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You are not alone. And it probably is not your fault. It may be chemical.

“Prediction addition” was coined by Jason Zweig, a staff writer at Money Magazine and the author of a fascinating new book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich (Simon & Schuster August 1, 2007).

It is the compulsive desire to try to make sense out of just about everything. Even events that are not predictable. Like the direction of the stock market or the future price of a particular stock or mutual fund.

This addiction is a particularly bad one. Not only are our brains hard wired to believe we can predict the future and make sense out of random acts, it rewards us for doing so. The brain of someone engaged in this activity experiences the same kind of pleasure that drug addicts get from cocaine or gamblers experience when they enter a casino.

When predicting the unpredictable goes south, as it inevitably will, the neurons in the brain start misfiring, causing panic and anxiety.

Anything less than total confidence in our predictions implies that we have lost control. The brain resists this conclusion. Random events are perceived as the enemy.

Enter the broker. Many reinforce “prediction addiction” by validating the process. Stock picking, market timing, and picking hot mutual fund managers are premised on this ability to predict the unpredictable.

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The Morningstar “star” system is often used by brokers and advisors to pitch hot mutual funds. A five star rating means huge inflows for mutual funds. A one or two star rating can mean significant outflows as investors flee these funds.

Over the years, there has been considerable research demonstrating that high Morningstar ratings are not predictive of future performance. Some of these studies demonstrated little difference between the performance of five star and three star funds in the years after the rating was given.

A new study by Professors Morey and Gottesman of Pace University concludes the opposite. The study looked at Morningstar rated, domestic equity funds for the three year period from July, 2002-June, 2005. They concluded that “higher rated funds, for the most part, significantly outperform lower rated funds.”

So, should you run out and buy five star rated funds?

Not if you are interested in superior returns.

With minor exceptions, the study found that, in all star categories, index funds outperformed all of the rated mutual funds.

This finding is not mentioned in the “Conclusions” to the study, which focuses on the predictive power of the higher rated funds, thereby missing the point. Why should investors care if five star funds outperform four star funds, when index funds outperform five star funds?

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When The New York Times reviewed The Smartest Investment Book You'll Ever Read, the headline was "A Stubborn Insistence On One Way To Invest." The reviewer went on to somewhat begrudgingly concede that "it is clear he is on to something."

Actually, I am only partly guilty. I do not believe there is only one way to invest. I do believe there is only one way to invest intelligently. Here it is:

1. Determine your asset allocation. You can do this by taking a free risk capacity survey. There are many of them on the internet. I admit to a bias for the one at the web site for my book.

2. Buy three low cost index funds from Vanguard.

• - The Total Stock Market Index Fund (VTSMX). Put 70% of the amount allocated to equities in this fund.
  
  
• - The Total International Stock Index Fund (VGTSX). Put 30% of the amount allocated to equities in this fund.
  
  
• - The Total Bond Index Fund (VBMFX). Put 100% of the amount allocated to bonds in this fund.

3. Rebalance your portfolio once or twice a year to keep your asset allocation intact or to change it if your investment objectives or tolerance for risk have changed.

That's it. You are done.

Depending on your asset allocation, the long term average annual returns of these portfolios have ranged from 9.06% to 10.86%. The portfolios with the highest allocation of equities have yielded the highest returns.

Other fund families, like Fidelity and T. Rowe Price, offer similar funds.

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Daniel R. Solin is our guest blogger during the week of October 29th. If you have any questions for Daniel R. Solin, add a comment to any of his posts. Here is some brief information about The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals:

Daniel Solin cuts through financial propaganda to show readers exactly how assets should be invested, using trusted, brand name fund managers like Fidelity and Vanguard. Solin's easy-to-follow plan allows investors to create and monitor their portfolios in 90 minutes or less a year, explaining how to assess risk and how to allocate assets to maximize returns and minimize volatility. Readers will also learn how to avoid the biggest mistakes investors make, from buying into media hype to giving their hard earned cash to hyperactive brokers and investment advisors.

About Daniel R. Solin

Daniel R. Solin is a leading securities arbitration lawyer and a principal in Academic Wealth Management, LLP, a Registered Investment Advisor. The author of Does Your Broker Owe You Money?, Solin has testified before a congressional subcommittee investigating the fairness of the mandatory arbitration system imposed on all investors by the securities industry. He has appeared on The O’Reilly Factor, MSNBC’s Week-end Economic Review, CNN’s Money, and Bloomberg Television. He has been interviewed on more than 40 radio programs, including USA, CBS, ABC, and a number of regional NPR affliliates. Formerly the host of his own financial cable television show in southwestern Florida, he is a much sought-after speaker for groups of investment professionals, lawyers, and accountants.