Can you predict the future?

A lot of investors don’t realize the importance of this question. If you cannot predict the future to a significant degree, and you sell stocks before you need the money in retirement, it is extremely unlikely that you will retire earlier--or have a higher net worth--than someone who does not so sell stocks. This is because you must be able to predict stock price changes to make a profit after paying the transaction costs involved in selling them and buying replacement stock.

The US stock market has performed 7.5% on average since 1930. It can cost 1% of your investment in average transaction costs to switch stocks. If you can’t predict the future then every time you switch stocks you reduce your average gain below the 7.5%, and the reduction compounds. This is why almost all day-traders whittle away their initial investment toward zero, learning this lesson the hard way.

Now suppose you fancy yourself on par with Warren Buffet, who has shown that he can beat the market average. If you can prove it to someone else then get thyself posthaste to Wall Street, where you will be paid $1 million+ annually for being right just 51% of the time. That’s how few people can do it! Only then invest your excess salary in the market. Until then, stay away from stocks except for a tax-deferred index fund (they don’t try to predict the future, which keeps transaction costs low).

 

Log in or Sign up to hide all adverts.

Well, it depends on what you mean. It's generally accepted that it’s impossible to (legally) predict what will happen to stock prices in the immediate future. On the other hand, certain kinds of investments – like investments in small-market index funds – have always provided a good return over long periods of time. Small market index funds will fluctuate from year to year, sometimes rising in value and sometimes falling, but over a span of 10 or 20 years they will always end up being worth a lot more than when you bought them. You only need to worry about 'predicting the future' if you plan to buy specific stocks and only hold them for a very short time before selling them.

 

Log in or Sign up to hide all adverts.

Zanket, so your telling me to hold my stocks until retirement, how long have you been an "investor"? A dollar invested today could very well be worth one cent or less at any given point in the future with no prospect of ever rising again. IMO anyone that takes investment advice from a forum such as this needs their head examined. Talk to a stockbroker it doesn't cost anything!

 

Log in or Sign up to hide all adverts.

kazakhan:

And just how good was the advice Martha Stewart got from her stock brocker?

zanket:
Transaction fees can be much less than 1%. Scott Trade charges only $7 per trade which is only 0.25% of $2800. I personally trade with a company that offers trades at $0.01 per share.
Index funds are good but "Spider" stocks such as SPY are an even lower cost way to invest in the market without picking stocks. SPY matches the Standard and Poors 500 Index. By the way if you can not perdict the future what is this talk about retiring. Sounds like a perdiction to me.

 

Yes, that’s the 7.5% average I mention; the long-term upward trend in a broad market index. The 7.5% is for the Dow Jones Industrial Average. Of course there’s no guarantee but it’s a good bet you’ll get a higher return on a stock index fund than the majority of investments. If you cannot skillfully predict the future then any selling in your portfolio reduces your return to below average. That’s why you shouldn’t sell until you need the money to spend elsewhere.

 

20 years.

If you know what to believe, you’ll get the best advice from a forum such as this. Stockbrokers have the opposite incentive. I once worked for a company in the business of defending stockbrokers in lawsuits brought by their customers. The brokers used every trick in the book to churn the account; that is, buy & sell as often as possible. The broker makes more money in fees that way. The best investing advice, buy & hold until retirement, pays the broker the least. Not even books have the incentive to impart that advice, for the book would be only 1 page long!

 

The transaction cost I speak of includes the spread cost, which is ignored by the common investor. By far the greatest cost of buying & selling stock comes from the spread, the difference between the bid and the ask price. Indeed, during the market heyday circa 1999 there was some talk of brokers charging no commission at all; they’d make it up in spades on the spread. They decided to not do it I think because it would have revealed to the general public that there’s a hidden cost.

A simple example of spread is buying a new car. It’s worth less than what you paid the moment you drive it off the lot. The difference between what you paid (the ask price) and what it’s worth when you drive it off the lot (the bid price) is a transaction cost.

While Scott Trade charges you only $7 per trade commission, they get a kickback from the floor specialist (the actual trader at the exchange) of say $25. The kickback is only a portion of the spread, the remainder of which the specialist keeps. The whole spread comes out of your pocket. To figure out the true transaction cost on a stock, calculate how much money you would have left over if you bought it at the ask price and immediately sold it at the bid price, after subtracting commission. Higher volume stocks typically have lower spreads, so they’re cheaper to buy & sell.

