Tuesday, September 24, 2013
Friday, September 6, 2013
Wednesday, August 21, 2013
Jim Parker - Broccoli and Pizza Portfolio
This article, written by Jim Parker of Dimensional Fund Advisors, is made available strictly for educational purposes only and should not be considered investment advice or an offer of any security for sale.
For some of us, it’s hard to give up on the idea that investing should be exciting. Picking stocks can be fun, after all, and there’s nothing like getting your timing right and bragging about it later with friends.
For all the accumulated wisdom about asset allocation, risk, diversification, and discipline, some people seem bound to see investing as an end in itself rather than a means to an end. For these folks, picking stocks is a hobby. They follow the gurus and soak up the financial media. Despite evidence to the contrary, they’re convinced they can build a consistently winning strategy by exploiting perceived mistakes in market prices.
Part of the reason is the human tendency toward overconfidence. For instance, we all like to think of ourselves as above-average drivers, when that’s simply not possible. Likewise in investing, many of us believe we have powers of foresight not evident in the wider population. A Duke University study of corporate executives published in 2010 found a dismal record of prediction among a group you might think would do well. Indeed, of 11,600 forecasts for the S&P 500 over nine years, the survey found executives’ estimates of future returns and actual outcomes were negatively correlated.1 (This is a technical way of saying the executives were hopeless forecasters).
Research also suggests the tendency to trade a lot and make confident forecasts about stocks has a gender bias. Whether it’s a testosterone-driven instinct among men to boast or something else, study after study shows men find it harder to accept that they are unlikely to “beat” the market.2 For these red-meat eaters, an investment approach that advocates working with the market, diversifying around risks related to an expected return, trading efficiently, exercising discipline, and watching fees and taxes is going to sound like the financial equivalent of a broccoli and walnut salad: healthy but boring.
Surely the point of investing is to try hard and, Don Quixote-like, to charge at those market windmills? Are we not men? There are a couple of ways of confronting this mindset. One is to hope for a change in human nature and persuade each would-be master of the universe to separate his urge for ego gratification from his need to build wealth patiently and efficiently. This is not impossible, of course. But one suspects it would take some time and would require a lot of face saving.
A second approach is to separate the investment nest egg from the play money. If someone really wants to speculate, he can be allowed to do that with the proviso that long-term retirement money be invested the boring way. This way, the investor can buy some (expensive) entertainment and accumulate a few war stories to share at his next golf game without compromising the asset allocation painstakingly designed for him and his family.
It’s understandable that investing is a kind of a hobby for some people. After all, this is what keeps much of the financial services industry and media in business. But in separating the concepts of speculation and investing, you can still enjoy the occasional treat while maintaining a balanced diet. Call it the broccoli and pizza portfolio.
--------------------------------------------------------------------------------
1. Ben-David, Itzhak, John R. Graham, and Campbell R. Harvey, “Managerial Miscalibration,” Duke University (2010).
2. Barber, B.M., and T. Odean, “Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment,” Quarterly Journal of Economics 116 (2001).
For some of us, it’s hard to give up on the idea that investing should be exciting. Picking stocks can be fun, after all, and there’s nothing like getting your timing right and bragging about it later with friends.
For all the accumulated wisdom about asset allocation, risk, diversification, and discipline, some people seem bound to see investing as an end in itself rather than a means to an end. For these folks, picking stocks is a hobby. They follow the gurus and soak up the financial media. Despite evidence to the contrary, they’re convinced they can build a consistently winning strategy by exploiting perceived mistakes in market prices.
Part of the reason is the human tendency toward overconfidence. For instance, we all like to think of ourselves as above-average drivers, when that’s simply not possible. Likewise in investing, many of us believe we have powers of foresight not evident in the wider population. A Duke University study of corporate executives published in 2010 found a dismal record of prediction among a group you might think would do well. Indeed, of 11,600 forecasts for the S&P 500 over nine years, the survey found executives’ estimates of future returns and actual outcomes were negatively correlated.1 (This is a technical way of saying the executives were hopeless forecasters).
Research also suggests the tendency to trade a lot and make confident forecasts about stocks has a gender bias. Whether it’s a testosterone-driven instinct among men to boast or something else, study after study shows men find it harder to accept that they are unlikely to “beat” the market.2 For these red-meat eaters, an investment approach that advocates working with the market, diversifying around risks related to an expected return, trading efficiently, exercising discipline, and watching fees and taxes is going to sound like the financial equivalent of a broccoli and walnut salad: healthy but boring.
Surely the point of investing is to try hard and, Don Quixote-like, to charge at those market windmills? Are we not men? There are a couple of ways of confronting this mindset. One is to hope for a change in human nature and persuade each would-be master of the universe to separate his urge for ego gratification from his need to build wealth patiently and efficiently. This is not impossible, of course. But one suspects it would take some time and would require a lot of face saving.
