Become a Better Investor

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It is challenging to find the right investment manager.  At a minimum, you want someone who is knowledgeable, ethical and takes the time to understand your goals and present situation.  Last week’s post on Greg Smith’s resignation from Goldman Sachs outlined some of the pitfalls you may experience with the wrong firm. 

While there is more to life than money, having enough of it when you need it most is extremely important.

The end goal of finding the right investment manager isn’t (or at least shouldn’t be) merely to amass piles of money.  It’s to form and adhere to a plan that offers you the best chance for achieving what you most want out of your life, while avoiding too many painful setbacks along the way.  If you look at investing through this lens, it clarifies how you and your advisor can view your wealth management in the same, best light:

Begin at the beginning: create a plan

Are you and your advisor guided first and foremost by a mutually formed plan that defines your unique financial goals and describes a sensible process for achieving them?  If not, what else can you rely on besides blind luck to find your way (and how reliable is that)?

Ensure that your goals drive the process

I recommend that your plan be in the form of a written Investment Policy Statement that you and your advisor have signed, and that you revisit together periodically to ensure that it continues to reflect your evolving circumstances.  By sticking with this approach, you’re investing according to your own goals, rather than the whims of an ever-fickle market.

Find a fiduciary

Financial intermediaries such as brokers expose you to potential and real conflicts of interest.  While some transactions are “perfectly legal,” by definition, they may benefit the broker and not you.  In contrast, a Registered Investment Advisor (RIA) is legally obligated to form a fiduciary relationship with you, which means that the RIA must act in your highest financial interests in managing your wealth.

If someone is determined to break the law, a written agreement isn’t going to stop them.  But, it is beyond me why anyone would open themselves up to the prospect of being legally ripped off (in the form of unnecessarily higher costs or less-appropriate investments), when it is so readily prevented by ensuring your advisor is a fiduciary.

Talk the talk

Have an investment strategy.  A plan is a great start, but, ultimately, it’s only as good as your ability to stick with it.  An advisor’s key role is not only to help you design your plan, but to serve as your constant ally in adhering to it under all market conditions.   He or she should consistently encourage sensible investment activities and remind you what you’re about if you are tempted to stray (such as panic-selling when the markets turn bearish, or chasing hot streaks when the market’s on a tear).

Walk the walk

Last but certainly not least, your advisor should establish his or her business and service offerings to complement rather than conflict with all of the above. Some of the characteristics to look for include: 

  • Transparent, fee-only arrangements.  Greg Smith’s Goldman Sachs op-ed piece illustrated all too clearly the conflicts of interest that can arise when your “advisor” is operating in an environment in which portions of his income are in the form of often undisclosed commissions and similar incentives coming from outside sources.
  • Arm’s length custody.  Your assets should be held by a separate custodian, who sends regular, independent reports directly to you, so you can substantiate your advisor’s activities on your behalf.  Ideally you should have online access to your account.
  • Passive management.  Easily a topic for another post, but the recommended investment solutions within your portfolio should be optimized to help you achieve your personal goals. Briefly, this translates to funds that are “passively” managed to capture available, long-term market risk factor premiums as effectively and efficiently as possible.  A passive strategy helps you avoid the costs and inconsistencies found in attempting to outfox the market through “active” predictions.  The market as a collective, highly informed entity is pretty tough (and expensive) to attempt to beat.
  • Go over your results at least once a year.  Find someone you can trust and also verify the results.  You can’t expect to do well every year, but you should at least know your returns.


There is a lot we cannot control: the business cycle, changes in tax policy, political instability and even acts of terrorism.  But we can concentrate on the things we can control.  The proper relationship with a fee-only advisor is your best chance for a positive result.


What Investors Should Learn From 2011

January 10, 2012 by  
Filed under Investing, The Education of an Investor

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The year 2011 will go down as one of the most volatile ever.  We witnessed political upheaval and wide swings in market prices.  Everything seemed to conspire to undermine investors’ composure.

Yet, the major U.S. stock market indices avoided a downturn in 2011 after two strong recovery years.  Those who bailed out after any one of the market  tumbles would have missed the year’s many improbable, unpredictable recoveries. 

So, what lessons can we learn from such a volatile year? 

