piece now with deep embarrassment. But from 1992 to 1998, the Beardstown Ladies had a spectacular run. Their books, audios, and videos sold in the millions. Their success spawned investment clubs around the country. They became investment advisors to the world.
In 1998, a journalist for Chicago magazine, Shane Tritsch, expecting to write the usual puff piece on the Beardstown Ladies, suddenly became suspicious. What aroused his suspicion was a fine-print disclaimer on the copyright page of the paperback version of the Beardstown Ladies' Common Sense Investment Guide. The disclaimer read, "This 'return' may be different from the return that might be calculated for a mutual fund or bank."
At the instigation of the Beardstown Ladies themselves, an independent audit of their investment returns was performed by the accounting firm Price Waterhouse. The study concluded that their investment return over the ten years had been not 23.4 percent but only 9.1 percent—underperforming the S&P 500 index by almost 6 percent instead of outperforming it.
The news should have come as no surprise to knowledgeable stock market and financial media observers. But it was of course devastating to the Beardstown Ladies' reputations as investment gurus. The error was apparently totally innocent. As Betty Sinnock described it:
In 1992, the club offered to buy the NAIC Accounting Software if I could get permission to use it on a computer at the bank since I didn't own a computer. I entered the data as of 12/31/91 and I thought I was inputting the data so the first eight years would be included in our returns. Because of this, when the computer showed an annual return for our members in 1993 of 23.4 percent, I thought it was for the first 10 years and shared the information with the rest of the ladies and with the producer of our video, which had recently been completed....
We have since learned that the 23.4 percent was for a two-year period and not for the first 10 years as we had always thought.
In giving this account of the error in a press release, Mrs. Sinnock added, "The Beardstown Ladies are just really, really sorry."
The error was duly reported in the media. Time magazine published an article under the tongue-in-cheek headline "Jail the Beardstown Ladies." The Beardstown Ladies' publisher dropped them. But the Ladies had clearly not connived, knowingly and maliciously, to propagate an erroneous number purely to enhance their own reputations and sell books. Their phenomenal success—though based largely on a falsehood—was not based on a deliberate, premeditated, and knowing falsehood but on an inadvertent one, a falsehood that the credulous public and the media lapped right up.
There was the expected, though muted, tut-tutting, implying that things had been set right again. Of course, mere amateurs like the Beardstown Ladies couldn't really beat the pants off the market and compete with professional investors on Wall Street. But this theme was surprisingly downplayed, not played very often, and not played much at all—in particular—by professional investment counselors themselves. It might seem like a case of professional courtesy, or just kindness and deference to some white-haired old ladies.
In fact, the muted quality and even nonexistence of "I told you so's" in the investment profession was also motivated by the perennial need of the investment advisory industry—the community of investment advisors, investment managers, investment consultants, investment commentators, and other investment "experts" of all stripes—to deflect attention from their own nakedness.
In March 1998, after the Beardstown unmasking, Tom Gardner, a founder of the offbeat Web-based investment commentary called "The Motley Fool," posted the appropriate comment on the Fool's Web site, fool.com. Noting that the Associated Press had run an article entitled "Beardstown Investors Called Frauds," Gardner wrote:
Over the past five- and ten-year periods, between 85-95% of all mutual funds have done worse than market average, and we haven't yet come across a single article entitled "Mutual Fund Managers Called Frauds." This even as their advertisements cloud over the real underlying value of their managed funds (after the deduction of all costs and taxes) relative to that of an index fund. Do mutual-fund families plan to hire outside auditors to scrutinize and then publicize the after-tax returns of their products over the past decade? (I've decided to start holding my breath now. Someone please tell me to stop.)
Compared with the Beardstown Ladies (their inadvertent fraud having been exposed at their own behest, to the ruin of their enterprise) —whose fraudulent practice was naive, unintended, and strictly from Hicksville—the fraud of the investment advice and management industry is studied, refined, Wall Street minted and Madison Avenue packaged, and extraordinarily effective.
Unfortunately, the real message of the Beardstown Ladies—the example they represented of the virtues of self-reliance, disciplined saving, and thrift—was lost in the shuffle. For the prurient taste of the public and the media, these virtues had to be mixed with a hint of avarice. The Beardstown Ladies fell short, in the end, on the avarice quota. But they needn't have.
If they had been more artful, more worldly, more knowing, more cunning in the ways of the investment advice industry, they could have come out smelling like a crafty rose. They could have admitted and quickly apologized for their error, then swiftly moved on to emphasize the years in which they did beat the stock market. They could have explained away the years in which they lagged the stock market by saying their investment approach was "out of style" in those years or some such thing. Their publisher would not have dumped them, they would continue to be regarded as investment gurus, and they would have joined the ranks of the true investment professionals.