A second approach is to separate the investment nest egg from the play money. If someone really wants to speculate, he can be allowed to do that with the proviso that long-term retirement money be invested the boring way. This way, the investor can buy some (expensive) entertainment and accumulate a few war stories to share at his next golf game without compromising the asset allocation painstakingly designed for him and his family.
It’s understandable that investing is a kind of a hobby for some people. After all, this is what keeps much of the financial services industry and media in business. But in separating the concepts of speculation and investing, you can still enjoy the occasional treat while maintaining a balanced diet. Call it the broccoli and pizza portfolio.
--------------------------------------------------------------------------------
1. Ben-David, Itzhak, John R. Graham, and Campbell R. Harvey, “Managerial Miscalibration,” Duke University (2010).
2. Barber, B.M., and T. Odean, “Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment,” Quarterly Journal of Economics 116 (2001).
Monday, July 29, 2013
Tuesday, July 9, 2013
Two Great Articles
(NY Times) Investment Plans and Forecasts Don’t Mix
Forecasts about the future of the market are very likely to be wrong, and we don’t know by how much and in which direction. So why would we use these guesses to make incredibly important decisions about our money?
Forecasts about the future of the market are very likely to be wrong, and we don’t know by how much and in which direction. So why would we use these guesses to make incredibly important decisions about our money?
(WSJ) The Intelligent Investor: Saving Investors From Themselves
One of the main reasons we are all our worst enemies as investors is that the financial universe is set up to deceive us. Approximately 99% of the time, the single most important thing investors should do is absolutely nothing.
One of the main reasons we are all our worst enemies as investors is that the financial universe is set up to deceive us. Approximately 99% of the time, the single most important thing investors should do is absolutely nothing.
Friday, June 28, 2013
Canadian Index Instruments - Pros and Cons
Last post we discussed what exactly is the TSX Composite Index.
Most investments containing Canadian equities are in some way measured against that index. Is this justified or not and, as discussed here, is an active or passive vehicle the best one to choose for an investor?
Let's talk about this for a minute with a hypothetical scenario. Let's say that it is 1999 and you own the TSX Composite Index in the traditional market-cap weighted manner. You own technology stocks, including Nortel Networks, JDS Uniphase, and others. These technology companies comprise over 1/3rd of your Canadian Equity holdings. Did you want that exposure? How did that work out for you? Is there a solution to avoid overexposure to one stock or a sector of stocks?
Enter the Capped Index or Equal Weighted Index. These have been created so investors can track equity performance without the 'bubbly' excesses of overinvestment and hype involved with many stock market manias. Investors are also able to purchase active or passive instruments that track these indexes.
There are also other new entrants into the index creation methodology including factor driven, intrinsic value, low volatility, income weighted, fundamental weighted indices and more. These all have instruments available for purchase that track them.
Now that we are fully confused about all of these options and choices what is an investor to do? What is the 'right' index to follow?
For example, if your objective is high income and low volatility than a strategy employing instruments that use those indices may be best. If your objective is to avoid bubbly market excesses, maximize growth, and take advantage of the small cap premium and value premium than a strategy employing those instruments may be best.
In short, finding a fee-based advisor who works with low cost index tracking instruments like Exchange Traded Funds could help the most, provided the advisor listens to your needs. Most importantly, it is vital to match your objectives with the indices and instruments that most closely fit what you are looking for in light of proper portfolio construction methods.
Most investments containing Canadian equities are in some way measured against that index. Is this justified or not and, as discussed here, is an active or passive vehicle the best one to choose for an investor?
Let's talk about this for a minute with a hypothetical scenario. Let's say that it is 1999 and you own the TSX Composite Index in the traditional market-cap weighted manner. You own technology stocks, including Nortel Networks, JDS Uniphase, and others. These technology companies comprise over 1/3rd of your Canadian Equity holdings. Did you want that exposure? How did that work out for you? Is there a solution to avoid overexposure to one stock or a sector of stocks?
Enter the Capped Index or Equal Weighted Index. These have been created so investors can track equity performance without the 'bubbly' excesses of overinvestment and hype involved with many stock market manias. Investors are also able to purchase active or passive instruments that track these indexes.
There are also other new entrants into the index creation methodology including factor driven, intrinsic value, low volatility, income weighted, fundamental weighted indices and more. These all have instruments available for purchase that track them.
Now that we are fully confused about all of these options and choices what is an investor to do? What is the 'right' index to follow?
For example, if your objective is high income and low volatility than a strategy employing instruments that use those indices may be best. If your objective is to avoid bubbly market excesses, maximize growth, and take advantage of the small cap premium and value premium than a strategy employing those instruments may be best.
In short, finding a fee-based advisor who works with low cost index tracking instruments like Exchange Traded Funds could help the most, provided the advisor listens to your needs. Most importantly, it is vital to match your objectives with the indices and instruments that most closely fit what you are looking for in light of proper portfolio construction methods.
Subscribe to:
Posts (Atom)