1.  Be humble about making predictions. Even the experts can get it wrong – just ask Pimco’s Bill Gross.

2.  Don’t even try to time the market. That’s difficult even in the best of times and these aren’t those. 

3.  Stay diversified and disciplined; that’s always the best course, regardless of volatility.

4.  Don’t buy into the crisis du jour mentality of the media.  Shock and awe sells; judicious analysis does not.

Weston Wellington, Vice President of Dimensional Fund Advisors, does an excellent job of summarizing the year’s events and the lessons we can learn from 2011.


Year-End Review

Equity investors around the world had a disappointing year in 2011 as thirty-seven out of forty-five markets tracked by MSCI posted negative returns. The US did well on a relative basis and was the only major market to achieve a positive total return, although the margin of victory was slim. Total return for the S&P 500 Index was 2.11%, and the positive result was a function of reinvested dividends—the index itself finished the year slightly below where it started.

Throughout the year, investors seeking clues regarding the strength of business conditions or the prospects for stock prices were confronted with ample reason to rejoice or despair. Optimists could cite the strong recovery in corporate profits and dividends, the substantial levels of cash on corporate balance sheets, low interest rates and inflation, a booming domestic energy sector, continuing strength in auto sales, and record-high share prices for leading multinationals such as Apple, IBM, and McDonald’s. Pessimists could point to persistently high unemployment, slumping home prices, tepid growth in retail sales, worrisome levels of government debt at home and abroad, and political gridlock in both Congress and various state legislatures.

Although the broad market indices showed little change for the year, there were opportunities to make a bundle—or lose one. Among the thirty constituents of the Dow Jones Industrial Average, thirteen had double-digit total returns, including McDonald’s (34.0%), Pfizer (28.6%), and IBM (27.3%). But losing money was just as easy: The three worst performers in the Dow were Hewlett-Packard (–37.8%), Alcoa (–43.0%), and Bank of America (–58.0%). If nothing else, the substantial spread between these winners and losers discredits the argument we often hear that all stocks are now marching in lockstep and that diversification is ineffective.

Achieving even modest results in the US market required more discipline than many investors could muster, since investor sentiment fluctuated dramatically throughout the year and the temptation to enhance returns through judicious market timing often proved irresistible.

For fans of the “January Indicator,” the year got off to a promising start as stock prices jumped higher on the first trading day, pushing the Dow Jones Industrial Average to a twenty-eight-month high. Bank of America shares jumped 6.4% that day, the top performer among Dow constituents. With copper prices setting new records and factory activity worldwide perking up, the biggest worry for some was the potential for rising prices and higher interest rates that might choke off the recovery. “Overheating is the biggest worry,” one chief investment strategist observed. By April 30, the S&P 500 was up 8.4%, reaching a new high for the year.

Stocks wobbled through May and June but strengthened again in July. On July 19, the Dow Jones Industrial Average had its sharpest one-day increase of the year, jumping over 200 points, paced by strong performance in technology stocks. Just a few days later, however, stocks began a precipitous decline that took the S&P 500 down nearly 17% in just eleven trading sessions. The century-old Dow Theory—a sentimental favorite among market timers—flashed a “sell” signal on August 3, and on August 5, Standard & Poor’s downgraded US government debt from AAA to AA+. As investors sought to assess the implications of sovereign debt problems in both the US and Europe, stock prices fluctuated dramatically, with the S&P 500 rising or falling over 4% on five out of six consecutive trading days in early August. Rattled by the sharp day-to-day price swings, many investors sought the relative safety of US Treasury obligations in spite of the rating downgrade, pushing the yield on ten-year Treasury notes to a record low. Stock prices hit bottom for the year on October 3 as some market participants apparently lost all confidence in equity investing. A Wall Street Journal article cited a number of individual investors as well as professional advisors who had recently sold all their stocks and did not expect to repurchase them anytime soon. “I feel like a deer in the headlights,” said one.

As it turned out, the article appeared in print on the second day of a powerful rally that sent the Dow Industrial Average surging over 1,500 points during the next 19 trading days, putting it back into positive territory for the year.

What can we learn from a difficult year like 2011? As Dimensional founder David Booth is fond of saying, the most important thing about an investment philosophy is that you have one. Many investors (as well as some allegedly professional advisors) apparently decided to switch from a buy-and-hold philosophy to a market timing strategy in the midst of an unusually stressful period in the financial markets. We suspect few of those adopting the change would have been able to clearly articulate their investing beliefs and why they had shifted.

