Why You Shouldn't Listen to Jim Cramer
CNBC's Jim Cramer has become one of the most recognizable faces in the investment world. His Mad Money has been one of the network's most watched shows. This week, we're going to take a look at some of the "wisdom" Cramer has given to his followers. As you will see, while profitable for CNBC, the advice handed out by Cramer is almost always detrimental to investors.
Consider the following. On his show Cramer stated: "It's 'hogwash' for those on Wall Street to tell individual investors that the market is too hard, and that they should just go with mutual funds or index funds ... While index funds are a valuable and welcome innovation for investors, they're not a way for average investors to play the market. Using only index funds, investors will have a hard time even matching the market, and will never beat it ... When it comes to investing, picking the right stocks and knowing when to sell, are the two skills that keep investors ahead of the markets, and not struggling to keep up."
The problem is that there is neither any evidence nor any logic to support Cramer's statements. Consider Cramer's statement about index funds not being able to beat the market. Of course they won't. But they won't underperform either (before considering their low expenses) -- which is what many individual investors do. And investing should not be about beating the market. Instead, it should be about adopting the strategy that will give you the best chance of achieving your goals. Now to the evidence.
Professors Brad Barber and Terrance Odean have done a series of studies on individual investors. The following summarizes their findings:
- Before costs, the stocks that individuals buy underperform, and the stocks they sell go on to outperform.
- The more individuals trade, the worse the results. Individuals that trade the most underperform on a risk-adjusted basis by 10 percent per year.
- Investment clubs underperformed by more than 4 percent per year on risk-adjusted basis.
Would you have done better listening to Cramer's picks? The study "Is the Market Mad? Evidence from Mad Money," examined his performance and found that after Cramer recommended a stock, its volume typically soared and there was an overnight rise in prices. However, the gains turned out to be temporary as prices completely reversed, turning the "gains" into nothing more than market impact costs for the buyers. Bottom line: Cramer's picks had negative value to naive investors who reacted to the buy recommendations.
A fitting conclusion to this post is this story related by Taylor Larimore of the Bogleheads Investment Forum. Larimore attended a March 2000 investment conference in Miami where Cramer was the keynote speaker. During Cramer's speech, he told the audience to get paper and pencil and write down a list of 10 "Winners of the New World." Fifteen months later, Money magazine reported that his list had cratered 82 percent. Accountability ruins the game.
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