One Phrase That Will Make You a Smarter Investor

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Financial Planning
Christopher Futcher/Getty ImagesYou'll succeed in investing if you do your research first.
By Daniel Solin

Few can forget the iconic phrase in the movie "Jerry Maguire," when Tom Cruise says, "Show me the money!" Here's a similar mantra that will change the way you invest: "Show me the evidence!"

A cursory review of what passes for "financial advice" demonstrates the importance of following this mantra. Here's a sampling:

Pimco's advice. Virginie Maisonneuve, deputy chief investment officer and global head of equities at Pimco, recently provided her views on the long-term outlook for the stock markets. Among the "key takeaways" was her advice that in order to get "alpha," investors should focus on growth areas that will benefit from solid fundamentals. These "growth areas" include regions, sectors and companies. Ms. Maisonneuve also advised investors to "focus on super-secular trends that will be drivers of growth or change over the long-term horizon." Candidly, I am not certain what that means, but I believe Maisonneuve is advising investors to engage in trying to pick sectors and stocks that will outperform the market.

The evidence: At best, stock-picking is an elusive (if not nonexistent) expertise. A 2010 study called "False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas," by Laurent Barras, Olivier Scaillet and Russ Wermers analyzed the performance of 2,076 mutual fund managers over a 32-year period. It could not find evidence of stock-picking expertise in 99.4 percent of these managers. If this is the track record of professional fund managers, how do you like your chances?

Trying to pick a sector that is likely to outperform is also very risky business. According to Morningstar, the volatility of the average technology fund (as measured by standard deviation) is almost twice the level of the Standard & Poor's 500 index (^GPSC).

The sheer number of sector funds available, which span eight different Morningstar (MORN) categories, make the odds of picking a "winner" daunting. By investing in a broadly diversified stock fund -- like the Vanguard Total Stock Market Index Fund (VTI), you would have exposure to most major U.S. industries. Why should you speculate with a sector fund?

Learning from Dr. Andrew Lo: It would be difficult to find someone with more impressive credentials than Andrew Lo. He has a bachelor's degree in economics from Yale University and holds a doctorate in economics from Harvard University. He is a professor of finance and director of the laboratory for financial engineering at the MIT Sloan School of Management. He has published many impressive articles on finance in peer-reviewed journals and is the recipient of numerous awards for his scholarship.

%VIRTUAL-article-sponsoredlinks%The evidence: According to a Business Insider article by Joshua Brown, an investment adviser, Dr. Lo is the principal in a fund called ASG Diversifying Strategies Fund. The fund uses many different approaches in the management of its assets, including derivatives and diverse "trading methodologies." According to Brown, since its inception in August 2009, the fund lost money in both good and bad years. Brown computes its compounding loss to be around a decrease of 7 percent a year since 2010. In 2010, a banner year for the market, it was up 8 percent. The S&P 500 index returned 15 percent. In the year to date, it's showing a negative return of 0.73 percent, even though almost all asset classes are showing positive returns.

Investors in this fund are paying dearly for this dismal performance. Mr. Brown computes its net internal expense ratio as being close to 2 percent of assets. Brokers who sold the A shares of this fund were paid 5.75 percent upon purchase.

Do you believe you are smarter than Dr. Lo?

The Dennis Gartman story: Dennis Gartman is the editor and publisher of The Gartman Letter. He is a frequent contributor on CNBC and Bloomberg TV, where he dispenses opinions about the direction of the markets and the future price of various commodities. He has been publishing his investment newsletter since 1987. Clients of his newsletter include many of the leading banks, mutual funds, hedge funds, energy trading companies and grain trading companies, to name a few. I assume these and other subscribers find his views of value.

The evidence: In an article published in The Wall Street Journal last week, Gartman admits his predictions about an imminent stock market correction were "wrong ... badly." He described himself as "going from nicely bullish to neutral sometimes and every time I turn neutral I wish that I hadn't." He conceded that it was "silly" for him to think that he could call a correction. He concluded that "the market will correct when it corrects. That's what I've learned in my 40 years in the business."

The track record of The Gartman Letter is probably no better or worse than other investment newsletters. A seminal study, "The Performance of Investment Newsletters," published in October 1998 analyzed the performance of all investment newsletters tracked by the Hulbert Financial Digest. The study found an "inability of newsletters to beat market averages."

The takeaway: You may be surprised when you ask your broker to justify his or her recommendations with peer-reviewed evidence. After getting over the shock that anyone would question his or her judgment, the answer most likely will be, "There is none."

If this happens to you, consider the sage advice of William Bernstein, one of the most prominent financial theorists of our time. Bernstein just published a gem of an e-book, "If You Can: How Millennials Can Get Rich Slowly." He counsels millennials to avoid all stockbrokers, all full-service brokerage firms, all newsletters, all advisers who purchase individual securities and all hedge funds.