Legendary investor Benjamin Graham offered the following observation nearly forty years ago: “There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he himself is a part.”

Good advice then, good advice now.

By Weston Wellington, Vice President of Dimensional Fund Advisors


Mark Gongloff, “Investors’ Forecast: Sunny With a Chance of Overheating,” Wall Street Journal, January 3, 2011.

Jonathan Cheng and Sara Murray, “Stock Surge Rings in Year,” Wall Street Journal, January 4, 2011.

Matt Phillips and E.S. Browning, “Tech Sends Stocks Soaring,” Wall Street Journal, July 20, 2011.

Steven Russsolillo, “‘Dow Theory’ Confirms It’s an Official Swoon,” Wall Street Journal, August 4, 2011.

Damian Paletta, “U.S. Loses Triple-A Credit Rating,” Wall Street Journal, August 6, 2011.

Tom Petruno, “Investors Stampede to Safety,” Los Angeles Times, August 19, 2011.

Kelly Greene and Joe Light, “Tired of Ups and Downs, Investors Say ‘Let Me Out’,” Wall Street Journal, October 5, 2011.

Benjamin Graham, The Intelligent Investor (New York: HarperCollins 1949).

The S&P data are provided by Standard & Poor’s Index Services Group.

MSCI data copyright MSCI 2011, all rights reserved.

Yahoo! Finance,, accessed January 3, 2012.


Risks Worth Taking

March 10, 2011 by  
Filed under Investing, The Education of an Investor

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Jim Parker of Dimensional Fund Advisors recently wrote a column on the proper approach to risk, as it applies to investing. To me it’s all common sense, but that sometimes is in short supply, just when you need it the most!  Read on to see if you agree.

A wise man once said that to profit without risk and to experience life without danger is as impossible as it is to live without being born. That all may be true, but which risks are worth taking and which are not?

The fact is even the most self-declared risk-averse people take risks every day. There are routine risks to our safety in crossing the road, in riding public transport, in exercising at the gym, in choosing lunch and in using electrical equipment.

Then there are the “big decisions” like selecting a degree course, choosing a career, finding a life partner, buying a house and having children. These are all risky decisions, all uncertain, all involving an element of fate.

In making these decisions, we seek to ameliorate risk by carefully weighing up alternatives, researching the market, judging possible consequences and balancing what feels right emotionally and intellectually, both in the short term and in the long.

Sometimes, we ask an independent outsider to guide us in making our decision. They do this by providing an objective assessment of the potential risks and rewards of various alternatives, by taking a holistic view of our circumstances and by keeping us free of distraction and focused on our original goals.

In investment, this is the value that a good financial advisor can bring—not only in understanding risk and return and how to build a portfolio but in knowing the specific needs, circumstances and aspirations of his or her individual client.

Quite simply, many people who invest without the help of an advisor take risks they do not need to take. They gamble on individual stocks, they rely on forecasts, they chase past returns, they fail to rebalance their portfolios to take account of changing risks and they run up unnecessary costs and tax liabilities.

To use an analogy, this is like trying to cross an eight-lane highway in the face of heavy traffic when there is a pedestrian bridge a little way down the road. You may well get to your destination safely through the traffic, but it will be despite your actions rather than because of them. Understanding risk in investment begins with accepting that the market itself has already done a lot of the worrying for you. Markets are highly competitive, which means that new information is quickly built into prices. Instead of trying to second guess the market, you work with it and take the rewards that are on offer.

Your biggest investment is in spending time with an advisor building a diversified portfolio designed to meet your long-term requirements, then meeting them periodically as your needs change and to ensure you are still on course.

In considering all of this, it is important to understand that risk can never be totally eliminated. If there were no risk, there would be no return. But your chances of a good outcome are far greater if you use the accumulated knowledge of financial science and the guiding hand of an advisor who knows you.

To sum up, risk and return are related. But not all risks are worth taking. The process of working this out starts with not trying to do it all alone.

Investment Pornography, Part 1

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Caught your attention, didn’t I?  Please don’t be offended by the title of this post, and please don’t snigger over it.  This is serious business, after all. Also called “Financial Pornography,” investment pornography consists of (1) alluring magazine cover headlines promising juicy riches, (2) articles featuring exciting ways to capitalize on supposed opportunities and (3) outlandish claims and predictions that may, in fact, be bad for your financial health. Finally, it has no redeeming value whatsoever (except that it is good for a laugh).

