On Tips and Tipping (Part 3)

On Tips and Tipping (Part 3)

What’s wrong with investment tips?

A “Rubbish Tip” in the UK. Photo: Bob Embleton. Source: Wikipedia

Investment recommendations rarely work out. Part of the reason is because they need to fit into an overall plan. But people who give advice rarely give the nuance and conditions that might make the advice less applicable. Think of all the times you’ve seen the headline: “5 Stocks that could Double in the Next Year!” But what are the risk factors? How will the advice get updated? What’s the benchmark?

Gurus and pundits usually don’t have much skin in the game. The rules of journalism require that a writer either have no position at stake, or follow significant disclosure documentation. It’s easier for them to write and talk about something they don’t own. But that makes them less interested in what might go wrong, and—especially—how things turn out after they make a recommendation.

What’s even worse is when the recommender has the opposite motivation as you. That’s the premise behind “pump-and-dump” stock schemes. In these situations a small firm will gradually acquire a large position in a little-known penny-stock—one that sells for less than a $1. Then they send out recommendations via email, post notes on social media, and write up official-looking research reports. That’s the pump. Once folks get interested and the price begins to move, they unload their shares. That’s the dump. In reality, there’s nothing special going on at the firm, and the price eventually collapses—leaving a lot of small investors with big losses.

Photo: Stuart Whitmore. Source: Morguefile

So when you think about a stock recommendation, the only reasonable way to use the advice is to re-create the analyst’s work yourself, to see if it’s legitimate. Even a good investment might not be appropriate for your portfolio. Looking for factors the opinionator might have left out—like how volatile might a company’s earnings be, or how much debt they have—and whether the debt is investment grade, or how fast the company is growing. These are all factors that can make a stock more risky—and perhaps too risky for you.

But most folks can’t or won’t do that work. They just want to sprinkle some magic pixie dust over their investments, hoping to get big gains in a period of short time. But “hope” is not a plan.

So, want a tip? Eat your own cooking: do some study.

Douglas R. Tengdin, CFA

Chief Investment Officer

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