The Dark Secret to Beating the Markets

According to charges levied by the United States attorney in Manhattan, Mathew Martoma, a former portfolio manager at SAC Capital Advisors, engaged in insider trading. Martola is accused of obtaining secret information from Sidney Gilman, a doctor involved in clinical trials for an Alzheimer's drug being tested by mega drug giants, Elan and Wyeth.

Gilman is a neurology professor at the University of Michigan. He allegedly provided Martola with confidential information concerning negative test results relating to the drug. Upon receipt of this information, SAC engaged in trades from which it allegedly made more than $276 million in illegal profits and the avoidance of losses. Gilman is cooperating with prosecutors in exchange for immunity from criminal prosecution. SAC and Martola deny any wrongdoing.

According to the New York Times, Gilman was retained by a number of financial firms (like hedge funds) eager to pay his $1,000 hourly rate for his "medical expertise", while he was engaged in overseeing drug trials for pharmaceutical firms.

Since this is the end of the year, it's also the time when "financial experts" come out in force, peer into their crystal balls, and predict the direction of the stock market for 2013. The fact that there is no evidence these predictions are more likely to be accurate than you would expect from random chance does not deter investors from relying on them. If you are one of those investors, I highly recommend a blog by Barry Ritholtz written on December 31, 2008. Ritholtz summarized some of the "hilarious" bad predictions made by prominent financial gurus for 2008. A senior writer for Fortune recommended the purchase of Merrill Lynch before it fell by 77 percent. Famed stock analyst Elaine Garzarelli recommended buying Lehman Brothers and Bear Stearns. You know what happened to them. Jim Cramer declared the "inevitability" of Goldman Sachs reaching $300 a share. According to Yahoo Finance, it closed on December 14, 2012 at $119. You get the drift.

You should ignore all these predictions. You can learn much more from the conduct of Gilman and his benefactors. I doubt his "medical expertise" alone is really worth $1,000 an hour. Hedge funds understand something many investors don't: Inside information is essential to their efforts to "beat the markets" and justify their obscene fees. The real skill of hedge fund managers is not in identifying inefficiencies in the market. It's finding those willing to engage in illegal conduct in exchange for hefty fees. The best investments these funds can make is in obtaining inside information and trading on it. You need to look no further than the alleged $276 million return on the investment made in Gilman's ability to provide confidential information about the results of an important drug test. Whatever was paid to Gilman for this information was a round up number on the petty cash receipts for the day.

The fact that hedge funds--the self-anointed "masters of the universe"--need to engage in this kind of activity is information that should fundamentally change the way you invest. Who do you think is on the other side of these trades? Do you think you can compete against big funds with vast resources they are willing to spend to achieve stellar returns?

If big hedge funds can't "beat the markets" legally, you might want to consider the possibility that you can't either. There's a better way. Fire your "market-beating" broker or adviser. Invest in a globally diversified portfolio of low management fee index funds in an asset allocation appropriate for you. I tell you exactly how to implement this responsible, academically-validated investment plan in The Smartest Investment Book You'll Ever Read and The Smartest Portfolio You'll Ever Own.

Dan Solin is a senior vice president of Index Funds Advisors. He is a New York Times best selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now: How to Defend Yourself Against Rigged Markets, Wall Street Greed, and the Threat of Financial Collapse, will be published on December 31, 2012.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.



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