When I go to conferences held by Dimensional Fund Advisors, one of the best run and most respected mutual fund companies, the lecture known affectionately as “Investment Pornography” generally gets the most attention and the most nodding heads of recognition. The presentation consists of articles from popular finance magazines followed by a quick analysis of what actually happened. Punchline: They were spectacularly wrong, time and time again.

Future posts will cover articles that are way too optimistic and were written simply to get you riled up enough to buy a magazine, newspaper or investment newsletter. Today’s topic is of the other kind of Investment Pornography, the alarming article that promotes fear. This is the other side of the outlandish approach to getting your attention.

Sympathy and Recognition

I feel sorry for a journalist who covers the stock markets. A writer typically takes the financial news of the day (which is, more often than not, pretty muddled), and tries to make some sense of it by quoting various people who at least sound as though they know what they’re talking about.

The fact is that sometimes stock prices go up and sometimes they go down, and sometimes they don’t do anything. And no one can predict what is going to happen next. That’s why it’s best to be a buy and hold type investor. But, really, who would read that story over and over? Would you?

So although writers try to be accurate, relevant and interesting, they frequently stray into making predictions. In my opinion, trying to predict the future is futile, and can be downright dangerous. Sometimes a writer will positively mislead you and convince you to do something you will regret.

Fear Mongering

A year ago, on March 6, 2009, I took the New York Times to task for fear mongering at (possibly) just the wrong time. By coincidence the stock market hit its actual bottom a year ago on March 9th, the next business day. Read that post for an egregious article that, if followed, would have cost you dearly.

While, in general, I love the New York Times’ reporting, here is a recent example of fear mongering from the January 25th article, Volatility and Politics Spark Fears of Market Correction, by Javier C. Hernandez.

Here are some questionable quotes with my comments:

“Brace yourself for another wild ride on Wall Street.” (Sounds scary, doesn’t it?)

“Worries about the strength of the global recovery and proposals from Washington to clamp down on banks have sent fresh jitters through financial markets, prompting chatter among traders that stocks could be poised for that rare but alarming phenomenon: a correction.” (Rare and alarming? Not really; it happens more often than you’d think.)

“Over three tense days last week, stocks tumbled nearly 5 percent; the Dow posted triple-digit losses on Wednesday, Thursday and Friday, ending the week at its lowest level since November.” (So? Five percent declines are quite common and mean nothing. Three days should definitely not make anyone “tense.”)

“Some analysts believe the downward momentum may continue.” (True, but other analysts don’t.)

“A confluence of all those headwinds creates a perfect storm of uncertainty on a market that had already been a bit vulnerable to a pullback,” said Quincy M. Krosby, a market strategist at Prudential Financial. (“Perfect storm”- nice phrasing; I sure hope that it didn’t convince you to abandon a well-thought out plan, though.)

“A severe decline in the market is far from assured. There are no certainties on Wall Street, and stocks have been known to bounce back after similarly turbulent periods.” (Thank you, thank you, thank you! I couldn’t have said it better myself.)

“In the near term, an unusual degree of uncertainty may bring more losses to the stock market.” (Yes, and then again it may not.)

Fast Forward Five Weeks

By contrast, after the market had gone up, the New York Times had this March 5th article: Markets Find the Upside of the Jobs Report also by Mr. Hernandez.

What a difference five weeks makes! Now, after the stock market has gone back up, we read “better-than-expected snapshot of unemployment in the United States lifted Wall Street on Friday, reinforcing hopes that the job market — and the broader economy — might be gaining strength.”

Here are more quotes with my comments.

“The fact that unemployment is not getting worse is great news for the market.” (First of all, it is possible that statistically the recession has already ended. Second, the unemployment news tells us only what has already happened, not necessarily what the stock market will do.)

“In light of that uncertainty, the question for Wall Street is whether the upward push can endure.” (You are free to guess what the stock market will do short-term, but no one knows.)

“The major indexes have recovered from their losses in January, and they are in positive territory for the year. Last week brought strong gains, with all three indexes ending the week more than 2 percent higher.” (Good thing we didn’t bail out and sell after reading that January 25th article, hmm?)


