This Secret Agenda Hurts Your Returns

Written by Daniel Solin.

If you follow the financial media regularly, you will find daily predictions about the direction of the markets. Breakout, a daily blog on Yahoo Finance’s website, is typical of what passes for financial information. On September 6, Breakout’s Jeff Macke featured Mike Jackson, the CEO of AutoNation, as his guest. Jackson opined that the economy “has moved into a self-sustaining recovery.” He may or may not be correct in that assessment, but relying on his views or the views of others claiming predictive powers is more akin to gambling than investing.

Macke’s program is no worse than what is dispensed by many of his colleagues in the media. The format is familiar to all of us: Intelligent people in positions of power and influence make rational-sounding statements about the economy, the direction of the market or the merit of a particular stock or fund. What’s missing is any data indicating that their views are worthy of consideration, based on a history of accurate past predictions or demonstration of predictive skill (as contrasted with luck).

There is ample evidence to the contrary. In a paper published in July 2010, three finance professors from Duke University and Ohio State University published the results of an extensive survey they performed. Each quarter from March 2001 to February 2010, they surveyed “top U.S. financial executives.” They asked them to predict one- and 10-year stock market returns and also for their predictions of best- and worst-case outcomes. The data they gathered aggregated 11,600 S&P 500 forecasts.

You would think the accumulated expertise of these executives would permit them to make fairly accurate predictions about a commonly used index such as the S&P 500. The opposite was true. The authors of the study found no correlation between the estimates of these top financial executives and the actual value of the index. In fact, the correlation was negative. When they predicted the index would decline, it was modestly more likely it would go up.

Nobel Laureate Daniel Kahneman commented on this study in his book, "Thinking, Fast and Slow", noting, “These findings are not surprising. The truly bad news is that the CFOs did not appear to know that their forecasts were worthless.”

Since the data is overwhelming that predictions are basically “worthless,” why do investors continue to pay attention to them, often to their financial detriment? Kahneman provides this answer: "Facts that challenge such basic assumptions – and thereby threaten people’s livelihood and self-esteem – are simply not absorbed. The mind does not digest them."

If investors accepted the fact that the predictive views of financial “experts” were “worthless,” the ramifications would be profound. Much of the financial media would cease to exist. Brokers would go out of business because clients would view their advice through the prism provided by sound academic studies and the views of scholars such as Kahneman. This result – threatening the livelihood and self-esteem of powerful segments of our society – is simply not going to happen.

While much of the financial media and many brokers are driven by this secret agenda to maintain their livelihoods, you should ignore their musings and base your investing decisions on reliable, peer-reviewed data.


Written by Jim Parker, Vice President, DFA Australia Ltd..

Markets recently have had a rocky time as investors in aggregate reassess prospects for monetary policy stimulus in the US. Is this something to worry about?

The world's most closely watched central bank unsettled financial markets by flagging that it may start to scale back its bond purchases later this year.  Under this program of so-called "quantitative easing," the Fed buys $85 billion a month in bonds as a way to keep long-term borrowing costs down and help generate a self-sustaining economic recovery.  What spooked the markets was a comment by Fed Chairman Ben Bernanke on May 22 that the central bank may start to scale back those purchases in coming meetings.

The mere prospect of the monetary tap being turned down caused a reassessment of risk, leading to a retreat in developed and emerging economy equity markets, a broad-based rise in bond yields, and a decline in some commodity markets and related currencies, such as the Australian dollar.  Gold, in particular, was hit hard by the Fed's signals, with the spot bullion price falling 23% during the second quarter on the view that rising bond yields and a strengthening US dollar would hurt the metal's appeal as a perceived safe haven.

For the long-term investor, there are a few ways of looking at these developments.

First, we are seeing a classic example of how markets efficiently price in new information. Prior to Bernanke's remarks, markets might have been positioned to expect a different message than he delivered. They adjusted accordingly.

Second, since the patient is showing signs of recovery, policymakers can publicly countenance a change in policy—"taking away the punch bowl."  This is not to make any prediction about the course of the US or global economy. It just tells you that policymakers and investors are reassessing the situation.

Third, for all the people quitting positions in risky assets like stocks or corporate bonds, there are others who see long-term value in those assets at lower prices. The idea that there are more sellers than buyers is just silly.