The Big Investment Lie
The saga of the Beardstown Ladies may seem like an aberration and a curiosity in the annals of investment gurus. But it is not an aberration and a curiosity. On the contrary, it is typical. Behind the success of nearly every wealthy investment professional lie a winning way, an air of confidence, and an erroneous or highly selectively quoted statistic.
The success of nearly all prosperous investment professionals consists not in procuring higher rates of return on investment for their clients but in procuring astoundingly high fees from their clients—without the clients taking much notice.
In other fields, too, professional advice can be of doubtful value. An abundance of savage lawyer jokes makes it clear that many people think lawyers often do more harm than good—and overcharge their clients. Even in the medical field, doctors themselves will admit that their medical expertise can make a real difference only in a minority of cases.
But in no service field in which customers pay for professional advice and assistance is the failure to help so clearly measurable, and so clearly demonstrated, as in the investment field. Furthermore, for this total and demonstrable failure, customers pay far, far more than they will ever pay for medical advice and treatment, or for the services of a lawyer, or for any other professional advice and assistance they will ever get.
The investment advice and management industry encompasses a vast and complex array of advisors, managers, financial analysts, custodians, brokers, traders, performance evaluators, auditors, accountants, actuaries, conference managers, journalists and publishers, writers, ghostwriters, newsletter publishers, computer systems developers, and an endless array of consultants and consultants to consultants.
The investment advice and management industry is enormous, with total revenues well over $200 billion per year in the United States alone. A percentage of investors' assets provides the entire financial support for this industry.
When an investor engages the services of an investment advisor or of a money manager, or both (usually both), the investor typically winds up with a combination of two investment strategies, one on top of the other.
The first is a sound, simple, low-cost strategy of investing in a diversified portfolio of stocks and bonds, a strategy that is almost certain to provide a strong positive return on investment in the long run.
The second strategy, which is skillfully and seamlessly overlaid on the first, is a gambling strategy, having expected zero return, and a cost paid to the croupiers rivaling the house take at any gambling casino in Las Vegas.
The vast majority of advisors and managers recommend not just the first strategy but also the second strategy packaged with it. Recommending both strategies as a package and collecting the large resulting fees is, quite frankly, like taking candy from a baby. Most investors—even those, surprisingly, who are very wealthy—seem totally unaware of what they are paying and equally unaware of the fact that they get nothing for it. On the contrary, they assume, against all the plainly available evidence, that they are getting something of great value.
In maintaining this situation, the community of investment professionals is helped greatly by what I will call "the Big Investment Lie." A Big Lie is a lie so bold, so often and so firmly stated that even in the face of contradictory evidence, people cannot believe anyone would be so assertive if it were not true. Once a Big Lie gains currency, it is repeated by many people, adding to its force.
The investing public has been fooled (and has fooled itself) for a long time by the Big Lie, a lie strongly supported by the investment advice and management professions. As the infamous former leader of Nazi Germany said,
The size of the lie is a definite factor in causing it to be believed, for the vast masses of a nation are in the depths of their hearts more easily deceived than they are consciously and intentionally bad. The primitive simplicity of their minds renders them more easily prey to a big lie than a small one, for they themselves often tell little lies but would be ashamed to tell a big one.
Excerpted from THE BIG INVESTMENT LIE by MICHAEL EDESESS Copyright © 2007 by Michael Edesess. Excerpted by permission of Berrett-Koehler Publishers, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of ContentsPreface
Introduction: Excuse Me, Is This the “Real” World?
Part I: How Much You Pay
1. The Beardstown Ladies versus the Professionals
2. The Extraordinarily High Cost of Investment Advice
3. The Outer Limits: Hedge Fund Fees
4. Taxes Down the Drain
5. Why Do We Give Golden Crumbs to Rich People?
Part II: How Little You Get
6. Why Investment Professionals Can’t Predict Markets
7. The Abject Failure of Professional Advisors and Managers
8. The Market Can Turn on a Dime
9. The Claims of Money Managers: “Smoking Our Brand Prevents Cancer”
10. Idle, Greedy Hands and Too Much Data Do the Devil’s Work
11. The Simple Rules of Nobel Prize Winners
12. There’s No Such Thing as a Free Lunch
13. Investment Genius or the Thousandth Coin?
Part III: How You Are Sold
14. Effective Pitches to Sell the Big Lie
15. How Investors Delude Themselves
16. How Hedge Funds Operate and Are Sold
17. How Consultants and Money Managers Sell to Institutional Investors
18. Derivatives: The Good, the Bad, and the Ugly
19. The Modern Slippery Slope of Business Ethics
Conclusion: The Ten New Commandments for Smart Investing
About the Author