Bernstein offers sound, evidence-based advice on investing. It is applicable to all investors. The 99 cents you'll spend on his book may well be the best investment you will ever make.

Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book, "The Smartest Sales Book You'll Ever Read," has just been published.

12 PHOTOS
10 Cities Your Financial Adviser Is Begging You Not To Retire To
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One Phrase That Will Make You a Smarter Investor
  • Cost of living -- 114.1
  • State tax burden -- 8.4 percent
  • Median house price -- $377,625, per Zillow.com
  • Climate -- 69/39 January, 105/75 July
  • Traffic congestion -- Didn't make the Forbes list
Scottsdale is a retirement mecca, with a reasonable cost of living, state and local taxes well below the national average, a great quality of life and plenty of amenities. But housing costs are nearly double the national average. Winters are warm, but summers are sizzling hot. Peak temperatures can reach close to 120 degrees -- after all, it's in the desert. The locals will dismiss it as "dry heat," but that kind of heat will still send your electric bill for air conditioning soaring, and can necessitate you buying new cars more frequently than you'd like.
  • Cost of living -- 130.0
  • State tax burden -- 9.3 percent
  • Median house price -- $417,600, per Zillow.com
  • Climate -- 74/64 January, 89/80 July
  • Traffic congestion -- Didn't make the Forbes list

Key West offers Caribbean weather in the U.S., an attribute that makes it a natural choice for retirees. And who could resist the Jimmy Buffett-Parrot Head thing, especially once you're living a life of leisure? 

You might be better off if you resist. The cost of living is 30 percent higher than the U.S. average, and housing costs at least twice as much. Travel is another issue. Key West is the most remote location in the continental U.S. The only road off the 6-square-mile island is the Overseas Highway, a 127.5-mile causeway that is largely one lane in each direction.

Hurricanes -- all too common in Florida -- are rare in Key West  -- though Wilma did hit it in 2005. But when they do impact the island, though, it's worth noting that the city has the Atlantic Ocean on one side and the Gulf of Mexico on the other, and there's no part of it that's more than 18 feet above sea level. So homeowners must pay several thousand dollars a year for hurricane insurance.

  • Cost of living -- 132.3
  • State tax burden -- 11.2 percent
  • Median house price -- $482,000
  • Climate -- 66/50 January, 77/67 August
  • Traffic congestion -- Didn't make the Forbes list
As big California cities go, San Diego is a bargain. But compared to the rest of the country, San Diego is certified high-cost. Yes, the weather is near perfect year-round. But the cost of living is one-third higher than the rest of the country, and house prices are nearly 2½ times the national average. Add in California's high state and local tax rates and the earthquake issue, and San Diego should be crossed off your list of potential retirement cities.
  • Cost of living -- 165.7
  • State tax burden -- 10.2 percent
  • Median house price -- $680,000
  • Climate -- 80/66 January, 88/75 July
  • Traffic congestion -- Second worst gridlock in U.S.
Can you imagine a more idyllic place to retire than Honolulu? Probably not. But as beautiful as it is, it shares many of the financial strains common to other cities on this list, plus a few more.

The overall cost of living is second only to New York City. After all, most of the goods people need have to be shipped across thousands of miles of ocean. The state tax burden is only slightly higher than the national average, but the median house price is triple the national average.

Finally, as far as cost of living is concerned, Honolulu has an unusual financial issue: travel expenses. Sooner or later, you'll want to get away from Hawaii. And there's no cheap way to escape from this paradise.
  • Cost of living -- 164.0
  • State tax burden -- 11.2 percent
  • Median house price -- $860,000
  • Climate -- 57/46 January, 70/55 September
  • Traffic congestion -- Third worst gridlock in U.S.
San Francisco frequently makes those "favorite cities in America" lists and for good reason. Situated on a peninsula between the Pacific Ocean and the San Francisco Bay, it is one of the most scenic cities in the world. Mild weather year-round, world class cuisine, charming neighborhoods and an eclectic population make it one of the most desirable places to live anywhere in the world.

But it has the highest median house prices in the country, which should scare off retirees. Its cost of living trails only New York City and Honolulu. And like the rest of California, its state and local tax burden is second only to New York.