Fourth, the rise in bond yields is a signal that the market in aggregate thinks interest rates will soon begin to rise. That is what the market has already priced in. What happens next, we don't know.  Keep in mind that when the Federal Reserve began its second round of quantitative easing in late 2010, there were dire warnings in an open letter to the central bank from a group of 23 economists about "currency debasement and inflation."  Yet, US inflation is now broadly where it was, and the US dollar is higher than when those warnings were issued suggesting basing an investment strategy around supposedly expert forecasts is not always a good idea.  So, it would pay to exercise skepticism with respect to predictions on the likely path of bond yields, interest rates, and currencies in the wake of the Fed's latest signals. Just because something sounds logical doesn't mean it's going to happen.

Fifth, a rise in bond yields equates to a fall in bond prices. Just as in equities, a fall in prices equates to a higher expected return. So selling bonds after prices have fallen echoes the habit some stock market investors have of buying high and selling low.

Finally, keep in mind the volatility is usually most unnerving to those who pay the most attention to the daily noise. Those who take a longer-term, distanced perspective can see these events as just part of the process of markets doing their work.

After all, the individual investor is unlikely to have any particular insights on the course of global monetary policy, bond yields, or emerging markets that have not already been considered by the market in aggregate and built into prices.  What individuals can do, with the assistance of a professional advisor, is manage their emotions and remain focused on their long-term, agreed-upon goals.  Otherwise, you risk reacting to something that others have already countenanced, priced into expectations, and moved on from as further information emerged.

Inevitably, second-guessing markets means second-guessing yourself.

You Have to Be in Gold

Written by Weston Wellington, Vice President, Dimensional Fund Advisors.

All of us could benefit by examining our inclination to invest with our hearts rather than our heads—especially when it comes to gold.

Content labeled as "Client Ready," can be made available to your clients or prospects. Material is subject to change. Periodic review is advised.

More information

  • “We are living in a world of money printing. … That is why I have to recommend gold again. ... Once gold surpasses $1,800 an ounce, it will run to the low-to-mid $2,000s.”

Quotation attributed to Felix Zuelauf, Zuelauf Asset Management. “Here’s What’s Cooking for 2013,” Barron’s, January 21, 2013.

  • “Investors can choose between artificially priced financial assets or real assets like oil and gold, or to be really safe, cash. … My first recommendation is GLD—the SPDR Gold Trust.”

Quotation attributed to Bill Gross, PIMCO. “Stirring Things Up,” Barron’s, February 2, 2013.

  • “I am recommending gold, as I have done for many years. I will continue to do so until the gold price hits the blow-off stage, which is nowhere in sight. … The environment for gold couldn’t be better. … Gold could go to $5,000 or even $10,000.”

Quotation attributed to Fred Hickey, The High-Tech Strategist. “Stirring Things Up,” Barron’s, February 2, 2013.

Each January, a group of prominent investment professionals gather in New York as members of the Barron’s Roundtable to trade quips, stock ideas, and the outlook for markets and economic trends worldwide. Barron’s—a weekly financial newspaper with a small but devoted following of professional and do-it-yourself investors—publishes a transcript of their remarks over three successive issues. The quotations above are excerpts from this year’s panel discussion, and to the best of our knowledge they represent the only occasion that three of the nine participants have highlighted gold-related investments among their choices for capital appreciation during the year ahead.

Although the year is far from over, it’s off to a rough start for gold enthusiasts. A sharp selloff in mid-April sent bullion prices to $1,395 on April 15, down 15.7% for the year to date and 26.4% below the peak of $1,895 reached in early September 2011. (Prices are based on the London afternoon fix.) For the 10-year period ending March 31, 2013, gold enthusiasts have a more positive story to tell: The annualized return for gold spot prices was 16.83%, compared to annualized total returns of 8.53% for the S&P 500 Index, 10.19% for the MSCI EAFE Index, 17.41% for the MSCI Emerging Markets Index, and 2.34% for the S&P Goldman Sachs Commodity Index.

Taking a somewhat longer view, for the 40-year period ending March 31, 2013, gold performed in line with many widely followed fixed income benchmarks, while lagging behind most equity indices. We find it ironic that the return on gold over the past four decades is essentially indistinguishable from five-year US Treasury notes, often scorned by gold advocates as “certificates of confiscation.”