I am not picking on the New York Times. It is a must read for me every day, for its reporting and also for its opinion columnists. In truth, if I had to give up either reading the New York Times or watching TV, it would be a difficult choice.

And the New York Times is certainly not alone in its fear-mongering role; almost without trying, you can easily find dozens of predictive articles in most, if not all, national publications.   Money magazine has had many silly articles that would have cost you big bucks.  SmartMoney is frequently not-so-smart.   Business Week and Forbes should be ashamed. Time magazine is well known for its lurid front covers of Depression-like photos.

My advice is to ignore such articles, because they are in fact “Financial Pornography.” They attempt to, and often succeed in, getting people riled up, by either pandering to fear or greed. More likely than not, they are heavily influenced by what has already happened.

If they correctly predict what the markets subsequently do, it is merely a coincidence, in my opinion. Save your time and your money. Pay no attention to sensational articles with worrying predictions, or ones that identify sure-fire investments for that matter. By the time you read the story, any relevant facts are already reflected in today’s prices. It is too late to consider what you read to be useful, actionable information.

Do not be influenced by short term fluctuations or worrying articles. It is much better to have a plan and to stick with it.

Learning from Investment Mistakes, Part 2

February 19, 2010 by  
Filed under Investing, The Education of an Investor

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“Individual investors tend to invest in a small number [of stocks] and they don’t know how to construct a portfolio. Professional portfolio managers control risk.” Jim Peterson, vice president at the Schwab Center for Financial Research.

My last post discussed the basic stock-bond allocation decision. This is a technique that many investment advisers use, but it is not the way most people approach investing. Most people are looking for an idea, a story or concept that they can build upon to make a winning investment, something that captures their imagination. They want to be a part of the next big thing, discovery or cure.

From time to time, a friend or acquaintance will tell me his or her investment philosophy. Years ago, one such friend offered the advice that you should “buy what you know.” That, of course, assumes that familiarity translates to good investment analysis. Unfortunately, there is no evidence that this is always the case.

Take, for example, people in Rochester, N.Y., who over-weighted their portfolios with Eastman Kodak and Xerox – more’s the pity for their retirement accounts. I submit that where you live (or where you grew up or where you work) should not be the guiding factor to which stocks you buy. Suppose you had lived in Houston and bought a ton of Enron stock or lived in Charlotte and invested heavily in Wachovia Bank stock?

Another past story line I’ve heard was “buy dominant technology companies with market power” as in Cisco, Microsoft, and other highflying tech stocks. That bit of advice was proffered in 2000, incidentally, just before all those “dominant technology companies” tanked.

More recently, a friend said that he liked GE, simply because Warren Buffett had invested in it. (And Buffett must know what he is doing, after all.) Fine, but Mr. Buffett’s company bought preferred shares with powerful guarantees and plenty of sweeteners; a much better deal than you or I or any “ordinary” investor will ever get buying GE common stock on the open market.

Some people follow trends, buying what “is going up” (which really means buying what has already gone up; granted, a small difference in interpretation, but a big difference in results). A good example of this is gold, which I have been asked about recently. (I’ll write more about gold in a future post.)

And, naturally, I’m also approached by the pessimists, who talk only of deficits, higher taxes in 2011 or 2012, third world debt, possible terrorism, etc., etc.

What is to be made from all these divergent concerns and predictions? In my opinion, not much. Hot tips and stocks with a good “story” or narrative are not necessarily going to reward you as an investor, because you cannot get the past performance that you have already witnessed.


My approach has always been and will continue to be this: If you are an investor, then you should invest. You should not allow yourself to be influenced by the news – good or bad – or by what your friends are doing or not doing. Investing is about cost control, having a globally diversified portfolio (preferably one holding thousands of securities), and taking the amount of risk that is right for you.

It is simple, but it is not easy.

To be continued…

Learning from Investment Bank Mistakes

October 21, 2008 by  
Filed under Investing, The Education of an Investor

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“The key to successful investing is to get the plan right and stick to it. That means acting like the lowly postage stamp that does one thing, but does it well: It sticks to its letter until it reaches its destination. The investors’ job is to stick to their well-developed plan (if they have one) until they reach their destination. And if they don’t have a plan, write one immediately.” – Larry Swedroe

What can investors learn from the mistakes of investment banks, such as Lehman Brothers and Bear Stearns? That question is what Larry Swedroe addresses in his article: Anatomy of a Crisis: Lessons Learned From the Credit Crunch.  Swedroe believes that one should not judge a strategy “solely on the outcome.” Nevertheless he identifies the “major strategic errors” investment banks made.

