To entice potential clients, some investment trading companies tout the results of their “model accounts.” This can lead some investors astray

To entice clients, some investment trading companies, or brokers, publish the results of what they refer to as “model accounts.” These hypothetical accounts supposedly measure the results you might enjoy by following the brokers’ research. In reality, the hypothetical account does much better than the brokers’ clients, because it enjoys advantages that are unavailable in real life.

It pays to be skeptical of investment performance calculations that companies calculate for themselves. This includes calculations by brokers, money managers and newsletter publishers. There are just too many ways to manipulate or “fudge” the numbers.

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An example of how some investment trading companies can manipulate or “fudge” the numbers

We recall one model account to which the broker could post new buys or sells after the close of trading, anytime up till the opening of trading in the morning. The broker based the gains on these late additions on the closing price of the night before.

At times, of course, overnight news or trading in foreign markets ensures that a stock will open substantially higher or lower when trading resumes in the morning. The advantage may rarely amount to more than a handful of percentage points. But those free gains add up and compound, just like the real thing. They can have an enormous ballooning impact on those hypothetical profits.

Other model accounts are calculated as if the account holder can get an unlimited ration of any hot new stock issue that shoots way up as soon as it comes to market. In reality, brokers reserve their best new issues for their biggest and most co-operative clients—those who do a lot of trading, or who buy every new issue the broker offers them.

Some investment trading companies offer online practice accounts. These can breed a false sense of confidence

Some investors are nervous about trading stocks online. So, instead of jumping right in, they start off by using the “practice accounts” or “demo accounts” that the online brokerage industry initiated several years ago.

Practice accounts are supposed to be identical to real accounts in all but one respect: you buy stocks in them with imaginary or “play” money, rather than the real thing. The brokerage industry says this gives would-be traders a free opportunity to learn how to trade online without risking any money.

Using an online broker’s practice account, you can learn online trading essentials: how to enter an order to sell or buy stocks; how to double-check your order before submitting it, so you avoid obvious but common mistakes, like buying 10,000 shares when you only meant to buy 1,000; and so on.

However, the big risk with practice accounts is that you’ll try out a risky and ultimately unwinnable investment approach, like day trading or options trading, and hit a lucky streak. This could embolden you to put serious money at risk just when your results are about to regress to the mean. This will most likely deliver losses instead of profits.

Some portfolio managers at investment trading companies may even suffer from “selective amnesia”

You should also be alert for what you might call “selective amnesia.” For instance, you’ll find mutual fund companies and portfolio managers that have been in business for decades, but who only advertise the performance of their most-recent funds and accounts. They don’t mention older accounts or funds that have so-so records. They also disregard more recent investment products that they eliminated early on, because they got off to a poor start.

This is all perfectly legal, mind you, provided that it meets fine-print disclosure requirements.

Bonus tip: How you can use a value investing strategy to form the core of a sound portfolio

Value stocks are the foundation of any long-term investment strategy because they trade lower than their financial fundamentals suggest. They are perceived as undervalued, and have the potential to rise.

In fact, value investing played a role in prominent investor Warren Buffett’s success. However, the main contributor to his success is his history of overall excellent stock-picking, and his practice of holding his top picks for a long, long time.

While virtually all successful investors have some understanding of value investing, many also have some knowledge of technical analysis, and most have some knowledge of a variety of other tools and shortcuts. But virtually all successful investors take a broad view, and apply everything they know to their investing decisions.

Successful investing is easy but not simple. Our process may seem complex, but the results make it worthwhile. Our Successful Investor philosophy helps our clients in two ways: it cuts their risk of severe or lasting losses during market downturns, and it helps you profit when markets move up.

What’s the highest return from a practice account that you or someone you know has achieved?

What do you value most in an investment trading company?