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Economic View: For Stock-Picking Advice, Don’t Ask an Economist

“O.K. Mr. Smarty-Pants,” she often asks me, “what stock should I buy now?”

She first asked me this question when I was an undergraduate at Princeton, majoring in economics. She asked again when I was a graduate student at M.I.T., earning a Ph.D. in economics. And she has asked it regularly during the last three decades when I have been an economics professor at Harvard.

Unfortunately, she has never been happy with my answers, which are usually evasive. Nothing in the toolbox of economists makes us good stock pickers.

Yet we economists have written countless studies about the stock market. Here is a summary of what we know:

THE MARKET PROCESSES INFORMATION QUICKLY One prominent theory of the stock market — the efficient markets hypothesis — explains how answering my mother’s question would be a fool’s errand. If I knew anything good about a company, that news would be incorporated into the stock’s price before I had the chance to act on it. Unless you have extraordinary insight or inside information, you should presume that no stock is a better buy than any other.

This theory gained public attention in 1973 with the publication of “A Random Walk Down Wall Street,” by Burton G. Malkiel, the Princeton economist. He suggested that so-called expert money managers weren’t worth their cost and recommended that investors buy low-cost index funds. Most economists I know follow this advice.

PRICE MOVES ARE OFTEN INEXPLICABLE Even if changes in stock prices are unpredictable, as efficient markets theory suggests, we should be able to explain these changes after the fact. That is, we should be able to identify the news that causes stock prices to rise and fall. Sometimes we can, but often we can’t.

In 1981, Robert J. Shiller, a regular contributor to this column and an economics professor at Yale, published a paper in The American Economic Review called, “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?” He argued that stock prices were too volatile. In particular, they fluctuated much more than a rational valuation of the underlying fundamentals would.

Mr. Shiller’s paper prompted a storm of controversy. My reading of the subsequent academic literature is that his conclusions, though not all his techniques, have survived the debate. Stock prices seem to have a life of their own.

Advocates of market rationality now say that stock prices move in response to changing risk premiums, though they can’t explain why risk premiums move as they do. Others suggest that the market moves in response to irrational waves of optimism and pessimism, what John Maynard Keynes called the “animal spirits” of investors. Either approach is really just an admission of economists’ ignorance about what moves the market.

HOLDING STOCKS IS A GOOD BET The large, often inexplicable movements in stock prices might deter someone from holding stocks in the first place. Many Americans, even some with significant financial assets, avoid stocks altogether. But doing so is a mistake, because the risk of holding stocks is amply rewarded.

In 1985, Rajnish Mehra and Edward C. Prescott, both now at Arizona State University, published a paper in the Journal of Monetary Economics called “The Equity Premium: A Puzzle.” They pointed out that over a long time span, stocks have earned, on average, about 6 percent more per year than safe assets like Treasury bills. This large premium, they said, is hard to explain with standard economic models. Sure, stocks are risky, so you can never be certain you’ll earn the premium, but they are not risky enough to justify such a large expected return.

Since the paper was published, economists have made some limited progress in explaining the equity premium. In any event, the large premium has convinced most of us that stocks should be part of everyone’s financial plan. I allocate 60 percent of my financial assets to equities.

Stocks may be an especially good deal today. According to a recent study by two economists at the Federal Reserve Bank of New York, given the low level of interest rates, the equity premium now is the highest it has been in 50 years.

DIVERSIFICATION IS ESSENTIAL Every time a company experiences a catastrophic decline — consider Enron or Lehman Brothers — reports emerge about employees who held most of their wealth in company stock. These stories leave economists slapping their heads. If there is one thing we know for sure, it is that sensible financial management requires diversification.

So, if you have more than 5 percent of your assets in any one company, call your broker and sell. Doing otherwise means exposing yourself to extra risk without extra reward.

SMART INVESTORS THINK GLOBALLY One widely documented failure of diversification is what economists call home bias. People tend to invest disproportionately in their home country.

Most economists take a more global perspective. The United States represents a bit under half of the world’s stock portfolio. Because Europe, Japan and the emerging markets don’t move in lock step with the United States, it makes sense to invest abroad as well.

