Evaluating Financial Advice: Always Ask “Why?”
Whenever you read or hear some piece of financial advice, always ask “Why?” Because how someone provides information is as important as what the information is. Here’s what I mean.
Pinyo at Moolanomy recently posted about his asset allocation. He was thinking of changing his because of a book he’s reading. In the comments, he writes this:
@hank - that was how I think too, but after reading these books and sites, 100% equity seems very risky now. For example (from Swedroe’s book):
“For the 23 year period 1966-88, the U.S. large-cap growth stocks…underperformed totally risk-less one-month bank certificates of deposit.”
and
“[As of January 2007] the Nikkei Index was still down almost 60% from the 40,000 level it had hit in 1989).”
Let’s take a look at the first quote and ask “why?” The first that jumps out at me is the time frame the author uses. Why does he use this particular 23 year period? It just so happens that during much of that time, the Dow Jones Industrial Average (which I’m using as a proxy for his “large-cap growth stocks”) was essentially flat (see chart below). Meanwhile, inflation was rampant - well over 10% some years. Consequently, CD rates were also running in the double digits for much of this time (see table below).
(click to enlarge image)
(click to enlarge image)
Clearly, the author is selecting a particular time period to illustrate the point he’s trying to make. Why use 1966 to 1988? Slide that time period back or forward or widen the time period and you’ll get a quite different result.
A second ‘why’ might be to ask why he uses large cap growth. Would the results be different if the total market were used? I didn’t check and I don’t much care. The point is, you need to ask the ‘why.’
Now take a look at the second quote. Why does the author use the Nikkei? Why use the all-time high as a benchmark? You get the point.
Don’t just take financial statements at face value. Even if the data is completely accurate, you must ask why the author is using that particular data. That’s the only way to know if something pertains to your situation and if it’s useful to you.
October 15th, 2007 at 10:59 am
Exactly, it’s how to lie with statistics. Or at least present a particular point of view. That’s a good example. The author wrote the question, not just the answer. Unfortunately, when we’re not experts, it can be hard to figure out what we should be asking and where to look for the data.
October 15th, 2007 at 2:41 pm
October 19th, 2007 at 11:43 am
Good point about the fact that writers can select data to support their work and that it should be verified by readers — don’t believe everything you read!
That said, I think the author sufficiently proved his point that the stock market can provide sub-par returns for an extended period of time, so any portfolio should be balanced enough to handle these long periods of low performing market.
October 19th, 2007 at 12:58 pm
@Pinyo - Like I said, I didn’t read the book and I’m sure he’s not preaching some nutty strategy (I’m sure you wouldn’t be reading the book or have mentioned it if he was). I was just using the opportunity to make the point.
October 26th, 2007 at 9:15 am
And your point was a very good one.
December 4th, 2007 at 3:13 am
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