2009 March

CD Ladders and Young Investors: Weekend Reading

A handful of posts from this week that are well worth the time to read:

Investing

Jim from Bargaineering has a great video explaining how CD ladders work.

Neal from Wealth Pilgrim reminds us that if we want to get our portfolios back on track, we need to stay on the train.

David at Pimp Your Finances discusses 10 tips for young investors.

Frugality

Trent from The Simple Dollar discusses the link (or lack thereof) between consumer spending and quality of life.

JD at Get Rich Slowly shares some tips for defeating temptation when you’re tempted to spend.

David at MoneyNing decided it wasn’t worth it to pay for haircuts anymore.

Taxes

From my tax blog:

Education

Four Pillars discusses the wisdom of going back to school during a down economy.

Enjoy the weekend. And as always, thanks for reading.

March 20, 2009

Entrepreneurship, Greed, and Investing

There’s a force in the world that goes by many names: profit motive, self interest, entrepreneurship, or greed. Some people think it’s a good thing. Others are convinced it’s a bad thing.*

Regardless of what you call it or what you think of it, we can confidently say a few things about it:

It is adaptable–it exists across the world in countless different social and political environments.
It is persistent–I imagine it will stick around as long as humans do.
To bet against it is foolish.

Entrepreneurs and businesses earn profits. That’s what they do.

Claims that “buy and hold investing is dead” are nonsense. It will always be profitable to own businesses (provided you own a sufficiently large quantity of them and you own them for a long enough period).

*In case you’re curious, I call it entrepreneurship, and I believe it has an overwhelmingly positive effect in the world–though not when left entirely unchecked.

March 19, 2009

What is Oblivious Investing?

The term “Oblivious Investing” is my way of acknowledging the fact that success in investing doesn’t require that you have some brilliant investment strategy that nobody else has ever thought of. It simply requires that you come up with an intelligent strategy and stick with it, even when things get tough.

In short, Oblivious Investing is about:

Coming up with an intelligent (if unoriginal) investment plan, and
Ignoring anything that might distract you from that plan (i.e., “the noise”).

Creating the investment plan is easy. Ignoring the noise is what’s difficult.

Coming up with your investment plan:

There’s really only a handful of things you need to worry about while developing an investment strategy:

Asset allocation: the single most important component of your plan. It will have an enormous impact upon both your rate of return as well as the year-to-year volatility of your portfolio.

Minimizing costs: For a young investor, the difference between investing in a fund with an expense ratio of 1.5% and a fund with an expense ratio of 0.2% could be measured in hundreds of thousands of dollars.

Diversification within asset classes: Greater diversification leads to more predictable results. I think most investors would agree that this is a good thing.

For most investors, an Oblivious Investing strategy looks something like this:

Dollar-cost-average into low-cost mutual funds (index or otherwise), and
Never sell them until you’re retired and need the proceeds to pay your bills.

Ignoring the noise:

While the plan itself is very simple, the list of things that could throw you off track is nearly endless. A few examples:

Short-term market volatility: It’s understandable that people worry when they see their account values decline. But if you aren’t planning on selling any time soon, you can ignore these price swings and focus instead on accumulating shares.

The financial media: Daily news about stock market performance is just noise. Better to ignore it.

Unscrupulous marketers: There will always be somebody trying to convince you how easy it is to pick stocks or time the market (both of which are far more difficult than they appear). These people are just trying to make a buck off investors’ gullibility. I’d suggest ignoring them.

Notice the pattern?

Over the years, many things will happen that could cause you to doubt your plan. Ignore them, stick with your plan, and you will succeed.

March 17, 2009

Taking Advantage of Investors

“If consumers have a less-than-fully-rational belief, firms often have more incentive to cater to that belief than to eradicate it.” –Thaler and Sunstein in Nudge

They really hit the proverbial nail on the head with that one. The examples in the investment industry are almost endless.

“It’s not hard to pick stocks!”

As far as I can tell, the circumstances that would provide a stock picker with the greatest probability of beating actively managed funds are circumstances in which the entire stock picking game is pure luck.

If it’s not luck, then actively managed funds, pension funds, and other institutional investors have got you beat on intelligence, time, and money. I don’t care how smart you are. It’s still true.
Alternatively, if stock picking success is based entirely upon luck, then I can’t imagine what anybody is doing using anything other than an index fund, as minimizing costs would be literally the only way to reliably improve returns on stock investments.

Note that neither scenario leads to the conclusion that stock picking is a wise move. And yet, countless books, magazines, newsletters, blogs, and other websites make money by telling people precisely the opposite: “Sure, you can pick stocks and beat the market. It’s easy!” All you have to do is buy their product.

“Timing the market isn’t that hard.”

Again, we’re presented with a scenario in which the evidence indicates that something is impossible. Further, the most successful long-term investors have stated time and again that timing the market is a worse-than-worthless endeavor.

Yet, since people want to believe it’s possible, businesses can make a fortune by selling products based on false hopes.

[Related side note: Taking your money out of the market and "waiting until things settle down" is just a euphemism for timing the market.]

How to protect yourself:

Of course, the real question is how we can protect ourselves from such unscrupulous marketers. Admittedly, it’s rather tricky. What makes such pitches dangerous is the fact that data can be found that makes each of them sound believable.

My suggestion is to do your own research. Look for your own data, rather than considering only the facts that the marketer has presented to you.

For example, try reading something from each side of the argument: Read a book explaining why index funds are the best investment strategy, and read a book explaining why picking stocks is the way to go. Then, having read both sides, you can determine for yourself who has the more persuasive argument.

What about you?

In what ways have you seen businesses try to take advantage of investors’ misconceptions? And how do you protect yourself from being sold a lie?

March 16, 2009

Index Funds Need Stockpickers?

In reply to my post at MoneyNing last week, one commenter (a writer for FiLife) replied that:

“Index funds NEED actively managed funds or stockpickers in the market. The market moves when people have opinions on individual stocks, sectors and ideas.”

Am I missing something? As far as I can tell, this statement represents a flawed understanding of the nature of the stock market.

Sure, over the short-term, market returns are the result of changes in demand. But over the long run, market results have more to do with corporate earnings than they do with fluctuations in the demand for stocks.

Example: $100 invested in the market in 1928 would have been worth $112,990 by the end of 2008. Do we really think that demand increased sufficiently to drive the price of the market up by a factor of more than 1,000? Call me crazy, but I doubt it.

I suspect it has a lot more to do with the fact that the stock market represents a collection of companies, and (most of) those companies make money. That’s what businesses do.

To attribute long-term market results purely to increases in demand, rather than to the collective creative power of our entrepreneurs seems like a mistake.

And if active funds and stockpickers are only contributing to short-term movements (i.e., volatility) rather than adding significantly to long-term return, why on earth would index investors need them around?

Is there something I’m missing here? Something I’ve left out that gives this argument a little more weight?

March 15, 2009

Paying Less Taxes: Weekend Reading

It’s a long list this week, but they’re all good ones. I promise.

Taxes

Don’t Mess with Taxes shares a tax horror story of somebody not receiving their refund–and being told “tough luck.” Yikes! (Apparently it’s way more common than I knew.)

From my tax blog: how are capital gains and losses taxed?

FiveThirtyEight thinks we should have a tax bracket for people earning over $1,000,000. He shares some great historical evidence of our having had similarly high tax brackets in the past.