Which brings me back to my mother’s question: If I could pick just one stock for someone to buy, what would it be? I would now suggest something like the Vanguard Total World Stock exchange-traded fund, which started trading in 2008. In one package, you can get low cost and maximal diversification. It may not be as exciting as trying to pick the next Apple or Google, but you’ll sleep better at night.

N. Gregory Mankiw is a professor of economics at Harvard.

Wealth Matters: Technology’s Impact on the Value of Financial Advice

But is the technology good enough to replace guidance from financial advisers? Or is technology actually good for advisers because they can use it to do their jobs better?

Several new reports look at what technology will mean for an adviser, who, at his or her best, protects people from their worst investment ideas. And that brings up a corollary question: What will this trend, and enormous investment, in technology mean for the clients, the people whose money is at stake?

It seems almost heretical to propose that technology will not make an existing service better. But after reading the reports and talking to advisers who have embraced technology, I was not sure that this emphasis was going to be better for clients.

The report from Accenture looked at how younger clients sought relationships through technology and how advisers had to be available to provide it.

“When we talk to firms, they think social media is a new thing, and they’re trying to control the risk of it,” said Alex Pigliucci, global managing director of the wealth and asset management business at Accenture. “I see these tools as an advantage today. They’re not something to plan for in the next five to 10 years.”

“The Out-of-Sync Advisor,” a report by Deloitte, imagined technology bringing clients who were managing their own money back to advisers and then allowing those advisers to give people with a couple of hundred thousand dollars the type of high-quality advice reserved for people with hundreds of millions of dollars.

Ed Tracy, leader of the wealth management and private banking practice at Deloitte, said this would be possible only if all the clients’ financial information was already in the system so the advisers could spend their time together talking about the clients’ goals.

Fidelity’s annual broker and adviser sentiment index, released late last year, tried to put a dollar amount on all of this: technology-adept advisers who were focused on clients in their 30s and 40s managed, on average, $8 million more than colleagues focused on baby boomers. Their clients also had slightly larger accounts. (Not in the data was how technology contributed directly to this.)

But is there any practical value to investors in this push for more technology? In some areas, yes. In others, it remains to be seen.

Patrick O’Connor, senior vice president for wealth, retirement, portfolio solutions at Raymond James, said some of the best technological innovations reminded him of a recent visit to his new dentist.

Instead of pointing to a murky X-ray and telling him to floss, his dentist wheeled around a monitor that showed his teeth — and the problems with them — from various angles. A bit more brushing here and flossing there, and the image changed to show healthier teeth.

“She was giving me more ownership of my teeth,” Mr. O’Connor said. “I’ve been much more diligent about flossing and paying attention to those areas. Before, I would have ignored her. I’d been lectured to for 10 years.”

Technology, he said, can do much the same thing for investors, showing them how they are doing and the consequences of their spending and saving. The technology also becomes the bearer of bad news, not the adviser. “Instead of saying, ‘Sorry you’re in the red,’ I become the facilitator in getting you from the red to the green,” he said.

And technology can help clients reduce mundane and time-consuming tasks and increase the amount of time they can talk about the things that matter most to them.

“If someone had my data, understood my goals, had buckets in my portfolio and I knew if I was on track or off track and they only spent three hours a year with me, I’d feel a lot better than I would with someone I sat down with who said, ‘Tell me what’s going on,’ ” Mr. Tracy said.

Wealth Matters: Smart in Medicine or Law, but Not in Managing Money Money Advice for Doctors and Lawyers and the Rest of Us

But their attitudes toward money and investing can create financial challenges later in life.

And the years of education that got them to where they are, their financial advisers say, can also stand in the way of their financial decision-making.

As Greg Erwin, managing principal at Sapient Private Wealth Management who works with doctors, put it, “A lot of these physicians would like to believe that investing and savings is pure science, and that’s not true. It’s an art form.”

Over the last two columns, I have looked at the behaviors of some highfliers — athletes and people who make their living drilling and transporting oil and gas; and those who have built their wealth in volatile fields like technology and real estate.

In each of those cases, I asked financial experts to share their insights into the financial and investing mistakes that are often typical of these clients.

In this column, I’m going to look at what the rest of us can learn from doctors and lawyers.

