Beware Investment-Newsletter Hype

I don’t know about you, but my e-mail in-box is flooded with pitches for investment newsletters. The solicitations typically brag about the letters’ incred­ible results. “I don’t want to say ‘I told you so,’ but [my picks generated] an impressive 63.8%,” says a pitch I received recently from one letter. “That’s the average gain investors who first accepted my offer to join are bragging about.” Another letter touted “winners” that would have generated $485,000 in gains for a hypothetical investor. “Becoming a millionaire is absolutely possible for you, but you must take this critical first step [to subscribe] now!” it said.

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After being bombarded with dozens of similar promotions, even a self-confident investor might begin to feel inadequate. So you may be tempted to pay a few hundred bucks to learn a letter’s secret sauce, abandoning the comparatively bland investment strategy you’ve been using, no matter how rational it once appeared to be.

Grain of salt. But before you act, take a moment to examine the promotion’s claims. Unlike mutual funds, whose advertising is heavily regulated, newsletters have a lot of freedom to highlight figures that cast them in the best possible light. One way they do that is to make it difficult, if not impossible, for you to verify the figures. Others may provide accurate data but no benchmarks. That allows them to mislead through omission rather than prevarication.

Would you be as impressed with that 63.8% return, for instance, if you knew that a broad market index earned 62% over the same 37 months? The outperformance amounts to just 0.4 percentage point per year. And with such a short record, it’s impossible to know whether that letter writer is good, lucky or simply knows how to cherry-pick the time frame to look smart.

Likewise, the alleged millionaire maker mentioned above failed to note that the trades that generated those $485,000 gains would have required an initial stake of $1.8 million. Worse, although the pitch noted that 170 of the letter writer’s trades were “winners,” it failed to mention the total number of trades she recommended.

To put this in perspective, consider what I might say in materials promoting my Practical Investing portfolio. They would shout: Kathy’s pick of Spirit Airlines (symbol SAVE) would have earned you a 368% return; her recommendation of Apple (AAPL) would have made you 137%; and her choice of Seagate Technology (STX) would have won you a 164% gain. I would proclaim that if you had invested $600,000 in each of those picks (to match the millionaire maker’s $1.8 million investment), you’d have $5.8 million today—a profit of more than 200%!

I might also mention that at one cleverly chosen point in time, the performance of my portfolio was solidly ahead of its benchmark. But I’d neglect to say anything about my losing picks or to fess up that my port­folio is trailing its benchmark today.

I mention these things not to tar all investment newsletters, much less my own stock-picking skills. I find many letters to be informative and enjoyable to read. And I know that professional investors trail their benchmarks at times. But bull markets tend to breed big winners who will happily sell you their swill. As the old Wall Street adage says, however, don’t confuse a bull market with genius. If you’re not skeptical, claims of astounding gains could make you abandon a reasonable strategy for the mindless buy-at-any-price approach that often signifies a stock-market top.

It is especially crucial in the late stages of a bull market to understand what you own. When this bull market ends, as it will one day, the confidence you have in your stock selection and strategy can help you survive the next bear market without panicking and selling at the worst possible time.