“The only true wisdom is in knowing you know nothing.” ― Socrates
This week is Blogger Wisdom week on Abnormal Returns. As we have done in previous years we asked an esteemed group of independent finance bloggers a series of (hopefully) provocative questions. Yesterday we asked what is it about 2017 that ten years hence we will be embarrassed about. Answers are not edited and the author’s name, blog name and Twitter handles follow. We hope you enjoy these posts as much as we do putting them together.
Question: If you could (magically) impart one piece of wisdom to all investors what would it be? (Answers in no particular order.)
I’d love all investors to truly understand how financial markets work. If they could see financial markets as a complex adaptive system, it would eliminate the futile cause and effect thinking that plagues so many investors. This framework would also help investors realize how difficult it is to find and profit from temporary market inefficiencies.
In addition, people that understand financial markets know that losses are incredibly normal, so they would spend less time trying to predict them and more time focusing on things within their control like savings rate, costs, taxes, etc.
All investing entails risk, so accept it, embrace it even — but don’t take any more of it than you can afford to, than you need to or than you feel comfortable taking.
If I’m allowed a second: Brokers and fund managers don’t need your charity. Your first priority is to ensure you don’t run out of money before you die. If there’s any left over once you’re on target, give it to people who really need it.
Diversification is not about owning more stocks. That’s not a particularly useful kind of diversification if they all end up rising or falling together. Diversification is about owning assets or running strategies that are uncorrelated or minimally correlated to each other.
Cut your confidence in half and double your patience.
Risk cannot be destroyed, only transformed. It may not be 100% accurate, but thinking about portfolio decisions as a trade-off of the risks you are bearing can help set better expectations around performance in different market environments.
Focus on the entire pie instead of the individual slices. The concept of diversification can be a beautiful thing, but only when used properly. Ignoring the recent losers in a portfolio – particularly when there are a handful very big winners – is a daunting task for most investors. It’s easy to get lulled into thinking that a perfect portfolio exists, consistently firing on all cylinders. Sadly, such a portfolio only exists in Lake Wobegon, where all the line-items on your brokerage statement are above-average. Remember that diversification is always working, you just won’t always like the results. If all investors could learn to appreciate this as a feature and not a bug, we would likely see improved investor outcomes and less performance chasing.
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It would be that all investors would suddenly be able to differentiate luck from skill in evaluating a manger’s track record. My hope being this newfound wisdom leads investors to making more informed hire/fire decisions and hopefully close the “behavior gap”.
The ups and downs of the market are beyond your control. Things like savings rates, maintaining proper asset allocation and reigning in your emotions are far more likely to be within your control. Focus on what you can control.
Focus on a time horizon where you have an edge. For most people, longer is better. Too many people are trading in and out of companies for no good reason.
That wisdom is in relatively short supply, and those that seem wise at one time seem foolish at another. We all get our turn in the barrel.
That there’s no magic; investment markets are not here to make your wishes come true. Stocks are just a leveraged part of the profits stream, and as such are subject to the boom-bust cycle because of the debt employed, and volatility because profits draw competition. There is no guarantee that you will get high returns over the period that you want them. Worse, the more that people rely on the markets to perform for them, the more likely they will be to underperform.
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To quote legendary trader, Paul Tudor Jones, “Every day I assume every position I have is wrong. I know where my stop risk points are going to be. I do that so I can define my maximum drawdown.” For newer traders and investors, I would add: “Strongly consider reducing your position sizes.” You are bound to make mistakes or endure a string of losses, especially early on in your learning curve. Make sure you can bounce back from these losses. You don’t want to destroy your account with huge, demoralizing losses and take yourself out of the game for years to come. You can always increase your trading size later, following a period of consistent gains and progress.
Tobias Carlisle, The Acquirer’s Multiple, @greenbackd, co-author of Concentrated Investing: Strategies of the World’s Greatest Concentrated Investors:
Patience. Good things really do take time. And don’t measure performance against the S&P 500. That thing’s really hard to beat.
Forget about other investors. Don’t worry how other people invest their money. Figure out something that works for you, your personality and your circumstances and don’t waste your energy trying to convert others to your line of thinking. Financial envy is a waste of time and it will only make you feel bad about yourself. Being comfortable with your way of doing things can be a liberating feeling.
The goal isn’t to beat the market, prove how clever we are or become the richest family in town. Rather, the goal is to have enough to lead the life we want.
Extrapolation of trends is the most dangerous mistake investors make.
Brett Steenbarger, TraderFeed, @steenbab, author of Trading Psychology 2.0: From Best Practices to Best Processes:
Test before you invest. Understand the limitations of any strategy you pursue and figure out ways of hedging against those limitations. Make sure you clearly understand your downside and can truly accept it. Even the best investment strategy will not make you money if you cannot sustain its ups and downs.
[2017 Campaign] You can help those in need of clean drinking water by taking part in our 2017 campaign.
Your best investments are likely to be made outside of the financial markets.
Wesley R. Gray, Ph.D., Alpha Architect, @alphaarchitect, co-author of Quantitative Momentum: A Practitioner’s Guide to Building a Momentum-Based Stock Selection System:
Check in on your investments every 10 years.
Do not assume that skills that work in your profession will make you a great investor. They will not even help you to identify great investors. Spend your time on what you love and enjoy most. Do not waste time on information sources that profit by telling you what you already believe.
Don’t index all your money.
Save more (a lot more).
The importance of tax efficient investing.
The long-term trend is your friend.
Michael Martin, MartinKronicle, The Michael Martin Show, @martinkronicle:
Turn off the TV and read every day. Stop listening to tv personalities and infotainment and learn to make your own decisions. You study financial literacy to make better decisions not to become “smarter” per se. It’s about investor behavior. Learn how other people behave around trading and investing.
To just follow Buffett’s rule. Invest in no load mutual funds that replicate the S&P 500. Be a passive investor and build wealth over time. You cannot beat the market.
Thanks to everyone for their time and effort. The next (and last) question has to deal with how to simplify your finances.