In his investing classic Market Wizards and its sequels, Jack Schwager profiled some of the world's most successful money managers. The books are a monument to the wisdom of certain investors, and how they've been so successful over long careers.
In his new book, Market Sense and Nonsense, Schwager essentially takes the opposite approach --focusing on common mistakes investors make and some commonly held views that are just plain wrong.
Among the most common mistakes and misconceptions:
Momentum Begets Momentum: "Past performance is no indicator of future returns," isn't just a legal disclaimer used by mutual funds; it's also a good rule for investors to live by, says Schwager, who co-manages the ADM Investor Services Diversified Strategies fund. Most investors look at what's worked best in the past 3- or 5-years. But chasing performance "not only doesn't do better than picking darts, you're better off picking what did worse," he says.
'Deficient Market Hypothesis': The financial crisis of 2008 disabused many investors of the idea the market is efficient and or rational. But the efficient market hypothesis remains "a cornerstone of all finance" and a "large part of the institutional business," Schwager notes. "The idea the price is always 'right' is absurd," he says. "You get situations where it's clearly, obviously not right."
In addition to the 2008 crisis, he cites the Crash of 1987 and the Dot.com Bubble as recent examples of why the efficient market hypothesis is "nothing short of preposterous."
Diversification = Protection: Diversification is very important, "but people carry it to absurd degrees," Schwager says. "They don't pay enough attention to how correlated their investments are." For example, a basket of equity mutual funds doesn't mean you're diversified, any more than owning a basket of tech stocks meant you were diversified in 2000.
"Many of the things people take for granted as ways to invest [are] just wrong," he says. "My hope is people read [the book] and it a light bulb goes off and they, for their own sake, do things differently."
Check the accompanying video for more of Schwager's misconceptions, as well as his current views on the market and why, despite all the technological changes, human nature still drives price.
Aaron Task is the host of The Daily Ticker and Editor-in-Chief of Yahoo! Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com
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