Financial firms are busy these days putting the tools of professional investors into the hands of the middle class.
This trend is often accompanied by a marketing pitch inviting the masses to “invest like a pro.”
It sounds great, but for most people it’s terrible advice, for the same reason you shouldn’t try boxing like a pro – you’re probably going to get hurt in the process.
The last 20 years have seen great improvements in access to financial markets, thanks in large part to the advent of exchange-traded funds.
The ETF is rightfully acclaimed for democratizing investing. It paved the way for the modern do-it-yourself investor, by making the building blocks of a portfolio available to anyone at minimal cost.
But the industry is increasingly testing the limits of what can be stuffed into an ETF wrapper.
A staggering number of new funds are being poured into the public markets, many of them using derivatives and leverage to torque short-term returns.
A small subset of DIY investors are sophisticated enough to understand how to use some of these funds properly. But there are obvious risks with making such complex instruments widely available to ordinary investors.
“For the masses at large, I think it’s a dreadful idea, and one that’s probably going to be – if pursued over a long period of time – disastrous to their financial health, because I think some of these products are toxic,” said Brian Madden, the chief investment officer of First Avenue Investment Counsel.
Some leveraged ETFs, for example, are built to magnify the daily moves in a given market or sector. They often come in bull and bear versions, doubling or tripling returns either positively or negatively.
But these funds are not meant to be long-term investments. They typically rebalance daily, so they don’t necessarily track a benchmark over any sustained period of time.
In fact, a bull ETF and its inverse bear ETF can both decline simultaneously.
Last year, for example, the BetaPro Crude Oil Daily Bear ETF (HOD-T) lost 27 per cent. This made some sense, since the fund is designed to double the inverse of daily moves in oil futures, and West Texas Intermediate gained about US$9 a barrel.
But the corresponding BetaPro Crude Oil Daily Bear ETF also declined, by 11 per cent. This makes no sense to the layperson, even though these funds are generally performing as intended and laid out in the fine print.
These products are primarily meant for retail investors – the pros have better ways of accessing leverage. Is the average retail investor expected to grasp their complexity?
Across the industry, what was once the purview of VIPs is increasingly being brought into the mainstream. Margin accounts. Options trading.
Lately, amateur investors have piled into single-stock ETFs, which use leverage to amplify the performance of a single company’s shares. While they can be highly lucrative when the underlying stock is rising, the downside can be severe if you pick the wrong entry point. Not a good idea for the buy-and-hold investor.
Regular investors have long been enthralled with the pros. The high minds of the business offer up top picks and market calls that reliably make headlines in financial media.
In ways big and small, everyday investors are encouraged to emulate the ways of gurus and billionaires. Full disclosure: for several years, The Globe and Mail published an annual package called Invest Like a Legend.
A few years ago, CXO Advisory Group tried to quantify the accuracy of stock market gurus over the years. They compiled around 6,500 forecasts made by 68 different recognized experts on the U.S. stock market between 2005 and 2012. Some were fundamental investors, others leaned more toward technical and sentiment-based models.
The results showed an aggregate accuracy of 47 per cent, meaning that the average guru was less accurate than a coin flip.
While their professional success speaks for itself, these legends of the trade do not offer some sort of financial compass for the rest of us to follow. Their goals, their risk tolerances, and their ability to absorb losses have little in common with those of us saving up for retirement.
So by all means, invest like a pro. But only if you are one.