Is it really possible to beat the market?
If you’re one of the many investors who are interested in stock newsletters so you can try and beat the market, then consistent strong returns are a really big deal.
But it seems like all investment newsletters claim to have amazing returns. They all display impressive graphs and boast about brilliant stock picks that doubled, tripled, or more.
So how do you know what’s real and what’s not?
There are three fundamental questions you should ask to decide if a newsletter’s claims of outperformance are realistic:
If you can answer these three questions correctly, you will have come a long way towards finding a high-performing newsletter. Let’s look at each in turn:
To decide if a newsletter’s performance is “good”, you have to first ask yourself what you’re hoping to get out of your subscription. Are you hoping for market-beating annual returns? Or reduced drawdowns during bear markets? Or sustained high dividend income?
Whatever your goal, you’ll want to find a newsletter that regularly tracks and reports their performance in that specific area. In other words, a dividend-focused newsletter should talk a lot about how good they are at earning dividends.
Most commonly, investors are seeking market-beating returns. In that case, you would look for consistently strong historical returns in excess of the appropriate benchmark. So what might that look like?
Imagine you’re shopping for a stock newsletter back in 2014 and you find one that advertises, “Our portfolio soared 30% last year!” That seems very impressive, right? Well, in 2013 the S&P 500 actually gained 32.3%, so the newsletter failed to beat a simple S&P index fund.
Context matters. And it’s incumbent on the newsletter to discuss their returns in a full and transparent context.
The number one thing we find missing from newsletters is a simple reporting of annual returns since launch compared to an appropriate benchmark for each individual year.
For example, we would expect to see something that looks like this for an imaginary “Large Cap Newsletter”:
In addition, they should show a line graph capturing performance over time compared to the appropriate benchmarks. Take for example our Active Stock Investor newsletter, compared to both the S&P 500 (SPY) and the Russell 2000 (IWM) small cap index:
Many newsletters only show a single bar chart with their strategy vs. the S&P 500 since inception. For example, here are returns since launch for our ASI newsletter in bar chart form:
While a bar chart is a great way to quickly visualize relative returns, it’s simply not enough. If a newsletter was started 10 years ago, it could have strongly beat the market in the first year, and then lost to the market every single year for the last nine years and still have a very impressive bar chart.
Similarly, we have seen newsletters that made one or two incredible investments early on that returned thousands of percent over the years. While that’s highly impressive, and a credit to their stock picking ability, you have to ask yourself: “What would their returns be like had they not bought that one huge-returning stock?”
In other words, do their strong returns seem to be the result of a consistently exemplary investment strategy, or just a few well-timed picks?
Along the same lines, it’s critical to see that the investing strategy has worked not just since inception, but somewhat recently as well.
Of course, even the best investing strategies will have periods of underperformance. And we discourage investors from chasing recent performance. But if a newsletter has not performed well in the past five years, you will want to weigh that carefully.
In addition to showing year by year returns, it’s critical that the newsletter compares their returns to an appropriate benchmark.
For example, if the newsletter is trading small cap stocks, they should include a small cap benchmark and not just the S&P 500, which holds the largest companies in the stock market.
If the newsletter is trading Biotechnology stocks, they should compare to a Biotechnology ETF or a Biotechnology industry benchmark.
If it’s trading value stocks, they should compare to a value-focused ETF or mutual fund.
Not only are these best practices for reporting returns, but they are powerful signals about the honesty and transparency of the newsletter publisher. If you see too many of the above items missing, proceed with caution.
So you’ve found a newsletter that performs well on the metrics you care about. Now you need to ask yourself, does this performance seem credible?
For 36 years, famed investor Mark Hulbert ran the respected Hulbert Financial Digest (HFD) which analyzed and reviewed hundreds of investing newsletters. In his final issue (February, 2016), Mark said:
“I have found that outright lying about performance is relatively rare. Far more common is spinning the numbers in a way that implies something that is false but doesn’t actually outright lie.”
The first thing to look for is whether the newsletter is clear and proactive about sharing the assumptions behind its performance.
There is no one right way to do this. It’s just important that a newsletter publisher has made some reasonable assumptions and shared them proactively with subscribers.
For example, for our Active Stock Investor newsletter, we assume:
Are these assumptions perfect? No, of course not. But they are reasonable and transparent.
Many other newsletters make different, but equally reasonable assumptions. The point is to make sure the newsletter is transparent, proactive, and sensible about how they’re reporting returns.
This is the trickiest question of them all. Assuming the newsletter’s performance really is good, could you have also achieved that strong performance in the real world?