One other reason people might avoid living in San Francisco is that it's prone to earthquakes. While that's certainly a concern for personal safety, few people from non-earthquake prone areas realize how it increases your cost of living. Homeowners need to pay several thousand dollars per year for earthquake insurance.
  • Cost of living -- 140.1
  • State/district tax burden -- 4.0 percent on first $10,000 and up to 8.95 percent on income greater than $350,000 in D.C., 10.2 percent in Maryland, 9.3 percent in Virginia
  • Median house price -- $395,000
  • Climate -- 43/29 January, 88/71 July
  • Traffic congestion -- 10th worst gridlock in U.S.
Washington is centrally located, is filled with historic attractions and has some of the most beautiful neighborhoods in the country. It also has one of the highest effective local income tax rates in the country. The district taxes the first $10,000 of income at 4 percent, then 6 percent to $40,000, then 8.5 percent on all income over $40,000 (you can exempt up to $3,000 in retirement income).

Like other cities on this list, Washington sports a high cost of living and some of the highest housing prices in the country. The area also has its share of toll roads, and traffic is a recurring problem. This is especially troublesome during the holidays and summer months. Interstate 95 -- which bisects the metro area -- is the principal travel corridor between the Northeast and Florida. Making traffic matters worse: the near-permanent road construction projects.
  • Cost of living -- 136.4
  • State tax burden -- 11.2 percent
  • Median house price -- $456,000
  • Climate -- 68/48 January, 83/64 July
  • Traffic congestion -- Worst gridlock in U.S.
As recently as the 1970s, Los Angeles was widely viewed as the city that all America was looking to move to -- or at least to imitate. Perfect weather, endless beaches, palm tree-lined streets, plentiful housing, a powerhouse economy and the lure of rubbing elbows with a celebrity or two. Today, about the only things L.A. has going for it are near-perfect weather and In-N-Out Burger. The rest is mostly a faded memory. The city's success was, in fact, a key contributor to its decline: The near-doubling of the metro population since the 1970s has created East Coast levels of human congestion.

Property values are higher than New York's and nearly twice those of Chicago. The state and local tax burden in California is second only to New York, and the overall cost of living in L.A. is more than one-third higher than the national average. California's unfunded pension liabilities are nearly as high as those in Illinois, threatening serious tax increases that could squeeze retirees. Nagging quality of life issues include the worst traffic congestion in the nation and smog that could lead to higher medical costs.
  • Cost of living -- 132.5
  • State tax burden -- 10.4 percent
  • Median house price -- $370,000
  • Climate -- 36/22 January, 81/65 July
  • Traffic congestion -- Ninth worst gridlock in U.S.
Boston is the quaintest large city in America, sporting centuries-old but impeccably maintained architecture, neighborhoods and surrounding communities that just ooze with charm and close access to the beaches of Cape Cod and the mountains of Vermont and New Hampshire. If Boston were a less expensive place to live, it could well be an popular and smart retirement destination.

But it isn't. The high cost of living and high housing prices are the main reasons cited by former residents for leaving the state. The state tax burden is higher than the national average; the cost of living is about one-third higher than the national average; and house prices are nearly double the U.S. median. Translation: a large chunk of your retirement income would be spent just covering basic living expenses.
  • Cost of living -- 116.9
  • State tax burden - 10.2 percent
  • Median house price -- $247,000
  • Climate -- 32/18 January, 84/68 July
  • Traffic congestion -- Didn't make the Forbes list
Based on the numbers, Chicago wouldn't seem to be the retirement financial disaster that other cities on this list are. The state tax burden is only slightly higher than the national average; the cost of living is tolerably higher than the U.S. average; and house prices -- while higher than the nation in general -- are downright affordable compared to the coastal cities.

However, in addition to being a generally more expensive place to live than the nation at large, the area faces burgeoning problems just over the horizon. Illinois faces the highest unfunded pension obligations of any other state in the country, at around $100 billion. Chicago faces a nation-leading $20 billion unfunded pension liability. Such deficits scream out for higher taxes across the board. We can only speculate as to which taxes will be raised (or created).
  • Cost of living -- 216.7 Manhattan, 145.7 Nassau County
  • State tax burden -- 12.8 percent
  • Median house price -- $972,000 Manhattan, $440,000 Nassau County
  • Climate -- 38/27 January, 84/69 July
  • Traffic congestion -- Fifth worst gridlock in U.S.
The area has fantastic amenities -– theater, music, concerts, festivals, ethnic foods, diverse and quaint neighborhoods and close access to beaches and mountains. It also has probably the most comprehensive public transportation system in the U.S. But it breaks down spectacularly when it comes to the costs. The area has close to the highest cost of living in the country, which gets markedly worse the closer you are to Manhattan. House prices are out of sight, particularly in the more desirable communities and neighborhoods. New York State has the highest state and local tax burden in the country. New Jersey has the highest real estate tax burden in the country. And nearby Connecticut isn't much better.

Weather runs from winter-time deep freezes to protracted summer heat waves. The preponderance of bridges, tunnels and their tolls -- as well as antiquated roads running through quaint town centers -- makes congestion a constant problem, even on the weekends.
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