Agreed. This is an exchange traded fund (ETF). Many advantages including that you are not subject to capital-gains taxes (in the US) when other fund members make withdrawals. Now with the mutual fund skimming scandal the ETFs look even better.

I call it planning. I could die before retirement age, but I plan for the possibility of retiring. I plan for the possibility of early death too, e.g. life insurance. If I were making a prediction I’d bet one way or the other, not both.

 

Zanket:

There are no specialists in the NASDAQ and I am really not sure how they work on the NYSE, however, it looks like the NYSE is thinking about doing away with them. When we as small investors buy stocks we can use "Limit" orders so that we can purchase the stock at the bid price and sell at the ask price. I may be wrong but in electronic based trading I think the only advantage institutional traders may have is that they can see more of the unfulfilled orders waiting for a change in the price.

 

NASDAQ calls them “market makers.” This page concludes: “So, what's the main difference between a specialist and a market maker? Not much anymore.”

That’s a common misconception. You can’t avoid paying the spread; after all, that’s how the middlemen make their money and there are no free lunches. With a limit order, at best you pay only the full spread plus commission. At worst you are scammed. At best, if you place a limit order to buy at $30, say, then your order will not be executed until the ask price reaches $30, at which time the bid is $29.875, say, for a spread cost of 0.4%. At worst, an unscrupulous broker will not buy the stock on your behalf until the ask price reaches $29.875. The broker then charges you $30 to double your spread cost to 0.8%.

Additionally the specialists keep an eye on limit orders and try to manipulate the price to maximize throughput. The higher the volume, the more spread fees they make. Suppose the stock is at $30.25 and there are thousands of limit orders to sell at $30. Although there is no outright collusion, the floor traders have a common incentive to get the bid price to drop to $30 so they can capture those orders and increase profits. If you must use limit orders, then, beware. I’d trust only a market order and expect it to execute within 2 seconds or so.

 

Buy LOW


Sell HIGH


That's my prediction and I'm right all of the time, well most of the time anyway!

Please Register or Log in to view the hidden image!

 

Most reputable money managers will tell you that buy and hold is no longer the right strategy for investing.

The right strategy is to periodically reassess your risk tolerance and find a good professional accordingly to invest for you. Investing on your own is more like gambling than investing, unless you are willing to quit your job to daytrade full time.

 

"Every man & his dog" has their opinions on investing so at least seek professional help before plunging/moving your life savings. My point about stockbrokers was that it doesn't cost anything to call one & ask a few questions about the market/investing/particular company you may be interested in etc. IMO Marthas problems are because she screwed herself. The stockbroker I've used in the past has never said "buy this, sell that", I usually get an overview of his companies reports of a particular stock it's up to me what I do.

 

What good is a company report when neither you nor your broker can predict future price changes of the company? The problem with professional help is that they don’t make money unless you lose money, assuming he or she cannot predict future price changes. The market is a zero-sum game. If no prediction--and only a handful of people in the history of man have shown they can do it to a statistically significant degree--then the best return/risk is had by investing in hundreds of stocks at the lowest possible cost (the economist who figured that out won a Nobel for it). That is easily done on one’s own, by buying SPY (the exchange-traded stock representing 500 stocks) or by investing in an index mutual fund. Don’t sell until you need the money.

Seeking a stockbroker’s FREE advice is like getting a FREE inspection from a plumber. They will ALWAYS recommend that you use their service. This is why every stockbroker and every money manager will tell you that buy & hold is no longer the right strategy for investing. It never is for these guys. How else are they going to eat?

Don’t take my word for it. Test the broker. Ask them to make predictions whether a stock price will go up or down. Track their performance of many stocks over time. If you find that they cannot predict, then contemplate how valuable their advice is. I tell you that if they cannot predict, their recommendations are worth precisely nothing! What you will find instead is that no broker will take you up on this offer, because all but the dumbest of them know that they offer only value perceived, not real value.

Investing on your own is the pinnacle of investing if you diversify among large companies and never sell until you need the money. You are gambling if you ever sell beforehand. Buy & hold investing takes only 15 minutes a month so there’s no need to quit your job. The odds are billions to one that your gains will exceed the average day trader’s ten years hence.

