Offering the wrong investment advice to the public to invest their hard-earned money is much worse than providing random trading tips to market speculators. The impact of wrong decisions on the former group can be devastating especially near retirement age.
- Most popular investment portfolios are data-mined with performance depending on specific market regimes
- Strategic allocations must be treated as timing strategies from the point of view of minimizing bias and validation
In financial and social media there is usually a focus on trading tips provided by shady operators often with the intention to pump and dump a penny stock or profit from introducing broker fees and order flow. While exposing those that promise high returns is good, there is little or even nothing mentioned about those who provide advice about investing in all sorts of portfolios and schemes, strategic or tactical. Here is why in my opinion a focus on the latter group is much more important:
Speculators that follow trading tips are a much smaller group on the aggregate than investors. They are usually younger people who miscalculate their chances of windfall profits but some are aware of risks. Most are also trading small accounts and take high risks in hope of quick riches from trading speculative markets like forex, penny stocks and more recently cryptocurrencies.
The important consideration here is that most of those reckless speculators will be ruined, never come back to the markets and in most cases they will have time to recoup their losses and invest in more traditional schemes, such as the 60/40 portfolio or in other more conservative and diversified portfolios that have growth potential.
But investors, especially those near retirement age, do not have the luxury of time. Time is the most valuable commodity for them in conjunction with investing. If a portfolio drops in value significantly, there may be not enough time to recoup the losses.
Therefore, while exposing shady trading operators is important to reduce their impact on speculator losses, it is maybe way more important to focus on the type of advice investors get from the various books, articles, magazines, websites, or even social media posts.
One example is the traditional stocks/bonds portfolio allocation. There are firms that have numerous variations of this portfolio according to investment age: for example,more emphasis on stocks for younger investors that gradually transforms to a focus on bonds for older investors. This is fine provided the future will be similar to the past but if a major regime change occurs and both bonds and stocks fall at the same time, investors in a late stage can end up in a big hole.
I have written about the risks of the 60/40 portfolio for example in another article. This is a quote:
Correlation of the 60/40 portfolio with stocks is 0.88. This portfolio offers no protection to investors in case of a large stock market correction. The sales pitch about the effectiveness of this strategic allocation is based on the assumption that money will flow from stocks to bonds in bear markets.
The future may no resemble to the past. Anyone providing advice to people to invest their hard-earned money must understand all the alternative scenarios. If there is no such understanding in depth, then the adviser may be way worse and dangerous than a scammer offering penny stock tips due to the larger impact.
Investment portfolios and data-mining bias
Many portfolios suggested in popular investment books and articles could be the result of data-mining and rely on the assumption that the future will be similar to the past.
For example, let us look at the famous “All Weather” portfolio with the following ETF allocation:
Since 2015, this portfolio has under-performed SPY total return by a significant 8% on an annual basis as shown below:
Investing in this portfolio has covered inflation and fees but there is little growth. In contrast, investing in SPY total returns has delivered significant returns.
There are at least two reason of the under-performance of the All Weather portfolio:
- A market regime change
- Data-mining bias
Markets have changed since the financial crisis and the introduction of quantitative easing. It is highly possible that the above portfolio was data-mined and although in the past it has delivered superior risk-adjusted returns, changing market conditions have contributed to its recent severe under-performance.
The question that arises here is the following: how many investors have been adversely impacted by portfolios suggested by market professionals versus speculator affected by trading tips issued by naive speculators and scammers? Is it maybe time to raise awareness that schemes presented as solid investments must be scrutinized in the same or even more rigorous way as random trading picks offered to speculators are?
In fact. any portfolio that is designed based on past data is no different in this respect than any data-mined strategy developed by a quant. This must be understood and the standards of validation that apply to trading strategies must be extended to investment portfolios, something that is rarely done, and this is the message of this article. Strategic allocations must be treated as timing strategies from the point of view of minimizing bias and validation.
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