A holiday tradition for many investment advisors is a request from members of the media for stock picks for the coming year. The presumption is that we somehow have the ability to foretell the future, the media can deliver more eyeballs to advertisers, and the public can pick up some free advice. At best, we can only satisfy two out of three outcomes.
Is there a way to play this exercise to your advantage? There is, but it probably is not what you may think. Due to the way our minds are wired, we naturally place a disproportionate weight on more recent events. Thus, if the market is rising, we will typically predict that it will continue to rise and vice versa. So advice on the future direction of the markets is fraught with danger, and it should be taken with a grain of salt.
Advice on the future prospects of companies can also be problematic. With most contests, there is a time frame for evaluating the success of a recommendation. The shorter the time frame, in this case usually the end of the year, the greater the risk the pick may slide.
As a general proposition, selecting individual stocks is not in the best interest of most consumers. They expose you to what we call company risk – that is, the risk that news affecting just that company can cause a major decline in a stock’s price.
Finally, most advisors naming picks are looking to stand out from the crowd. The odds are good that their selections will end up at the top or the bottom of the charts at the end of the year. So what positives can you take away from annual stock picking contests? Rather than looking for individual picks in which you can invest, look for investment themes that can serve as the basis for additional research. Take notice of any investment metrics which seem unfamiliar to you. Perform an internet search to see if you can learn a bit more about the pros and cons of using specific indicators. Try to develop a sense whether someone has really done their homework or is just giving you superficial answers.
Stock picking contests can be useful, if you know the right way to use them.