There’s an old saying, “a fool as his money are soon parted”. Whoever came up with that saying could not have foreseen how true that statement can be, particularly as it relate to investing.
Most financial planners and investment advisors operate above board. An increasing number hold to a fiduciary standard. This means that they take no action that does not benefit their client. However, there is a whole industry devoted to separating investors from their money.
Many of these web sites and newsletters use attention-grabbing, and often fear-inciting, headlines that draw you in. Then, to support the claim they are making they use what appear to be relevant statistics.
But statistics can be misleading. Here are four tips that investors can use to separate fact from fiction.
First, know the difference between a statistic and a survey. While it’s true that statistics can be misleading, a survey presents the particular issue of bias. A survey is only as good as the basis behind them. It’s always important to understand the methodology behind the survey. Who was polled? How representative of a sample was it? In his 1954 book, How to Lie With Statistics, Daniel Huff wrote, “No conclusion that ‘sixty-seven percent of the American people are against’ something should be read without the lingering question, sixty-seven percent of which American people?”
Second, remember your middle school math. When looking at an average, there is a difference between the mean and the median. A median means that half of the numbers are higher and half the numbers are lower. The mean is the arithmetic average of a group of numbers. Both are right, but the significance of the number depends on which method is being used.
Third, beware of the scary graph. When looking at economic data over time, the horizontal line typically plots dates and the vertical axis plots quantity or size. If either of the axes is skewed (by stretching the scale or skipping over entire time periods) a graph can be skewed to show a story that does not reflect reality. Most of the time, historical graphs can show predictable trends. A graph that tells a wildly different story should be looked at skeptically.
Finally, be sure to that both the cause and the effect make sense. For example, according to Huff an infamous survey once tried to prove that non-smokers got better grades in college than smokers. The problem is that the survey never attempted to explain if that meant smoking led to poor grades or if poor grades led to smoking. In this case, the conclusion reached was probably based on a survey that had bias and led to a spurious correlation.
As you can see, statistics can be misleading. However, by applying a healthy dose of skepticism and not taking any information at face value, investors can be better informed and make better investment decisions. As with many things, if a statistic sounds unbelievable it usually is.