Why Paying for Stock Advice is a Bad Idea

Proj Omni: Jan 18, '17

If investing in stocks is your ‘thing’, at times you may feel tempted to seek advice from self-declared ‘experts’ and people who know more about stocks than you do.  One idea that comes to mind is to consult a stock broker—a person who recommends and trades stocks for living, and has dedicated bandwidth to help clients like yourself.  If that’s an idea you’re entertaining, hit a pause button.  Read the below perspectives on why you should NOT pay for stock advice.

Your and your stock broker’s incentives are fundamentally misaligned.  

Paying an advisor for stock picks is like funding someone to play poker for you, but you bear the consequences.  You pay the broker per round of poker played, not the decisions they made or results they achieved.  A broker’s objective is to maximize the number of rounds played, but yours is to ensure they are making the right moves.  How do you know whether the broker has the right skills and/or judgment to make good decisions for you?  Do they understand your goals and what you’re trying to accomplish with your investments? 

A stock broker can abuse the discretion to churn your account. This involves trading in excess with the aim to boost commissions. Unfortunately, the advisor does this at the expense of your outcomes, since trades can significantly diminish your overall return.  That’s why it’s important to be up to date with what is happening in the stock market and what the broker is doing with your portfolio.

History shows that even famed investors don’t outperform the market in the long run.

The ‘famous investor’ myth is something that continues to occupy the American consumer’s mind.  In the United States we like the culture of winning, and we forget the losses when they occur.  Famed investors are famous because at certain points in time, they outperformed the market.  In fact, they outperformed the market indexes so significantly that they wound up making themselves a fortune, and getting other people to invest in their funds (which ironically pays future dividends).  The one thing that the retail investor forgets is that even famous investors such as Warren Buffett don’t outperform the index in the long run.  Berkshire Hathaway, which is essentially an actively managed portfolio of public and private companies, is losing out to the S&P 500.  But somehow investors don’t register that. 

The irony is, what you need to get rich as a hedge fund manager is: 1. A noticeable asset base to start with, which you can then put to work/invest; 2. Success (i.e., exceeding the overall market return) in a year or two, so you can then charge a performance fee.  (The performance fee, structured as an allocation of partnership profits for tax purposes, has historically been 20% of each investor's net profits for each calendar year.  The asset management fee, which generally runs between 1% and 2% of the fund’s net assets, and is typically used for fund’s operational expenses).  If you strike a homerun in the beginning, you can then underperform for many, many years, and you may still maintain your brand equity—as is the case with Buffett.    

What should you do if you still want good stock advice from ‘professionals’?

If you have the time, you may want to try doing stock research yourself.  Understand the fundamentals, read the news and review blogs and opinions.  That way you’ll teach yourself a bunch and get ready to make ‘better’ stock picks (if you believe that’s doable). 

If you don’t have the time, you should pay someone to do the research for you and give you the scoop.  As always, you’ll need to communicate precisely what you need, and what your expectations are.  Pay them per work product or by the hour (if they know exactly what they need to deliver, and you have full confidence they are working efficiently and maximizing the use of their time).      

In conclusion, the stock market ‘experts’ aren’t really experts at all.  They may be able to get lucky over a short period of time, but the longer they invest, the less likely they are to continuously beat the market.  Even Warren Buffett says that most investors should choose index funds.  So be careful about paying stock brokers for advice.  Instead, invest your time in researching stocks you may want to invest in, or pay someone to do the research for you (if your time is scarce, and you still want to invest in individual stocks).    



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