Gold vs. Benchmarks, 1973–2013*


Annualized Return (%)

Growth of $1

Dimensional Large Cap Value Index



Dimensional US Small Cap Index



S&P 500 Index



MSCI EAFE Index (gross div.)



Barclays US Credit Index



S&P Goldman Sachs Commodity Index



Barclays US Government Bond Index



Five-Year US Treasury Notes



Gold Spot Price



One-Month US Treasury Bills



Consumer Price Index



*40-year period ending March 31, 2013.


Considering the volatility of gold prices, even a 40-year period is too short to provide conclusive evidence regarding gold’s expected return. And the issue is further clouded by shifts through time in the legality of gold ownership and its changing role in various monetary systems worldwide. In his book The Golden Constant, published in 1977, University of California, Berkeley Professor Roy Jastram examined the behavior of gold in England and America over a 400-year-plus period—and suggested that the long-run real return of gold was close to zero. Even with centuries of data to study, however, he couched his conclusions in cautious language.

When we last commented on gold in February 2012 ("Who Has the Midas Touch?”), the mysterious metal was changing hands at $1,770 per ounce. We directed readers’ attention to the Berkshire Hathaway 2011 annual report, which presented an engaging discussion by Chairman Warren Buffett on the long-term appeal of gold—or, in his view, the lack of it. Since that time, the role of gold in a portfolio has provoked vigorous debate in the investment community, with thoughtful, articulate, and successful investors lining up on both sides of the issue, including at least three billionaire hedge fund managers making the case for gold.

Some might argue that gold’s price behavior will never succumb to rational analysis. For those seeking to try, a recently updated paper by Claude Erb and Campbell Harvey offers a useful framework for discussion without necessarily resolving the debate. Along the way, it provides the reader with a few nuggets of historical interest, including a comparison of military pay between US Army captains of today and Roman centurions under Emperor Augustus. (Apparently, little has changed over 2,000 years.)

The authors cite a number of reasons advanced in support of gold ownership, including a hedge against inflation, a safe haven in times of stress, an alternative to assets with low real returns, and its “under-owned” status across investor portfolios. Although the inflation hedge argument is likely the most frequently cited attraction for gold investors, the authors find little evidence that gold has been an effective hedge against unexpected inflation. They go on to poke holes in the assertion that gold qualifies as a genuinely safe haven or presents an appealing alternative in a world characterized by low real yields.

The most interesting argument, they believe, is the claim that gold is under-owned in investor portfolios and that a small shift in investors’ allocation strategy could lead to a significant rise in the real price of gold. Putting aside for a moment the ambiguity of the “under-owned” statement (all the world’s gold is already owned by somebody), the authors suggest it is plausible that individuals or central banks could choose to have greater exposure to gold. If they are insensitive to prices, this choice could cause the real price of gold to rise, particularly if gold producers are unwilling or unable to increase production. (On that note, it’s also conceivable that a significant real price increase would encourage development of electrochemical extraction of the estimated 8 million tons of gold contained in the world’s oceans, dwarfing the existing gold supply.)

The “gold is under-owned” argument has been advanced by a number of thoughtful investors, and only time will tell if such a shift in allocation strategy takes place with the consequences they expect. While acknowledging the bullish implications for gold prices under this scenario, the authors point out that gold prices relative to the current inflation rate are roughly double their long-run average since the inception of gold futures trading in 1975. They suggest $800 per ounce is a suitable target when applying this metric. Which is more plausible—that prices will gravitate closer to their historical average or that a new world order is emerging that calls for a sharply different valuation approach? No one can be sure; hence, the title of their paper, “The Golden Dilemma.”

What should investors make of all this? In our view, long-run investment results for any individual reflect the combination of available capital market returns and the investor’s behavior and temperament. As Warren Buffett has observed, excitement and expenses are the enemy of every investor, and all of us could benefit by examining our inclination to invest with our hearts rather than our heads. The decision to own gold often is motivated by an emotional response to current events, leading to abrupt shifts in asset allocation strategy and a failure to achieve capital market rates of return there for the taking. If adopting a permanent 5% allocation to gold encourages investors to maintain a buy-and-hold strategy for the remaining 95% of their portfolio, perhaps that is the most sensible solution for some. Many other investors undoubtedly will be just as content to stock their portfolios with securities offering interest and dividends—and let gold fulfill their innate human desire for rare and beautiful objects of adornment.