DO NO HARM Doctors have a reputation among financial advisers for spending every bit of money they make. They earn a lot, after all, and figure they can work a long time. But doctors who engage in this type of spending can forget how hard it will be to maintain their lifestyle in retirement without millions of dollars saved.

“Doctors can have a sense of entitlement,” said Lewis Altfest, chief executive of Altfest Personal Wealth Management, who has a specialty in advising doctors.

“Doctors are highly respected in their communities. They have historically been among the most gifted intellectually and they’re not afraid to exercise it.”

(He has dentist clients as well, but said they generally acted more like accountants than doctors: conservative and more risk-averse.)

While doctors are certainly smart, their medical ability does not necessarily translate to financial acumen.

Mark Gurland, 59, a hand surgeon in New Jersey who is married to a psychiatrist, said he had a theory about doctors’ financial behavior. Since most do not finish their internships and residencies until age 32 — if they have gone straight through from college — they have been living cloistered existences even as their college friends have been working for at least a decade.

“When they’re done, my feeling is, there is this repressed self-sacrifice and when money appears, they’re living in huge houses and driving the fanciest new cars,” he said. “They have a lot of money they worked hard for, and they’re spending it.”

On the investment side, he said, doctors often believe that their knowledge of medical issues translates into something seemingly simpler, like investing.

Dr. Gurland, who has always been a saver, said he had been guilty of making investments on a tip or a hunch. A cardiologist friend persuaded him to invest in fiber optic cables a decade or so ago: he said he doubled his money and then lost almost all of it. When he invested in a company that was promoting a drug for hand surgeries, he thought he had a winner but lost money on that one as well.

Now, he said, he defers to his adviser on investments and thinks of some of his most annoying patients who try to tell him what’s wrong with them.

“Every day, we see patients in today’s world who seemingly know more about medical conditions than the doctor,” he said. “Why? Because they went on the Internet and read about this.”

Mr. Erwin, the adviser, said he tried to offer doctors a financial plan that dealt with their desire for rewards. At the same time, he lets his clients know about the risks inherent in not saving and in trying to fit in time for investing when they have an all-consuming job.

“They’re very methodical thinkers, but they’re also extremely busy,” Mr. Erwin said.

He said he spent time coaching his doctor clients not to get swayed by a friend who thinks they should invest in something they know nothing about or has an opinion about timing the market.

But doctors generally get two important things right. Doctors, particularly those with a unique specialty, buy disability insurance because they know that if they can’t work as a hand surgeon, for example, their income will plummet, even if they can still work as a doctor in a different capacity.

Shortcuts: Advice for Keeping Holiday Parties and Guests Safe

LAST Thanksgiving, I learned a valuable safety tip: be careful when using a foil roasting pan. It can puncture and fat can drip in the oven, resulting in a fire.

All this caused quite some excitement because 22 people were waiting to be fed. We managed to save the turkey, though, and the oven suffered no long-term harm. But the incident reminded me that when we prepare meals and our homes for the holidays, most of us tend to concentrate on how nice everything will look and taste. We don’t really think about keeping our guests safe.

Cynthia Weber, a decorator in Ontario, remembers a similar situation.

She was at her aunt’s house for Christmas. “Boughs of pine were elegantly draped over the crystal chandelier above a stunning centerpiece of candles.” Everyone was seated at a formal dinner, complete with Waterford crystal and Limoges plates. Then, a candle lighted the pine on fire. Alarms went off and the security system started calling.

“We couldn’t swat at it because it was in midair attached to a crystal chandelier,” Ms. Weber said.

Her aunt, thinking quickly, went to get wet tea towels and smothered the flames.

“But everybody felt a little singed,” Ms. Weber said.

As the holidays approach, people start poring over decorating magazines and online sites and “get completely fixated on everything looking beautiful even if it’s completely impractical,” she said.

Most of us think first of beauty, then comfort, then safety, said David Mauldin, owner of the home repair company House Medic, based in Austin, Tex.

“That order should be reversed,” he said.

It may not be a Hallmark saying, but I strongly believe that a good holiday is one where you avoid the emergency room.

Start with the first impression your house will make. Is there adequate lighting, even in rain and fog? Is there a loose step?