 

predicting the future is a very very small part of investing.

 

Other than the mundane stuff like opening an account and buying shares, what else is there about investing that involves a broker?

 

You are confused between investing and gambling.

Investing is all about financial management. Predicting the future is a very small part of management. A big part of management is managing the risks.

Buying stock is buying a piece of a company. You need to make sure the company has good management team in place, good organizational strategy, sound business model, good cashflow, high assets low debt, etc.... It takes a lot of research and inside knowledge. A well managed company with solid fundamental is going to grow. No crystal ball is required.

Not all companies are in growth mode anyway. Some stocks are bought because of dividends. No crystal ball is required either.

 

Managing risk requires only buying & holding all highly liquid stocks. That’s all there is to it. It doesn’t require an MBA or outside help. It is mathematically proven that, in an unpredictable market, the portfolio that contains all stocks offers the highest risk-adjusted reward in the long term. A stockbroker or money manager will not offer value in managing risk or provide any useful info about a company that you cannot look up yourself on Yahoo.

You do not need to know that the company has a good management team in place, good organizational strategy, sound business model, good cashflow, or high assets low debt, unless you can use that info to predict future price changes in the company’s stock. If you can’t predict to a statistically significant degree--and only a handful of people in the history of man have shown that they can--then all that research and inside knowledge is exactly useless.

I agree that a well-managed company with solid fundamentals is likely going to grow, but is the average such company going to beat the market average? No. If it did, then thousands of people at least could be expected to have beaten the market average to a statistically significant degree by investing so simply. But that hasn’t happened. One problem is that well-managed companies with solid fundamentals don’t stay that way forever, and mismanaged companies with poor fundamentals can turn around, and you cannot predict what on day it will change. The solid company's stock sells at a premium to the mismanaged company's, making them equal value on average. If you get dividends you’re effectively selling part of the stock (it reduces your long term average gain below the market average). You’d want to do that only if you need the money.

If you aren’t clairvoyant, all you need to know about a company is whether billions of dollars’ worth of its stock has been floated to the public; that is, is it a highly liquid stock? All S&P 500 stocks qualify. If yes, then add it to your portfolio if you can buy it at a low spread as described above. Since spreads are themselves unpredictable, it’s best to buy into a popular large-cap (highly liquid stock) index fund or the SPY or other broad-market exchange-traded fund described above.

The bottom line is, if you try to predict future price changes and you are wrong like the other 99.99999% of people have been wrong about their clairvoyance, the costs of switching stocks will reduce your odds of matching the market average from approaching 100% to approaching 0%. If you switch stocks even a couple times a year, it is extremely likely that in ten or twenty years your return will fall significantly below the market average, in which case you under-performed the buy & hold investor who did no research. Switching stocks is gambling because it assumes clairvoyance that presumably does not exist. The pinnacle of investing does not include gambling, so the pinnacle of stock market investing is buy & hold.

 

My Bachelor's degree is in Finance, and I made straight A's, and I have been investing in the market for 15 years, and I have no idea what the hell you are talking about.

Sounds like you lost your ass on some stocks Z.

 

If you have been switching stocks (not buying & holding) for 15 years and have exceeded the market average that a buy & hold investor can get with no research, you have beaten extremely high odds against you. Is that simple enough?

If you have a finance degree, surely you learned about the efficient market theory (random walk) and modern portfolio theory (diversification). They taught that to you, right?

Nope, I’ve gotten the market average in stocks. As close as one can expect to get to it with an index fund anyway.

 

One of the funniest moments of my college years: A certain PhD was teaching us about the dividend re-investment model of stock valuation, and I brought up a certain stock that I owned (MSFT) and explained that it was one of the best performing stocks of that fiscal year, and yet it paid no dividend. Obviously if the dividend factor is 0 in the equation, the equation breaks down. Predictably, I was met with a change of subject, much like the trend on this forum when a posters argument is met with completely objective data. From the subsequent exchange following my question, I realized that even a so-called "expert" on a subject can often be lost in book-learning and have no real expertise in the current reality of a given subject. Not a bad lesson to carry with you throughout life, imho.

I'm a fundamental analysis guy, but for everyone like me, there is a technical analysis guy that can prove his methods as being profitable. Such is investing.