First, they “bet the house” by using too much leverage, meaning the company would go bust if these bets lost. Highly leveraged institutions must be right all the time because even if they are correct in the long term, they may not weather a short-term storm. This is a lesson these institutions should have learned from the 1998 experience of hedge fund Long-Term Capital Management (LTCM).

Second, they failed to effectively diversify risks, placing too many eggs in just a few highly correlated baskets (such as residential and commercial real estate).

Third, they forgot that even if assets have low correlation, risky assets have a nasty tendency to have their correlations turn high at the wrong time.

Fourth, they treated the unlikely (housing prices falling sharply) as impossible. They also forgot that just because something had not happened does not mean it cannot.

Fifth, they failed to understand that liquidity can be illusory: there when you don’t need it, but “gone with the wind” when you do.

Lessons Investors Should Learn

  1. Investment banks and active managers (including hedge funds) cannot protect investors from bear markets. All crystal balls are cloudy … If their money managers could protect you, why did Lehman Brothers and Bear Stearns go belly up and Merrill Lynch have to run into the arms of Bank of America to prevent the same fate? …
  2. Never take more risk than you have the ability, willingness or need to take.
  3. Diversify broadly, and don’t concentrate labor capital and financial assets in one basket. Many employees of once-great companies lost not only their jobs but also much of their financial assets because they made this mistake.
  4. For fixed-income assets, stick only with government bonds and the highest investment-grade bonds. Anything else (such as junk bonds and preferred stocks) can have the risks show up at the wrong time.
  5. We live in a world of uncertainty (the odds of events occurring cannot be measured), not a world of risk (the odds can be measured). Thus, stocks are high-risk investments, no matter how long the investment horizon. That is one reason for the large equity risk premium.
  6. Treat neither the unlikely as impossible, nor the likely as certain. And, if something has not yet happened doesn’t mean it cannot or will not.
  7. Make sure your investment plan incorporates the high likelihood of crises. The only way to avoid them is to not take risk, and thus accept Treasury bill returns. While bear markets are painful, there is no good alternative to buy and hold except to avoid risk. Timing the market is a mug’s game.

As further evidence against the folly of market-timing efforts, a study on 100 pension plans that hired the “best managers” around to engage in tactical asset allocation (a fancy term for market timing) found that not one had benefited from the efforts.

Is It Different This Time? Part 1


“We cannot assume that even if the economic news gets worse that prices will decline further. It’s quite possible that prices are already reflecting investor concerns of more trouble ahead and may rise despite more gloomy business reports in days and months to come.” – Weston J. Wellington.

Scary Headlines

Lately, it seems that all we have been reading and hearing about are falling real estate values, failing national banks, global brokerage firms in dire straits, and stock prices plummeting in markets all over the world. This is no fun, no fun at all. Surely, we are in big trouble. You may believe that our current financial problems are “unprecedented.” For a different view, though, read on.

Needed Perspective

Dimensional Funds Advisors Vice President, Weston J. Wellington, offers perspective on how the current market downturn compares to past bear markets. His short, 17-minute presentation Is It Different This Time?  shows how resilient markets have really been.

Video highlights include brief discussions of past articles from Time, Newsweek, Fortune, and Business Week, which shows how past crises and bear markets were covered. What is surprising is how often the word “unprecedented” gets used.

Creative Commons License photo credit: sorian

Investment Lessons from a Big Dog: No New Tricks

September 29, 2008 by  
Filed under Investing, The Education of an Investor


“By following a disciplined policy of maintaining a well-diversified set of portfolio exposures, regardless of market zigs and zags, investors establish the conditions for long-run success.” – David Swensen.

I recently attended a meeting hosted by a very large financial services company about their approach to investment management. This presentation was given to a group of financial planners in Northern New Jersey, and the goal was to identify those planners who would like to outsource the money management portion of their practice.

This company manages almost $200 billion in assets for pension funds, wealthy individuals, not-for-profits, and financial institutions. They had a marvelous bound handout with great graphics. And they used some very impressive terminology such as Distribution-Focused Strategies and Total Return Investing.