As for beauty, take a hard look at your front door. Last year, my colleague Bob Tedeschi wrote a great article on how to spruce up your front door for the holidays, taking on everything from picking out a new doormat to installing new door handles and locks.

If you don’t want to do it yourself, Mr. Mauldin said his company, which is a franchise of HouseDoctors.com, can make a front door look almost like new in a few hours.

Although garlands draped over banisters can be festive, don’t forget that handrails serve an important practical function, Ms. Weber said.

“People are sometimes afraid to touch the banisters if they’re decorated,” she said. Securing a decoration to the outside of the rails allows people to still use them.

When your guests enter your house, make sure they’re not assaulted with an overload of smells. Hold back on the scented candles, Ms. Weber said, because the combination of food and perfume can become overwhelming.

We often entertain more people than usual at holidays and drag out card tables or folding chairs that we use only annually. Check to be sure that they’re in good operating order. At another Thanksgiving my family attended years ago, the beautifully laid table collapsed just as the turkey was placed on it.

And while dishes of colorful candies can be attractive, they can also be a choking hazard for toddlers, Ms. Weber said. Place them high enough so that children can reach them only with an adult’s help.

The bathroom may not be the first place you think of when entertaining, but it is a room a lot of guests will visit while in your house. Always make sure there’s a fairly full roll of toilet paper and if necessary, an extra one in easy sight. Finding the host to inquire about more toilet paper is never enjoyable.

Speaking of places to escape to, it’s not a bad idea, if possible, to set up a “quiet room” with no music or decorations for someone who needs to nurse a baby or recover from a headache, Ms. Weber said.

If you’re having houseguests stay over a night or more, the bathroom becomes even more important. Wet hair, steam and an unfamiliar shower can be a recipe for disaster.

“Most accidents happen when people are stepping from one wet surface to another,” Mr. Mauldin said. So make sure there’s a nonslip mat outside your shower.

Sometimes people want to go the extra distance to ensure their older guests’ safety in the bath and buy grab bars that stick to the walls with suction.

Shortcuts: Advice for Keeping Holiday Parties and Guests Safe

LAST Thanksgiving, I learned a valuable safety tip: be careful when using a foil roasting pan. It can puncture and fat can drip in the oven, resulting in a fire.

All this caused quite some excitement because 22 people were waiting to be fed. We managed to save the turkey, though, and the oven suffered no long-term harm. But the incident reminded me that when we prepare meals and our homes for the holidays, most of us tend to concentrate on how nice everything will look and taste. We don’t really think about keeping our guests safe.

Cynthia Weber, a decorator in Ontario, remembers a similar situation.

She was at her aunt’s house for Christmas. “Boughs of pine were elegantly draped over the crystal chandelier above a stunning centerpiece of candles.” Everyone was seated at a formal dinner, complete with Waterford crystal and Limoges plates. Then, a candle lighted the pine on fire. Alarms went off and the security system started calling.

“We couldn’t swat at it because it was in midair attached to a crystal chandelier,” Ms. Weber said.

Her aunt, thinking quickly, went to get wet tea towels and smothered the flames.

“But everybody felt a little singed,” Ms. Weber said.

As the holidays approach, people start poring over decorating magazines and online sites and “get completely fixated on everything looking beautiful even if it’s completely impractical,” she said.

Most of us think first of beauty, then comfort, then safety, said David Mauldin, owner of the home repair company House Medic, based in Austin, Tex.

“That order should be reversed,” he said.

It may not be a Hallmark saying, but I strongly believe that a good holiday is one where you avoid the emergency room.

Start with the first impression your house will make. Is there adequate lighting, even in rain and fog? Is there a loose step?

As for beauty, take a hard look at your front door. Last year, my colleague Bob Tedeschi wrote a great article on how to spruce up your front door for the holidays, taking on everything from picking out a new doormat to installing new door handles and locks.

If you don’t want to do it yourself, Mr. Mauldin said his company, which is a franchise of HouseDoctors.com, can make a front door look almost like new in a few hours.

Although garlands draped over banisters can be festive, don’t forget that handrails serve an important practical function, Ms. Weber said.

“People are sometimes afraid to touch the banisters if they’re decorated,” she said. Securing a decoration to the outside of the rails allows people to still use them.

