Commentary: Educated Investor - Beware of statistical marketing

Recently, I was reading the latest quarterly edition of a newsletter published by one of the largest mutual fund companies in America. Although the newsletter was trying to give comfort and guidance to their clients during these bearish times, it was quite clear that the ultimate intent was to sell their products.

Unfortunately, in my opinion, the publication was slanted towards getting its investors to stay in the market and even add to their current equity positions without presenting the entire story.

The company supplied the readers with historical statistical data comparing what would have happened to two different investment scenarios at the end of the 1973-1974 bear market.

In their example, one investor, which we will refer to as Investor A, bailed out of his stocks after suffering from the prolonged bear market beating. On the other hand, Investor B stayed the course and remained fully invested. After two years Investor A decided to reenter the stock market.

The author then goes on to compare the results of the two portfolios after 25 years.

Obviously, since the Monday morning quarterback portfolios were created by a marketer of mutual funds, you already know the results. Investor B who stayed with his investments throughout the 25-year period came out on top.

What disturbs me the most about the above example is that the newsletter only presented one scenario. In other words, they did not provide the reader with the entire story.

They picked Sept. 30, 1974, as a starting point. Interestingly, that date was just four days shy of the 1973-1974 bear market trough, which occurred on Oct. 3, 1974. So in order to make the results particularly favorable to Investor B, the mutual fund company chose a span of time which was obliviously partial to Investor B, the buy and hold investor.

But what if there had been an Investor C, and he had exited the stock market on Jan. 7, 1973, just four days prior to the previous bull market peak, and then reentered two years later? Investor C would have outperformed both Investors A and B by a substantial margin, and as Paul Harvey says, and that is the rest of the story.

The newsletter's portfolio comparison is an example of what I refer to as statistical marketing. Investment companies as well as stockbrokerage firms use statistical marketing to their advantage in order to sell their wares and keep you, the investor, in the stock market.

Why?

Mutual fund companies only make money if their fund managers have the public's monies to invest. Their revenues are based on the amount of monies they manage, and the more the better.

Currently, the mutual fund industry's revenues have been whacked with a double whammy. First, their asset base has taken a severe beating due to the ongoing bear market. If the S&P 500 Index has free fallen 49 percent during this current bear market, you can bet the management fees on equity mutual funds have suffered a similar fate.

Secondly, many investors have transferred monies from their stock funds to money market funds, which generate significantly lesser fees for the investment companies. In addition, some investors have completely withdrawn their monies and have invested in other asset classes such as real estate.

For mutual fund companies to suggest you do anything other than to invest in their funds would be suicide for their corporations and eventually their jobs. The investor must always remember the number one priority of any investment company is to make a profit for the owners of their corporations. Unfortunately, this gives rise to a built-in conflict of interest on the part of mutual fund companies.

So it is not unreasonable to be suspect of any literature you receive from your investment companies because it is only natural for their newsletters to contain conflict of interest articles. After all, they are in the business to make money just like any other retail establishment, and, if they provide good advice and products, they deserve to make a profit.

But the next time you receive investment company-sponsored information, review it objectively. Play the devil's advocate before you invest your hard-earned dollars. Develop your own models and examples using different time frames. Call the company's customer representatives that sent you the information and ask what if questions. You might be amazed at their answers or lack thereof.

Also, instead of trashing the newsletters, file them away for future reference. See if their market forecasts were correct. To me their advice is far more important than the funds they provide.

They could offer the best fund performance available, but if the market tanks, what good are their funds? Not much!

The above illustration of the two investors implies that we are at the end of the bear market. I'm anxious to see if they are correct, or how far off they are. This same company, in their first newsletter of 2002, predicted we would have a steady recovery during the third and fourth quarters of the year 2002. Unfortunately, they were wrong on that prediction.

Bottom line: Mutual funds serve a need for the individual investor. It gives the investor diversification with small amounts of money. It is a convenient way to fund your retirement plans.

Also, mutual funds allow the investor to allocate his investments easily and make changes quickly. But you need unbiased and objective advice to be a successful investor.

Just keep in mind the purpose of statistical marketing and how it can influence your investment behavior. Keep greed and fear under wraps, and, in the long term, you will do just fine. Locate a mutual fund with unbiased forecasting, and you might just find yourself spending your retirement years in luxury.

David R. Clogg, ChFC is an account executive at Chapin, Davis. He can be reached at 410-435-3200 or visit his Web site at www.theeducatedinvestor.info.

Copyright 2003 Dolan Media Newswires
Provided by ProQuest Information and Learning Company. All rights Reserved.