However, after listening to their sales pitch and reading through the propaganda, I remain unconvinced that they are doing anything that innovative, at least when compared to that which an experienced financial planner already does. Because using them would only add an additional layer of fees and not provide any significant value, I was not interested in using their services.

Their presentation, though, brought up several valid points that you should consider in managing your own affairs or when finding a financial planner. Summarizing the key points to consider in creating a portfolio:

• Your Goals
• Your Time Horizon
• Your Risk Tolerance

All of these are inter-related, and it is important to remember that the real risk is not meeting your goals.

In creating and managing a portfolio, the basic factors are the same for everyone:

• Asset Allocation
• Costs
• Tax Management

Keeping these basic, yet profound, concepts in mind will serve you well over the long term.

The Total Return Investing concept is actually valid and quite useful, and worth explaining. What is implied from that term is that investment decisions should be based on total returns, not just interest and dividends. Many people looking for an amount to replace a paycheck in retirement, for example, often focus only on the yield of their portfolio. This translates to dividends and interest income.

There are three reasons, though, why the Total Return Investing strategy is at a disadvantage.

First, while interest and dividends appear to be something you can count on, only about 20-25% of stocks actually pay dividends. If you excluded the rest merely because they don’t pay out dividends, you are excluding the majority of companies.

Second, dividends are not always secure; they can be reduced or eliminated. Loading up on stocks that pay a high dividend can be riskier than you thought.

Third, when investors realize that the projected income is not going to be “enough” to meet their goals, they frequently “reach” for yield by either buying riskier bonds that promise to pay higher returns, or they buy longer term bonds, which ordinarily pay more in interest. Unfortunately, as we have seen recently, if you buy riskier bonds you may suffer a substantial loss, rather than get a higher yield. And if you buy longer term bonds, you will lose principal if and when interest rates go up.

Fourth, you are not likely to keep up with inflation, if you concentrate too much on current yield. To keep up with inflation, you need to own equities.

I am not suggesting that you should avoid bonds in your portfolio, only that they are usually not sufficient for most people.

As I said, these concepts are standard operating procedure for experienced investment managers. I just thought that their importance bore repeating.

Creative Commons License photo credit: mahalie

The Education of an Investor, Part 1

August 22, 2008 by  
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“Experience is the toughest kind of teacher — it gives you the test first and the lesson afterwords. Perhaps, by learning a bit of history, you can assimilate the lesson vicariously without bearing the costs.” – Burton Malkiel

I’ve been an ardent reader and believer in “How-To” books since, as a teenager, I read The Education of a Poker Player by Herbert Yardley. It was one of the first books published which addressed poker from a mathematical perspective. What an eye-opener, because it proved (to me, at least) that there is a huge difference between a professional with a well thought out strategy and someone who merely played poker by relying on hunches and the appearance of Lady Luck.

About the same time, I also read How to Play Winning Checkers by Millard Hopper. While not exactly an investment book, it was useful nonetheless, especially if you were willing to practice until you had your winning strategy down pat.

Based on personal experience, it is definitely possible to improve your game by reading “How-To” books.

The concept of learning how to win at a game gives rise to these two real world investment questions: Can someone actually “play” the stock market? Is investing just a “game” or is it something else entirely?

My perspective on this goes back decades (all right, a lot of decades) to when in high school, I first started reading books on the basics and fundamentals of finance and investing. I was intrigued enough to include the biographies of several very successful financiers such as J.P. Morgan, Bernard Baruch, the Rothschilds, etc. Of the many books I read on investing, these three titles stood out among the rest:

  • Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay
  • The Battle for Investment Survival by Gerald Loeb
  • The Intelligent Investor by Benjamin Graham
  • I had no idea that these books would one day be considered investment classics. At the time, I read them because the titles attracted me. I read them passionately, often nodding my head in agreement, or shaking my head in wonder at the collective brilliance. And after all these many years, they all continue to be available for sale, albeit in new and updated editions.

    Now, there may be selective memory at work, but I cannot remember the titles of any of the other books, the ones which, apparently, did not become classics, merely used book store fodder.

    How many and which books about investing should you read? Obviously, that depends on what you have already read, where you are starting, and what your investment goals are. For a beginning investor, though, a good book to start with would be Mutual Funds For Dummies by Eric Tyson.

    For more advanced investors, there are several books you might consider, which I’ll discuss in future posts. Stay tuned.