Why Stock Tips Aren’t All They’re Cracked Up to Be

“I want easy money, easy money, easy money,
I could get lucky, oh, things could go right.”
                                                                     -Billy Joel

Every investor loves a stock tip, right?  What simpler way is there to make easy money?

Well, not so fast.  What seems like just one easy-to-implement decision is actually much more involved.

Let’s imagine a scenario where the person giving the advice is actually good at this kind of thing (statistically a rare trait), and that the stock tip he/she gives is well-timed.  Now what?  Along with that tip comes the requirement to not only get the timing right with respect to selling that stock, but also the responsibility to remember to advise the recipient that it’s time to sell.  Again, let’s assume for discussion’s sake that this stock picker is generally good at this kind of thing, and mindful enough to remember that tip they gave late one night at a cocktail party.  What’s to say they get the timing right when it comes to selling this particular stock?  And what’s to say the recipient heeds that advice?

Investors are not just robots but very much emotional creatures, fueled by greed and fear, even when they don’t recognize it in themselves.  You can almost hear the reaction on the part of the investor … “Sell now, are you kidding me, this stock is on a roll?!”.  Soon afterward that great stock tip soon turns south, and those paper profits with it.  Coulda, woulda, shoulda.

But I digress, let’s keep the optimistic scenario alive just a little longer, and assume that the recipient complies with the adviser’s mindful and well-timed sell instruction, and pockets those profits.  Now what?  Well, it’s a sure thing that adviser will get solicited for yet another stock tip.  And on and on it goes.  What are the odds that this profitable and perfectly choreographed scenario can be repeated?

And what about those tips that don’t turn out so well?  You know, that unfortunate stock tip that’s a loser, and that the recipient refuses to sell because of the very real phenomena of what Nobel Prize winner Daniel Kahneman refers to as loss aversion.   In my experience most investors aren’t adequately hardwired to think about or much less properly assess probabilities and outcomes when it comes to investing, especially when it comes to individual stocks.

And notice that I haven’t even touched on other very real considerations.  First, what’s to say that the stock tip is appropriate for the person asking the question?  What’s their risk tolerance?  How much of their net worth do they intend to invest in this stock?  What’s their time horizon, etc.?  Second, and equally important, is that investors should be approaching their investments not as isolated silos but rather holistically, i.e., as part of a broadly diversified portfolio.  The notion of focusing on just one stock without proper context is risky behavior on the part of the investor and irresponsible on the part of any professional money manager.

To recap, even under the best of circumstances, a stock tip is not just one decision but three:

  1. Buying a stock at the right time
  2. Knowing when to sell it
  3. Replacing that stock with another – again, at just the right time.

That’s a lot to get right.

The bottom line: the next time you’re at a cocktail party or at the water cooler, and the subject of stock tips come up, steer the conversation back to something really important, like the adventures of Kim and Kanye or the whereabouts of Tom Brady’s Super Bowl jersey.

Ned is the founder and investment officer of Salisbury Capital Advisors, LLC, a registered investment advisor in Los Angeles, CA.

Please note: I reserve the right to delete comments that are offensive or off-topic.

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