When your guests enter your house, make sure they’re not assaulted with an overload of smells. Hold back on the scented candles, Ms. Weber said, because the combination of food and perfume can become overwhelming.

We often entertain more people than usual at holidays and drag out card tables or folding chairs that we use only annually. Check to be sure that they’re in good operating order. At another Thanksgiving my family attended years ago, the beautifully laid table collapsed just as the turkey was placed on it.

And while dishes of colorful candies can be attractive, they can also be a choking hazard for toddlers, Ms. Weber said. Place them high enough so that children can reach them only with an adult’s help.

The bathroom may not be the first place you think of when entertaining, but it is a room a lot of guests will visit while in your house. Always make sure there’s a fairly full roll of toilet paper and if necessary, an extra one in easy sight. Finding the host to inquire about more toilet paper is never enjoyable.

Speaking of places to escape to, it’s not a bad idea, if possible, to set up a “quiet room” with no music or decorations for someone who needs to nurse a baby or recover from a headache, Ms. Weber said.

If you’re having houseguests stay over a night or more, the bathroom becomes even more important. Wet hair, steam and an unfamiliar shower can be a recipe for disaster.

“Most accidents happen when people are stepping from one wet surface to another,” Mr. Mauldin said. So make sure there’s a nonslip mat outside your shower.

Sometimes people want to go the extra distance to ensure their older guests’ safety in the bath and buy grab bars that stick to the walls with suction.

Bits Blog: Carol Bartz on the Yahoo Board That Fired Her and Advice for Marissa Mayer

If Carol Bartz, the former chief executive of Yahoo, could go back in time, she would have changed one thing about her relationship with the board that fired her by phone last year.

Ms. Bartz would have spent more time understanding the relationships between the board members, she said Tuesday at Fortune’s Most Powerful Women summit in Laguna Niguel, Calif.

Alex Gallardo/Reuters Carol Bartz at Fortune’s Most Powerful Women event.

“I didn’t understand or have the time or take the time — that’s a much better thing to say, take the time — to understand the relationships they had between themselves,” she said.

How could she have done that as chief executive? “Well, you go in the men’s room,” she said. In reality, she added, she should have arranged dinners with two board members at a time.

Ms. Bartz gave Yahoo’s former board some credit — but also a little dig.

“Unfortunately for the board, they had gone through one year of the acquisition battle with Microsoft,” she said. “And in fairness to them, they just wanted it to be simple, like no more press, no more anything. But the business is tougher than that.”

Now Marissa Mayer has taken over as chief executive of Yahoo, with an entirely new board. Ms. Bartz said she and Ms. Mayer have spoken about the job.

Her advice for Ms. Mayer was to understand that change at such a big company is hard. Ms. Mayer is trying to change Yahoo’s culture in ways big and small, like serving free food and acquiring more startups.

“One piece of advice I would give her is changing culture is not a sprint, it’s a marathon,” Ms. Bartz said. “It’s very, very hard to affect culture. And you can get surprised thinking you’re farther down the path of change than you really are because, frankly, most of us like the way things are.”

Employees might nod when an executive suggests changes, she said, “then they go back to their cube and go, ‘I ain’t doing that.’ And so I think that’s important for all of us, is to realize how stuck individuals can be, much less 14,000 people.”

Ms. Bartz did not rule out taking another chief executive role, saying she is an opportunist rather than a planner.

“I grew up in a small town in Wisconsin,” she said. “I never thought I’d be where I am. I never thought I’d have bling,” she said, flashing the rings on her fingers before adding, with perfect comic timing, “that I bought.”

Ms. Bartz is the lead director of Cisco Systems, where she has been on the board for two decades, and she has also served on seven other public company boards during that time.

The difference between a good board and a bad one, she said, is not panicking, which she said the Cisco board achieves, and being genuinely interested in the company rather than prestige or money.

She said she has turned down board positions from banks because “I like banks because they keep my money safe, but I don’t want to talk about banks 12 times a year.”

Directors who are genuinely interested will take the time to get to know one another and the executives, but not be afraid to fire one another, she said.

“When trouble strikes, which it always does — bad economy, bad quarter, activists, takeover — when trouble strikes, those board members who don’t understand or are not committed are not helpful,” she said.