Here is a common scenario:
After much research, you find an amazing newsletter with attractive and credible historical returns. You subscribe for 6-12 months, are disappointed with your returns, and decide to quit.
It’s a very common pattern. Honestly, we’ve done it ourselves. Before subscribing, you have to ask yourself, “Could I have replicated their performance in the real world?”
There are a few things to keep in mind when considering this important question.
First, how many positions does the newsletter hold and how often does it place trades? Will you be able to keep up with its trading?
For example, if you’re planning to follow a “Model Portfolio” newsletter that holds 15 stocks and typically places two trades every month, you must ask yourself, “Am I willing to trade 24 stocks each year?” For many investors, that’s very achievable.
But what about a portfolio of 50 stocks that trades five stocks each week. That would be 260 trades each year. Could you keep up with that trading? Some investors absolutely could, and for others that would be impossible.
We once subscribed to a popular and well-performing “List of Ideas” stock newsletter that recommended one new stock each month and graded its past recommendations using a “Buy / Sell / Hold” model. At first, 12 stocks each year seemed very easy to replicate.
But after following the newsletter for a year and buying 12 stocks, we realized the newsletter’s stellar performance reporting was including 71 past recommendations, going back years, that were still currently rated as “Buy” or “Hold"!
In order to have a chance at achieving their strong returns we would’ve had to also purchase all 71 past recommendations. We cancelled our subscription.
There is no right answer and no “correct” amount of trading. It all depends on your goals and what you can follow. A large cap deep value strategy might hold stocks for years before they increase towards their fair value. Whereas a small cap momentum strategy might turn over positions every week.
Research shows that for some investing strategies, turning over positions more frequently can lead to higher returns. And with brokerage trading fees coming down (and some brokerages completely free), it’s easier than ever to trade stocks frequently.
Regardless of your preference for portfolio turnover, there are many different investing strategies that can “work.” More frequent trading is not better or worse than less frequent trading. It all depends on what investing strategy is being pursued and what you can keep pace with.
(NOTE: We strongly recommend you understand the five main types of newsletters and choose carefully which one would work best for your goals and investment strategy.)
The most important thing to remember is if you can’t execute the same trades at roughly the same times and prices as the newsletter you’re following, you simply won’t achieve the same returns.
Finally, ask yourself if you’re prepared to fully implement the newsletter’s investing strategy and give it a chance to perform.
It’s common for an investor to find a great newsletter with attractive and credible historical returns, subscribe and begin to trade its recommendations, become disappointed with six months of mediocre performance, and cancel his subscription.
Every sound investing strategy will have stretches of good performance and stretches of bad performance. If you’ve done your homework and have confidence in the newsletter, give it a chance to perform over time.
Building wealth takes time. Legendary investor Warren Buffett said it best:
"Successful Investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can't produce a baby in one month by getting nine women pregnant."
So you’ve decided what you’re hoping to get out of an investing newsletter, done extensive research based on everything you’ve learned in this report, and narrowed your choices down to a few great newsletters. Now what?
In his final issue of HFD (February, 2016), Mark Hulbert offered his subscribers sound advice on how to test a new newsletter:
“My first suggestion is to track, on your own, any adviser you’re interested in following. Just sign up for a several-month trial subscription to his service and paper-trade his recommendations over that trial period. Pay close attention to not just whether your overall numbers match his, but also such details as whether the execution price you obtain for your paper trades are close to what he reports. Discrepancies are a red flag, to say the least.”
Once you’ve carefully narrowed your possible newsletter subscriptions down to a few top choices, we suggest you subscribe to them all. Think of it as taking each for a test drive.
You should read their welcome and orientation materials, browse past issues, paper trade their recommendations, and ask any subscription-related questions you might have. Pay close attention to whether you would be able to keep up with the newsletter in your own real-world portfolio.
Whenever you’re ready, narrow your subscriptions down to just the newsletters you want to try longer term. If you end up paying for a few at once while you decide which are the right fit, that’s fine.
The goal is to find a newsletter that will have a meaningful positive impact on your long term financial future. If that means a few small costs up front while you decide, we think that’s money well spent.
Once you’ve found a newsletter that meets your goals, appears credible, and is easy to follow, then it’s time to commit. Give it a chance to perform and don’t get too caught up in the ups and downs of short term market movement.
Remember the wise words of the great Warren Buffett:
"The stock market is a device for transferring money from the impatient to the patient."
NOTE: Above is a sample excerpt. For the full article and more, download the free 25-page report, "How to Pick the Best Stock Newsletter: 7 Must-Read Secrets Before You Invest a Penny"
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