Looking Before You Leap
You learned your lesson. After falling victim to the dot-com delusion of the go-go late '90s, you decided to try to emulate the stock-picking superstars of yesterday who are now back in vogue. Guys like Warren Buffett and Peter Lynch, who compiled legendary investment records by buying and holding on to shares of companies whose businesses they understood and whose books they thoroughly analyzed. But more than three years into a bloody bear market, that sensible strategy probably isn't working for you either. Despite the market's recent revival, many investors will remain impatient until all those battered portfolios are back closer to even.
So it's understandable that you might consider toying with some alternative strategies. Ads and infomercials tout day trading ("it's new and improved!"), technical analysis, no-cash-down real estate, and other ventures. "I think there are a lot of investors who have given up on buy-and-hold and think there has to be another way--a way they can earn 15 to 20 percent a year on their money," says Jeremy Siegel, finance professor at the University of Pennsylvania's Wharton School and author of Stocks for the Long Run. Some of the methods are completely nutty, while others have a nugget of validity. Either way, you would probably be better off taking a pass.
Day tripping. It's tempting to say that day trading is back, but it never really went away. Sure, lots of Web sites disappeared, and traffic in the investing chat rooms is way down since the days when it was pretty easy to day trade because every stock seemed to go up, up, up. Yet there are plenty of investors still hoping a fast-and-furious investment style will drive their portfolios to fat returns. Take Yun Soo Oh Park, for instance. Better known as Tokyo Joe, Park made his name in the mid-1990s on Internet message boards plugging his hottest stock picks, and he later started his own stock advisory service on the Web. In 2000, the Securities and Exchange Commission charged him with defrauding his subscribers through a variety of means, such as inflating his stock-picking record and stock scalping. Park settled the suit without admitting or denying wrongdoing and agreed to pay $755,000.
Click on over to TokyoJoe.com, and you'll find he's still pumping out "stock alerts." E-mailing U.S. News from his base in France "near Monaco," Park writes that business is "very good. I had 6,400 [subscribers] paying $29.99 a month [and] now I have 320 paying $300 a month, one half institutional; pros listen to my picks." He still makes a handful of trades a day and writes that during the past six months his picks "have done no less than 10-500%." Asked if day trading is different now, Park replies, "Sitting in front of a computer all day scalping 10 cents is for monkeys on dope. Only makes brokerage houses rich."
Judging from Park, it's not clear that day trading has changed much. But Baron Robertson, who runs the popular Elite Trader.com Web site (17,041 members, he says) from his headquarters in Orlando, thinks it has. "We have seen a massive shift away from day trading stocks to trading index futures," he says. A popular contract is the "e-mini S&P 500," a futures instrument based on the S&P 500. Volume on the contract has risen 141 percent during the first four months of this year vs. a year ago. One reason investors may be switching, Robertson explains, is that the futures traders aren't subject to the "pattern day trading rule," which says that any customer who frequently day trades must maintain a minimum $25,000 account.
But whether you are jumping in and out of index futures or stocks, academic research indicates that the more investors trade, the worse they do. In their now famous "Trading Is Hazardous to Your Wealth" study of 2000, Brad Barber and Terrance Odean, finance professors at the University of California, found that investors who traded frequently earned an average annual return 7 percentage points lower than those who didn't. And even a full-time day trader like Robertson says it's hardly a sure path. "It's a high-risk endeavor with a chance for high rewards and high losses."
Land grab. What could be a better investment than real estate these days? As the saying goes, they're not making any more of it. Even that isn't necessarily true, given all the recent privatization of government-owned land. Real estate, like any investment, has its complex ins and outs and isn't about getting rich quick. Some real-estate infomercials raise hopes: For little or no money down, you can buy property and instantly start earning thousands of dollars in monthly cash flow--or even become a millionaire! All you have to do is buy some tapes or attend some seminars and put all that transmitted wisdom to work.
That's the promise of the Russ Whitney Web page, which cited the testimonial of a follower who turned $300 into $1 million in just three years. "It's the great American dream to own real estate," says Nancy Holland, senior portfolio manager of the ABN-AMRO Real Estate Fund in Chicago. "It's at the core of who we are. But I think the theme of getting rich quick is also at the core of who we are."
It's that latter dream that drives John Reed crazy. On his Web site (johntreed.com), Reed examines the programs of nearly 120 real-estate gurus, noting any legal trouble--and recommends only 20 or so. All the rest run afoul of his "B.S. Artist Detection Checklist," which includes 41 warning signs such as an "emphasis on no-down, low-down techniques." Reed notes that a no-cash-down deal, for instance, is very rare and usually involves a special situation where a lender feels comfortable making the loan, such as a property with a high-credit tenant like a government agency with a long-term lease. "It is very frustrating when you try to help people, and they say you are stealing their dreams," says Reed, who notes he just wants to shed light on potential scams.
Inflated expectations are at the heart of the real-estate hype. On Robert G. Allen's site, he implies that real estate returns 20 percent a year. That's too high. According to the National Association of Realtors, home prices rose an average of 6.3 percent from 1968 through 2002--per year, not per month. And data from Ibbotson Associates, a Chicago research firm, reveal that real-estate investment trusts have risen an average of 12.25 percent per year since 1972 vs. 10.97 percent for the S&P 500. Nice numbers but not the kind that will make anybody rich overnight. They certainly don't impress Whitney. "Using the techniques we show, you can beat that number [12.25 percent] all day long."
Getting technical. One of the big lessons of the bull market is that many individual investors aren't thrilled about number crunching (not that many Internet stocks had any actual numbers). One alluring alternative is to employ technical analysis, or "chart-reading," which involves tracking a stock's price and trading-volume patterns as a way of predicting future performance. Loads of investing Web sites are devoted to supposedly predictive patterns such as "head and shoulder," "pennants," and "descending triangles."
Does any of this really work? Most academics would just shake their heads (and probably mutter something about "voodoo" or "tea leaves"). Since efficient markets theory holds that a stock's current price already incorporates all information about the stock, there's presumably nothing to be learned by examining past prices. Still, most brokerages employ a few technical analysts. "I think technical analysis can help you spot turns in the market," says Davidson Lowdon, president of BarChart.com. "I think people who had the tenacity to stay with their [technical analysis] systems would have seen the last turn [in 2000]. But it is no panacea, and you can go wrong with it."
There is a smattering of academic research that seems to lend some credence to the method, but the brainiacs behind it are hesitant to advise its use. "There is more to it than the standard academic answer--which is that there is nothing to it," says Blake LeBaron, an international finance professor at Brandeis University. Moving averages, for instance, tend to indicate that there is some momentum for a stock in a particular direction. So it might be one factor in an investment decision. But "I would caution the average investor that these things are difficult to implement and require a good deal of discipline," says LeBaron.
Professionals, for instance, can constantly test and retest their strategies and tweak as needed. The average investor who doesn't want to take the time to read a company report would seem unlikely to do that. Even so, he could fall prey to all sorts of statistical traps. Apply enough trading schemes to 100 years of stock data, and you will surely find some patterns that seem to bring huge returns, yet they may not have the power to predict future returns. It's like a famous 1997 study by money manager David Leinweber, who found that variances in butter production in Bangladesh seemed to predict the direction of the S&P 500. With enough computing power at your fingertips, you can always find a chart pattern that will predict the past. But the future? Don't bet on it.
This story appears in the June 16, 2003 print edition of U.S. News & World Report.