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Watch out, litigators. Your high-testosterone, high-intelligence personality may drive you to believe you can beat the market. You think you have all the answers. You know you’re smart and quick. You love the hunt. You’re addicted to the chase. But this attitude may lead you to make bad investing decisions and open you up to be victimized by stockbrokers and financial advisers. So Daniel Solin tells me. Solin, who is both a lawyer and an investment manager, wrote The Smartest Investment Book You’ll Ever Read. Since its release last November, the book has been what Solin calls a surprise hit, making it onto the BusinessWeek best-seller list and drawing praise from such distinguished investment writers as William Bernstein and Larry Swedroe. The reason for the endorsements by Bernstein, Swedroe, and others is relatively clear: The book has a lot of good material, ranging from the building of a balanced portfolio to the value of index funds to the importance of holding down investment costs. All of these points are important (and some of my key themes in this column). But what I want to focus on this month is how a certain personality — which Solin ascribes to litigators, but which can fit other lawyers as well — plays out in the investing world. What happens if a drive to win translates into a drive to beat the market? And what happens when a person with high self-confidence meets brokers who encourage trading in an adrenaline-filled challenge to score big? The results, even for smart people, are not usually pretty. But a dispassionate look at the evidence about investing performance reveals a calmer, more sensible path for even the most gung-ho lawyer. BEATING THE MARKETS? The financial system that, according to Solin’s book, undermines investors is staffed by brokers and financial advisers. A key section of Solin’s book is titled “Your Broker or Advisor Is Keeping You From Being a Smart Investor.” And these brokers and advisers are experts at exploiting aggressive, hyperconfident investors. ( Legal Times readers should take note. According to the paper’s latest readership data, 37 percent of subscribers use a broker, 30 percent use a financial planner, 25 percent use a private banker, and 10 percent use some other sort of investment adviser.) One big warning sign is when you find yourself focused on beating the market. And then you hire someone who promises, either expressly or implicitly, that you can do that (with his help). Granted, many people would consider this the main reason to hire an investment adviser. And the hunt for the next Microsoft can be exciting. Solin writes about the “rush” that some investors get from “trying to outwit other investors.” And there’s the “bragging rights at the nineteenth hole as to what a great broker they have.” Unfortunately, this excitement does not produce good investing results. Those who hire advisers to beat the market must believe that advisers can reliably and repeatedly (1) pick stocks or mutual funds that will do better than the average or (2) pick fund managers who will do so. Reams of evidence oppose such beliefs. In his book, Solin cites one study by Edward O’Neal of Wake Forest University, who looked at all 7494 actively managed mutual funds that aimed to beat the S&P 500 index during the 1990s. Mutual fund managers earn more prestige and better pay than most stockbrokers who work with individual investors, so if anybody can beat the market, surely they can. Yet the results showed that mutual fund managers typically failed against the S&P 500. O’Neal found that of these managers, only 46 percent were able to beat the index from July 1993 to June 1998. And only 8 percent beat the index in the next five-year period, from July 1998 to June 2003. (It’s not unusual to see some variation in the failure rate over different time periods. Another frequently cited statistic is that 80 percent of actively managed funds will fail to beat the relevant index over a five-year period.) Most people saving for retirement will invest for more than five years, so a more fitting measurement might be what percentage of managers outperformed the index during both five-year periods studied. “These results are sad indeed,” O’Neal reported (according to Solin’s book). “The number of funds that beat the market in both periods is a whopping 10 — or only 2 percent of all large cap funds.” If you are trying to pick stocks, either on your own or with a broker, look to see if your investment portfolio is outperforming the market over the long term. The odds are very much against it. HYPERACTIVE TRADING Another warning sign of an investor gone awry is a willingness to engage in active trading, often based on market timing. Solin labels this “hyperactive investing.” But you might also call it gambling. Active trading is nothing more than a series of bets, and it can be exciting for investors (as well as for brokers earning trading commissions). That hyperactive brokers and advisers intermittently produce winners, writes Solin, “reinforces this instinct, just like the sound of coins hitting the tray at a slot machine.” But just as gamblers ultimately lose to the casino, Solin continues, hyperactive investors too will lose to the house (in this case, the brokerage firm). Another psychological tendency underlying active trading is too much confidence. Solin warns, “This is particularly true of men, whose perception of their skills in many areas — especially athletics — is often at odds with objective reality.” Few practicing lawyers will ever play professional sports. But the odds of that are probably better than the odds of long-run success at market timing. Consider the authors of market timing newsletters — in this context, the equivalent of full-time athletes. Market timing newsletters provide subscribers with stock picks based on predictions of where the market will go. If this kind of analysis worked, these newsletters would dominate the investing world. In fact, Solin cites one study that found that almost 95 percent of market timing newsletters themselves failed within 12 years. Do you think you’re a master of the investing universe, able to make brilliant trades because of your great timing? Be careful. If you haven’t been comparing your trading results ( all your trading results) over time against the relevant index, you may be overestimating your abilities. BALANCED PORTFOLIOS There is a sound alternative to hyperactive investing. Solin advises a four-step process of (1) determining a desired asset allocation, (2) opening an account with a mutual fund company with low-cost index funds (Solin recommends Fidelity, Vanguard, or T. Rowe Price), (3) selecting a balanced portfolio composed of stocks and bonds, and (4) rebalancing that portfolio periodically. The result, he writes, is “likely to beat the returns of 95 percent of actively managed mutual funds over the long term.” Solin tells me that the majority of his fellow lawyers who hear the book’s message understand. Lawyers are intelligent people, he says. They are trained to analyze, look at data, and reach conclusions. When presented with the evidence about sound investing, they get it. As he puts it, “You can see the light bulb go on.” I hope that light bulb has gone on for you. If not, Solin’s book (an easy read) is worth 90 minutes of your time. Even — and perhaps especially — for high-testosterone litigators.
Robert L. Rogers, associate opinion editor at Legal Times , writes the Legal Tender column on personal finance. E-mail Rob with comments or suggestions for future columns.

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