Many Investors Are in Over Their Heads

04/09/2009 1:18 pm EST

Focus: MARKETS

Howard Gold

Founder & President, GoldenEgg Investing

Do individual investors really know what they're doing?

After speaking with thousands of investors for more than a decade, I've reluctantly decided that many do not.

From the dot.com boom to the financial meltdown, investors have been ill-prepared to navigate the wild swings we've seen in the markets. Too many do not have a plan, too many abandon good plans in panic, and as I'm writing this, too many are making the next big mistake: trying to become traders and erase the losses in their portfolios by chasing the next hot stock.

I write this with sorrow and regret. I've met so many people at Money Shows and other venues who are smart, knowledgeable, and well-prepared. One of the things I've enjoyed most about my current role (and the previous one as editor of Barron's Online) has been sharing my knowledge with investors and learning from them as well.

But the financial crisis and ferocious bear market we've been through has led me to conclude that the vast majority of investors simply can't do it on their own; they need help.

And by help, I don't mean a long buy list of "can't miss" stocks or "sure thing" exchange traded funds. I mean qualified, reputable organizations to manage most of your investments.

Full disclosure: MoneyShow offers recommendations from independent advisers to active, self-directed investors and traders. We also run shows for financial advisors who get paid for managing people's money. So, we work both sides of the aisle.

But wherever you sit, this financial crisis has been the acid test-and many investors have failed.

Americans yanked a record $320 billion from mutual funds last year and shifted $422 billion into cash, the Financial Times reported.

They've also shoveled $370 billion into bank deposits in the 12 months through mid-March.

Depending on when those moves were made, some of them may have been taking sensible precautions in a dicey market. But the lion's share, I'd guess, was sheer panic.

Financial planners I spoke with told me that up to 5% of their clients abandoned ship, dumping all their stocks because they couldn't sleep at night. Maybe 20% slashed their equity exposures substantially-from, say, 60% of their portfolios to 30%-turning big paper losses into real ones.

Granted, maybe 60% in equities was too much for some people. And we might well be in one of those times when stocks simply don't return as much as other asset classes do.

But is wholesale abandonment of a carefully conceived strategy the right answer? I don't think so.

And if that's happening to people whose assets are being managed by professionals, what about investors who don't even have that? It's likely far worse. The lesson many people have drawn from the crisis is that they should become more active investors-even traders.

As The Wall Street Journal reported Wednesday, "many individuals have lost faith in the long-term growth of their investments and are trying to make money off the market's volatility." Some advisory services have been peddling the message that "buy and hold" investing is dead (the subject of a future column) and that the only way investors can protect their assets is to become traders.

It's good for investors to take more control over their financial lives. But traders and investors have different skill sets, maybe even different personality traits. And being a successful trader-or active investor-takes a lot of work.

"Some people do OK, and a lot of people don't," says Marilyn Capelli Dimitroff, president of Capelli Financial Services, a financial advisor based in Bloomfield Hills, Michigan.

"Certainly people are capable of doing it themselves," says Brad Sorensen, director of sector analysis for Charles Schwab & Co. "Whether they want to put the time and effort into it is another story."

Nonetheless, the Journal reported, "discount brokerage firms.are seeing record levels of trading activity and new-account openings."

So, what are these people trading? How about Citigroup (NYSE: C), the basket case of all basket cases, now stumbling along on life support from the US taxpayer?

Indeed, last week, the Journal noted "a surge of individual, or retail, investors buying shares of Citigroup during the past five months."

"'This is my opportunity to make some money,'" a 22-year old Californian said.

Haven't we seen this movie before? Remember the late Nineties, when commercials told you to "boot your broker" and anyone could be a successful day trader by buying and selling Yahoo (Nasdaq: YHOO) stock 20 times a day? How'd that turn out?

Look, I have a lot of sympathy with individual investors-I'm one of them. My portfolio has taken a big hit along with everybody else's. And investing is difficult. As I wrote here previously, a lot of the so-called experts blew it in this bear market.

"I don't know if professional managers can take a lot of credit in this area, either," acknowledges Christopher J. Cordaro, chief investment officer of RegentAtlantic Capital, a Chatham, NJ-based financial advisor.

Heck, even Nobel Prize-winning economists can't manage their own money. In his book, "High Wire," about the growing risk American families face in their financial lives, journalist Peter Gosselin of The Los Angeles Times interviewed seven Nobel laureates who either made big mistakes with their retirement portfolios or didn't pay attention to them at all.

If Harry Markowitz himself, the founding father of modern portfolio theory, couldn't stomach having too much in equities when he was young, how can we blame a 55-year old for cashing out his stock portfolio with retirement on the horizon?

Face it: Taking charge of our own investing is not something most of us wanted. Over the last 20 years, companies have abandoned traditional pension plans to be competitive in a global economy, and individuals have had to take up the slack.

Now, the whole system of self-directed retirement investing has faced its first real crisis, and the results have been pretty lousy.

Individuals are right to take more control of their investing, but as I've written many times, they should invest actively with no more than 20% of their portfolios.

For the rest, we all really need a plan.

Howard R. Gold is executive editor of MoneyShow.com. The opinions expressed here are his own and do not reflect the views of MoneyShow.

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