17th
Pushing Past Performance for Retail Investors
A growing number of personal investment startups threaten to cost people real money. This is despite what I assume are the good intentions of the founders, who are trying to take on the massive and opaque mutual fund industry. Covestor, Cake Financial, and most recently kaChing offer many features, chief among them a ranking of their members’ investments, calculated one way or another from their past performance. We are then offered the opportunity to invest in the same trades as the star performers (and the poor performers as well, I guess). KaChing even advertises that they will soon allow you to setup your actual investment account to automatically trade on the decisions of other members.
Investing money in stocks because they are recommended by a highly ranked member of one of these sites is a costly mistake. Not to belittle the achievement of someone making money when most of us are down 40% this year, but in any random selection of stock picks, about half will outperform the market on average, and a much smaller percentage will do so by an impressive margin. This distribution is what makes the market average the market average. But the past exceptional performance of these lucky winners will tell you nothing about what will happen next. Even worse, using this performance to inform your investment decisions will inevitably lead to losses from overconfidence.
What’s interesting is that there are so many opportunities to inform and help retail investors. Fifteen years after retail trading commissions came down from $100/trade to about $10, the finance world is still dominated by information not available to those of us who can’t spend $1,500 a month for a Bloomberg terminal.
For education and analysis, these sites are onto something of real value, but it is more than undermined by this nonsense about picking winners among random portfolios. The challenge for these startups is to lower the barriers to seeing and understanding information for retail investors, without misleading us into falsely simple outcomes. What we need are tools that allow us to better allocate our investments based on our needs, not tricks telling us we can outsmart some average.
