Why the Conventional Wisdom is Wrong

Want to make a lot of money in the stock market? Then ignore conventional wisdom. Or better yet, do the opposite… Instead of investing your money based on economic forecasts or market call, use proven principles.

This article is published with permission from InvestmentU.com.

Want to make a lot of money in the stock market? Then ignore conventional wisdom. Or better yet, do the opposite

Five years ago, for instance, investors were told to adjust their sails and get ready for “the New Normal.” This proclamation, issued far and wide and trumpeted by market pundits as well-known as Pimco bond king Bill Gross, claimed U.S. stocks — which had returned roughly 10% a year for the past two centuries — would start returning considerably less, perhaps half as much.

Conventional wisdom said stocks simply weren’t worth the risk.

So what has happened the past five years? The S&P has returned 16.1% a year — a whopping 60% more than the average — and turned in its best performance last year since 1990. If this is the new normal, I’m bullish on normalcy.

Another example: In the years leading up to the financial crisis, investors were told that they should “buy and hold” stocks for the long run. This is indeed a viable strategy for those with a very long-term horizon (measured in decades) and a cast-iron stomach.

But this approach turned horrifying as the stock market plunged more than 50% from the 2007 highs to the 2009 lows. Buy and hold was a good way to get flattened. It’s far better to buy and use a trailing stop. That gives you unlimited upside potential with strictly limited downside risk.

Fourteen years ago, stock traders were told that we were in a “new era” for technology and that “the Internet changes everything.” They promptly bid the technology-laden Nasdaq index up to more than 5,100. Not only did this sector crash and burn, declining more than 75%, but — nearly a decade and a half later — it still hasn’t reached that nosebleed level again. The Internet changes a lot of things, but not the truism that investors who buy into bubbles end up taking a bath.

Today’s “wisdom”

I mention these things only to provide a little perspective on the current conventional wisdom: that the U.S. economy is likely to experience slow growth and the stock market is likely to go up about 8% to 10% this year.

Don’t bank on it. While the long-term average of the stock market is 10.1%, not once since 1926 (when modern data on the U.S. stock market began) have U.S. stock markets returned between 8% and 10% in a single year. That’s right, not once in 88 years.

As Jason Zweig noted in The Wall Street Journal last week, “Many investors believe that financial markets exist to facilitate the efficient allocation of capital. That’s a myth. The purpose of financial markets is to humiliate anyone who thinks he can predict how they will perform in the short run.”

So while conventional wisdom is calling for modestly positive stock returns in 2014, we could be in for a shocker. Third quarter U.S. growth was recently revised up to more than 4%. Unemployment is coming down. Inflation and interest rates are low. Profits are up. And so are profit margins.

So rather than a middling single-digit return, U.S. stocks could have another banner year in 2014.

Or not. After all, my guess isn’t the result of divine inspiration either. And you shouldn’t be running your money based on economic forecasts, market calls, guesses, theories or hunches, anyway, but on proven investment principles.

However, we all have to place our bets somewhere. And history shows you’re better off placing it almost anywhere than on the conventional wisdom.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.