In the late 18th century Austrians were amazed at a mechanical man who could play chess. He became known as the Mechanical Turk. The automaton, consisting of gears and levers, could engage any player in a game while exhibiting stunning skill for a machine. Of course, people eventually learned it was a hoax. A man hidden under the playing table operated the arms.
People today could never be fooled by such a farce, or could they?
Much like the automaton, today’s television financial “professionals” put on a good show but lack any real ingenuity or skill. This passive engagement appeals to the public’s sense of novelty and theatrics. As media theorist, Marshall McLuhan theorized "The medium is the message." The medium is the problem.
Advertising, Not Acumen
The most popular financial shows in the world are not in the business of dispensing financial advice. They’re in the business of generating advertising revenue. They use sensationalism to keep viewers interested. This bombastic approach is not limited to those who unabashedly embrace exuberance like Jim Cramer of Mad Money. Hosts of other shows like Squawk Box and Power Lunch do the same.
The problem is the business model. The networks live and die by their ratings. This metric is critical because it drives their ability to generate advertising revenue. Therefore, the only goal is to bring viewers to the screen, not provide sound financial acumen to the masses. How do they get our attention? They use brute force. Amid an ever-increasing list of entertainment options (Netflix, Amazon, and others) hosts must resort to chest beating analysis to be heard. As one CFP summarizes, “The presentation is superb at creating confusion, yet greatly lacking in delivering worthwhile guidance.”1
The pressure for ratings comes not only from competing channels and sites but the omnipresent data of today’s world. Investors can find up to the minute research anywhere at anytime. With the sum of all human knowledge in our pocket, there is little reason to have allegiance to any particular program. Traditional television programming attempts to compete with sophisticated graphics and charting. The result of these tactics is a cacophony that never rises beyond noise.
More problematic is the authoritative stance hosts take. Jim Cramer has long abandoned any pretense of professionalism or elitism. As a result, he is the more honest of the hosts on TV. He shouts and screams and never pretends to be anyone but himself. For many viewers, this is the basis of his appeal. However, other hosts sporting a tailored suit and perfect tie offer themselves as a sage voice amid the manufactured confusion of the markets. This presentation is dangerous because it invites viewers to see them as Chartered Financial Analysts or Certified Financial Planners when they are neither. The more authoritative the presenter becomes, the more skeptical we should be.
The president on CNBC once remarked in his discussion of the network’s programming, “some people like politics, some like sports, some like news, but everybody is interested in money.”2 This interest in money that is, making more of it, is the only reason anyone would watch Mad Money, Squawk Box or Power Lunch. For this reason, it seems appropriate to measure the performance.
Researchers at Northeastern University reviewed the performance of Jim Cramer’s stock selections and concluded: "his aggregate or average stock recommendations are neither extraordinarily good nor unusually bad.”3 This finding is in keeping with the tenor of the show. Too often the host predicts all outcomes to hedge their reputation. The exhaustive research arrives at an unsurprising finding that “A portfolio constructed as described from Cramer’s ongoing recommendations would not produce superior performance over the entire period of analysis after adjusting for market performance, size, and book-to-market characteristics.”4
Part of the problem with executing Cramer's buy and sell recommendations is that it requires the investor to make rapid-fire trades. This activity generates burdensome fees, brokerage costs and taxable gains. It’s more than the ordinary investor can track. Following the twisted path of any host’s recommendations will cause the same problem.
However, the cost of fees and taxes are secondary to the costs associated with risk. “Systematic risk is about 20% greater than the passive S&P 500 index” warn the same researchers. While you might make a few gains, the risks incurred are dangerous and unnecessary given the middling returns. From July of 2005 through December of 2007 Cramer issued 1,387 explicit buy recommendations and 534 sell recommendations. Some of the more aggressively low-priced online brokers offer a flat fee of $4.95. However, at Cramer’s trading volume an investor would incur $6,865 in fees alone just to execute the buys. Even if an investor opted to purchase a quarter of the recommendations, their total cost would clock in at $1,716. This total is a high bar to hit just to break even.
The Heat of the Moment
Sound investing focuses on fundamentals. The brazen hosts of network television, however, focus on the heat of the moment. Their stock selections are designed to capitalize on topical events and other short-term aberrations that have little bearing on a long-term plan.
If an investor embraces the short-term in the drive to wealth, they risk losses from unforeseen events. These television personalities live in the narrow space of intraday news. They attempt to profit from short-lived movements. The inherent problem with this approach this the broad viewership of the shows. Millions of others are watching the same program and hearing the same information. Therefore, any opportunities in the stock market are likely to be fleeting as others act to capitalize on the advice. It simply is not possible to embrace a new wealth management plan every night.
Furthermore, the frenzy of trading means missing the benefits of compounding. As share prices appreciate year over year investors, experience exponential growth as they earn interest on interest. Compounding is possible only with a consistent plan. Deviation disrupts compounding.
Supporting the importance of consistency is research from the University of Texas where academics concluded that “more style-consistent funds tend to produce higher total and relative returns than less consistent funds.”5 With so much influence on the minutia of earnings reports and nuanced company politics the TV, hosts are paying little attention to the underlying fundamentals. As a result, “unintentional style drift can lead to inferior relative performance.”6
This style drift underscores another problem with program hosts; they do not adopt a holistic approach. They choose a stock based on the news of the day without regard to how it will perform in the broader context of a cohesive portfolio. This concept forms the underpinnings of modern portfolio theory (MPT) which works to reduce idiosyncratic risk or the risk associated with the unique characteristics of a particular stock. The goal of MPT is to group various uncorrelated investments so that if one falls, the investor is not faced with a complete collapse in value. In fact, the strategy strives to see one investment rise as another falls, keeping the portfolio more or less even, while the whole of the portfolio increases in value over time.
If an investor blindly follows the recommendations of the hosts, they risk overweighting in a particular sector or succumbing to home bias which is the tendency to have a disproportionate amount of stocks from your home country. Each of the televised selections carries risks. Rarely is the risk factor of one offset by that of another.
In reality, the day to day financial news has very little impact on your overall financial situation. The best approach is to form a plan and stick to it. You are better off financially if you focus only on what you can control. Turn off the TV.