About six months ago a friend of mine in the arts world who knows absolutely nothing about finance inherited eight hundred thousand dollars. To “Steven” (and his new wife) this was a significant amount of money. They could finally afford to buy a house.  Steven reckoned he would put  $200,000 of the inheritance towards a $700,000 house — mortgaging the remainder. He could then get the remaining $600,000 to  “work” for him. He met with three financial planners and then called me up to ask my opinion.

  • Financial planner A had  told him he could achieve 5% per year.
  • Financial planner B had told him he could achieve 8-10% per year.
  • Financial planner C had told him he could achieve 12-15% per year.

This is what I told him:

I was skeptical of the property market, but since ownership was their priority and the two of them did not have a consistent income I suggested he put $600,000 to the house.  I didn’t want him worrying about the mortgage. I reckoned that if he really felt the need to make the rest of his money “work” for him, he could invest half of the remainder in stocks. I figured it would do him some good to lose some of his money in the markets. That is because it’s better to lose a little bit of it sooner than a lot of it later.

Oh and I also told him that financial planner A sounded sensible, B was exaggerating slightly and C was a liar.

In my years in the industry, I can count on one hand the number of people who have convinced me that they have “it” — “it” being that special gift of timing the market. I don’t include myself in that category. For the 99.999% of investment professionals like me who don’t have ‘it,” we can take solace in the fact that we could still get rich by convincing others that we know what the market will do (as opposed to getting rich from knowing what the market will do).

The discovery that Bernie Madoff’s superior hedge fund “returns” were hocus pocus is a good reminder of this. A lot of retail investors aren’t particularly concerned by this event, because they don’t think it effects them. This is short-sighted. I expect this fraud will accelerate redemptions at hedge funds. This effects all of us because increased redemptions means increased selling of assets by hedge funds which means more market weakness.

It’s time for investors to start using their own heads and to stop caring what others say, whether it’s promises of investment returns or forecasts on the market: