Yahoo Finance Learn From This New Low in Financial News
I woke up on Dec. 14 to this stunning headline in the New York Post: "High school student scores $72M playing the stock market."
It was a sensational story. The story was sourced to an original report in New York Magazine that reported Mohammed Islam, a 17-year-old student at Stuyvesant High School, was "rumored" to be worth $72 million. How did he amass this fortune? He did so by trading stocks part-time on his lunch breaks.
Islam, who was described as "shy and modest," would only confirm his net worth as being in the "high eight figures." The New York Post article referred to him as "the teen wolf of Wall Street." With his massive winnings, Islam bought a BMW and rented an apartment in Manhattan. These possessions justified the colorful description of him as a "cherubic prodigy... living, and dreaming, large."
Islam didn't have ordinary dreams. He and his friends intended to make $1 billion "by next year," all while attending college. My first reaction was skepticism. There was nothing in either the New York Post or New York Magazine indicating these claims had been verified.
On Dec. 16, New York Magazine issued an apology to its readers, acknowledging it was "duped" by Islam. In a statement, the magazine conceded: "Our fact-checking process was obviously inadequate; we take full responsibility and we should have known better."
The original story concerning Islam garnered extensive coverage in the financial media. The fact that such an outrageous claim would be taken seriously is shocking, given its inherent implausibility. In an article for MarketWatch, Steve Goldstein demonstrated the compound annual returns Islam would have needed to earn in order to generate $72 million in gains. Assuming he built his fortune over an eight-year period, and started with $10,000, Islam would have had to earn an annual return of 203.5 percent. The compound annual growth rate of the Standard & Poor's 500 index over the same period was 6.59 percent.
The need to believe in financial gurus. Investors can be extremely gullible in financial matters. They have a deep-seated need to believe someone can make order out of chaos. How else can you explain the popularity of CNBC, Jim Cramer, hedge funds, technical analysis and software that will tell you when to buy and when to sell? Many investors engage in the perpetual search for a guru or the right technology able to help them "beat the market." The search is rarely successful.
Beware of gurus with impressive credentials. Many self-anointed "financial gurus" do have a few credentials to back up their exalted status. When their backgrounds are impressive, investors are more likely to believe they have the expertise to deliver outsize returns.
Andrew Tsai is a physicist turned hedge fund manager. My colleague, Larry Swedroe, wrote an insightful blog post for CBS MoneyWatch about the returns Tsai generated as chief investment officer of Chalkstream Capital Group. Tsai had an impressive list of clients in his hedge fund. Most were partners and executives at other hedge funds and major banks, or asset managers who were investing their personal funds. It would be difficult to imagine a better endorsement for a hedge fund manager.
From 2003 through 2012, Chalkstream posted annualized returns of 5.6 percent. Those returns underperformed every major stock asset class. They also underperformed an all-stock portfolio divided equally between domestic and international equities and a portfolio with 60 percent of assets allocated to stock and 40 percent allocated to bonds.
In 2008, when the markets tanked, investors in Chalkstream got clobbered, losing 44 percent. Investors who thought an investment in this fund was a "hedge" against losses in a falling market must have been very disappointed.
The takeaway. The financial media is always quick to anoint the next financial guru, often without doing even modest fact-checking or analysis. The reality is that identifying prospectively those fund managers who can "beat the market" is a very daunting task. Don't fall into the trap of believing there is a correlation between high intelligence and "guru" status. As Swedroe noted, "being smart isn't enough to generate market-beating returns."
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is "The Smartest Sales Book You'll Ever Read.
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