1) Don’t expect a high win percentage of winners.
Most stock investors don’t realize how low the winning percentage of a successful stock newsletter or hedge fund is. Typically, we consider a winning percentage of 65-70% or higher a good barometer in the medium to long-term (provided the winners more than offset the losers).
When comparing the newsletters investment recommendations to its benchmark (small caps to small caps, large caps to large caps, bio-tech to bio-tech etc.) the win percentage drops even further.
While winning percentage is important, it’s how much your winners return compared to your losers that dictate results. In other words, it’s not how many winners or losers you have, but how much you win compared to how much you lose for each dollar invested. That’s why stock newsletters (particular options and futures), can still be losers with a 80-90% win rate and others can provide great results with barely a 50% win percentage.
2) You need to diversify.
All our top-rated newsletters have had stock selections suffer catastrophic losses. Those that hold stocks long-term such as Motley Fool Stock Advisor and Motley Fool Insider have had stocks lose more than 90% of their value since the time they were recommended. Those newsletters that sell losers quicker have still suffered 30-50% losses.
That’s why it’s important to diversify. Too many investors put too much of their investment dollars into one or two recommendations and complain when they’ve lost their money.
Maybe you’re smarter than the stock newsletter editor, but probably not. If the newsletter editor had any idea which stocks would be the big winners and big losers, they would simply eliminate the losers. It’s not that easy.
3) Leadership changes year to year.
The Undoing Project by Michael Lewis is a great book that will change the way you think about hot hands. After extensive research, it was found that the hot hand is a myth. It only permeates the brain as a reality because people remember when it worked and forget about the times it doesn’t. In tracking results over time, we have found a negative correlation in newsletters remaining at the very top or the very bottom year to year.
If you chase last year’s leaders, you will lag the market overall.
4) Pick a stock newsletter investing style that fits your personality
If you try to follow a momentum stock letter but are a conservative investor, you won’t be able to stomach the wild swings that come from following momentum stocks. Conversely, if you’re a high risk, high reward investor, you’ll become impatient or bored waiting for value stock returns to come to fruition. Based on anecdotal evidence, you’ll do worse if your personality doesn’t match the newsletters investment style.
5) The 2% Rule
If the newsletters track record isn’t at least 2% or better than its benchmark, remember that you’re doing this for fun. Otherwise, you’re better off just investing in an index fund due to taxes, trading costs and risk. It’s not as exciting, but it is safer due to diversification.
The last thing I’d like to remind you about is paying attention to how a newsletter calculates its returns. Most will do it in the most favorable light.
For example, the Independent Advisor for Vanguard Investors compares its returns to the average Vanguard Investor. They consider this as someone who invests an equal amount in all funds Vanguard offers which is ludicrous. This is very misleading because it’s similar to comparing the returns of a portfolio of 50% stocks, 45% Bonds and 5% money market funds to a portfolio of 90% stocks and 10% bonds.
Instead they should compare their returns to an appropriate benchmark such as Target Date Funds with similar risk profiles, in which case their performance looks remarkably less spectacular.
Blue Chip Growth advertises that it beats the market 3-1. To me, that either means for every $1 you invest you get $3 back for a total of 4. Or for every dollar you invest you end up with #3. Yet, when you look at their actual results the returns are closer to 150% meaning if you invest $1 you’d have $2.50. Maybe they can explain the difference to me or perhaps they simply round up.
Other newsletters also use similar tactics. As always, it’s buyer beware.