When we left our advisor, we had to take personal control of our investing. We decided the first step in setting up an investment portfolio is understanding what we were doing. So we got learned. Only thing needed was a library card (or an amazon account). And it ends up that investing can be as simple (or complicated) as anyone wants it to be.
The following is my suggested reading list for Investments 101 (and maybe part of 201), as well as the key points I took from the literature. And I do suggest you read it all & soak up the knowledge. Obtaining an understanding of investing will empower you to remove fear from decisions, take control, and set a course for financial success.
In the beginning, avoid the daily press. There is too much incentive for fear mongering. Confusion and worry sells papers & attracts web readership. Instead, read some books that have proven track records. Learn when the times have been good/bad, where you fit it, and how the market works in general.
Investment Book Recommendations
Four Pillars of Investing (William Bernstein, 2010) – Fantastic overview of knowledge needed to build successful portfolio. Pillars include: Investment Theory, History, Psychology, and Business.
- The Intelligent Investor (Benjamin Graham, 1949) – Along with the more detailed Security Analysis provide the backbone to modern value investing. A must-read.
- The Intelligent Asset Allocator (William Bernstein, 2000) – Plain spoken, but with significant research backup. Provides info on the nuts & bolts of building a diversified portfolio.
- A Random Walk Down Wall Street (Burton Malkiel, 1973) – Examines both technical and fundamental investment analysis; concludes that both have significant flaws. An investor cannot significantly outperform the market since asset prices exhibit signs of a “random walk.”
- Snowball: Warren Buffett and the Business of Life (Alice Shroeder, 2008) – A biography that is inseparable from its investing lessons. Highlights the possibilities from genius, effort, and rationality in investing. A contrast to the random walk theory.
Hot Stock Tips from these Books
Buying stocks does not have to be gambling. You are really buying a (small) portion of an operating business. As that business produces profits, you should ultimately see that cash flow (or value appreciation).
We need to understand our tendencies as humans – and protect our portfolios from ourselves. We have instincts that can negatively affect returns such as (1) pattern recognition/invention, (2) overvaluing the recent past in forecasting, and (3) anchoring to an idea.
Timing the market is a fool’s errand. I have a hard time with this, probably due to some of the points above.
No serious research shows that anyone has the ability to reliably forecast if a fund will outperform the market for a medium or long period. This is important- funds/investors have and do beat benchmarks. Some for extended periods. But no one has found a way to determine which fund will do so going forward.
Long-term returns of a stock = dividend yield + growth (Gordon Equation). Bonds are same, just growth = 0. Keeping this in perspective is important.
Understanding the history of the markets (not just US, and not just this century) gives tremendous perspective to everything from interest rates, to panics, to manias.
The only free lunch in the markets is diversification. It provides better return for a given level of risk than an un-diversified portfolio.
Compounding is powerful. Time invested has (by far) the highest correlation to return. It is like a snowball – you just need to get it started, and keep from messing it up once going. Get something invested as soon as you can.
Fees compound also – they can really eat into returns over time.
Taxes are an important consideration. You can always optimize, but it’s hard to go too wrong with taxes in a passive longterm investment plan.
Passive funds (limited trading, just track a subset of the market) provide diversification and low fees.
We have quite non-normal circumstances in today’s market, with historically low interest rates. Should have an effect on future returns based on the Gordon Equation.
A Kind of Random Walk
As you can tell, I subscribe pretty closely to the random walk, passive investing methodology. I do believe that some people can beat the market. I just don’t believe for a second that my (former) advisor is likely one of those people. So why pay him a bunch of fees? From vanity, I think I could maybe do it – but I would have to commit more than a full-time job to it. And even then it’s close to a crapshoot. So onward with Ben Graham’s advice – without the commitment I’m better off with a low-fee diversified approach to copy the market’s returns.
So from there, I recommend focusing in on asset allocation strategy. William Bernstein really blew me away with his research and understanding of the mechanics of the markets. In a future post I will cover several good options for asset allocation – which can be as simple or complicated as you want.
These key points will keep you out of a good bit of trouble. But they are not the whole of the education. I highly suggest reading these books, whether you invest your own money or not. Understanding history and your weaknesses can help you guard against irrational exuberance. With the knowledge of the markets, you will be much less susceptible to being taken advantage of. And on the contrary, you can use the market to work quite efficiently for you.