WSJ's latest investment advice is plain wacky

(MoneyWatch) COMMENTARY Bad investment advice is all too common. Whether it's because investment promoters have products to sell or are, like most of us, prone to irrationality, we're often advised to buy investments that have already hit their peaks and sell those that have reached their nadir. In other words, you're constantly encouraged to buy high and sell low -- the polar opposite of what a wise investor should do.

Still, it would be hard to find worse counsel for your long-term economic health than what Boston University management professor Zvi Bodie and financial consultant Rachelle Taqqu advised in Monday's Wall Street Journal. To avoid having to read the drivel in their article, "Why Stocks are Riskier than you Think," here is a  quick summary: Rather than buying stocks as a way to meet long-term financial goals, such as retirement, instead scale your expectations down to the bare bones. Then save like a crazy person so you can invest in idiotically "safe" investments, such as Treasury Inflation Protection Securities, that will only meet, not beat, the rate of inflation. Ever.

In other words, if you want to have $2,000 per month in future buying power, you should save $2,000 per month now. With this so-called "aspirational" money (which appears to be the amount above that minimum $2,000 that you're supposed to set aside in TIPs and inflation-linked savings bonds), you can engage in complicated "collars" that will both limit your upside and downside when investing in stocks.

Normally, advice this bad is best ignored. But because the WSJ is usually a credible source of information, it's worth taking the time to explain why this particular piece is completely "wackadoo," as the brilliant investment editor Anne Kates Smith described it to me in an email. Let's start with the graphic accompanying Bodie's and Taqqu's story titled, "The conventional wisdom... and why you should look deeper." I'm going to take their points one at a time to show how these authors are using half-truths to promote a boneheaded strategy.

From the graphic: "THEY SAY diversification can protect your portfolio. BUT that's only true up to a point; correlations between different investment types aren't constant."

It is true that "correlations" are not exact, nor are they constant. You diversify because different investments move at different times and different speeds  -- in investment speak (the language Bodie and Taqqu appear to favor), that means they're not "closely correlated." Sometimes, a wide array of investments appear to be moving in the same direction and at the same rate, as the authors contend. But the pattern usually doesn't continue for long and, it's worth noting, is highly unlikely with a diversified portfolio that includes many types of assets, such as stocks, bonds, cash, and international securities. 

It is also true that diversification does not mean you'll never suffer an investment loss. It just means that your losses -- and your gains -- will be muted. For example, a portfolio made up exclusively of large-company stocks has returned up to 54 percent in a single year, but it also has suffered losses of as much as 43.4 percent. On the other hand, a portfolio that's composed half of stocks and half of long-term government bonds has gained as much as 35 percent in the best year, but lost only 25 percent in the worst year. On average, over a 20-year rolling period, a portfolio that consists entirely of stocks has earned about 11 percent, while a portfolio that's 50/50 stocks and bonds has earned 8.7 percent.

Inflation -- the proxy for the portfolio Bodie and Taqqu are advocating -- has averaged 3.8 percent, according to Ibbotson Associates. What does that mean to your wealth? This: If you invested $2,000 a month over a 20-year period and got the diversified portfolio average of 8.7 percent, you'd have $1,357,370 at the end of the period. If you invested in an inflation proxy, you'd have $724,472.

From the graphic: "THEY SAY buying and holding stocks is a sure-fire key to asset growth. BUT the longer you hold onto your stocks, the better chance you'll run into a bear market."

Again, this is basically true. But it's a dumb argument. Why? Let's say you invest for 20 years and then suffer the worst bear market in history right before you retire. Using the numbers above, you can see what would happen to the value of your diversified portfolio, which declined (in its worst year) 24.7 percent. Your $1.36 million would get hit to the tune of $335,270. That hurts, to be sure. And yet that still leaves you with over $1 million invested versus the $724,472 you would have if you followed the bone-head approach.

From the graphic: "THEY SAY stocks have beaten bonds over every 30-year stretch but one since 1861. BUT there have been only five 30-year periods that don't overlap -- too few to justify the conclusions."

Guess what? You're living in an overlapping 30-year period, and you're going to retire into one, too. If you live multiple years, your investment returns are going to be cumulative. There are 121 overlapping 30-year periods, and bonds have beaten stocks in only one of those. That's good enough for me.

From the graphic: "THEY SAY stocks are the only way to make up what you've lost in the market. BUT the desire to get back what you lost can cloud your judgment and lead you to take more risk than you can handle."

It's true that people sometimes make stupid decisions out of fear or greed. That's why, frankly, you should have a smart investment strategy that you stick with, regardless of market whims. You shouldn't sell when stocks tank. You shouldn't buy when they're hot. You should have a diversified portfolio that you keep through thick and thin. But investing in a diversified portfolio of stocks and bonds isn't your biggest risk. Your biggest risk is following idiotic investment advice.

If you are worried about risk and want to find ways to mitigate the volatility of stocks, check out Jeffrey Kosnett's always insightful "Cash in Hand" column in Kiplinger's, which shows how to find yield in a low-yield environment without taking excessive risk. If you want sage advice on retirement or investments, it's hard to find better counsel than from MoneyWatch's own Steve VernonDan Burrows, or Allan Roth.

In some ways, Bodie's and Taqqu's advice about figuring out how much money you really need to meet your financial goals isn't bad. But their investment strategy conflicts with the "conventional wisdom" for a simple reason: It's unwise.