Wednesday, January 15, 2014

My Investing Philosophy - Part 1

Sometimes I get asked about my investment philosophy - how have I saved for retirement?

I was lucky enough to go to a good MBA program at the University of Toronto in the mid-80's that taught investing.  Between the MBA courses and some reading, I came up with an approach that is successful for me.

The professors taught me about efficient markets, indexing, diversification, CAPM, MPT, beta, and alpha.  Their teaching was rooted in efficient markets and I took it to heart.  Part 1 will cover my equity investing approach based on what I learned, Part 2 will cover bonds and portfolios.  My approach:

  1. It is very hard to beat the market in picking individual stocks.  Why?
    1. There are professionals out there who get more information better and faster than you.  They will beat you in terms of buying winners before the price goes up and selling losers before the price goes down.  They will also do better analysis because they have more time and better tools.
    2. There are inside traders out there who will beat you even more because they have information you and the general market do not have.  This is a crime but seems quite common right now.
    3. There is no pattern to stock results, so looking at the past tells you nothing about the future.
    4. Buying and selling has transaction costs that cut into your profits and increase losses.
    5. It is impossible to identify the top or bottom of a market, that is, you cannot time your buys and sells.  Here is the latest New York Times article covering the proof of this.
    6. If you buy individual stocks, you do not have enough diversification and your losses and gains will be more acute.
  2. It is very hard for a professional mutual fund or ETF manager to beat the market.  Why?
    1. There are professionals out there who get more information better and faster than your manager.  Just like point 1. above.  
    2. There are inside traders out there who will beat your manager.
    3. There is no pattern to stock results, so looking at the past will not help the manager.
    4. Buying and selling has transaction costs that cut into the mutual fund's profits and increase losses.
    5. The manager cannot time his buys and sells to increase returns.
    6. The mutual fund manager, the company running the fund, and others have to get paid which further increases costs and reduces your return.
    7. I went to MBA school with a representative group of people who became portfolio managers and, sorry to say, they are not good investors.
  3. The best approach is to buy and hold index funds or ETFs with low costs.  Why?
    1. History tells us that this is the lowest risk way to get good returns.
    2. You will never be beaten by the market because you bought the market.
    3. You will not lose a lot of your profits to expenses as the fund will not buy and sell much, does not need an expensive stock-picking manager, and marketing expenses are low.
    4. You will not be burdened with a poor mutual fund manager who picks bad stocks.
    5. You will get diversification as the indexes contain hundreds or thousands of stocks.
    6. In the USA, Vanguard, Fidelity, and other companies offer low cost index funds that track the S&P 500, Russell 2000, and other big national and international indexes.
The best read for the average person that covers this approach is a book my professors recommended at MBA School.  "A Random Walk Down Wall Street" by Burton S Malkiel.

Let's take a look at a simple comparison of some funds that I own or owned at one time.  The first three Vanguard funds are index funds with expense ratios under 0.25%.  The last two funds are higher cost (0.5-0.76%) managed funds.  The important number is the long term return (10 year).  The index funds beat the managed funds by about 1% over 10 years.  It doesn't sound like much but if you look at the return on $10,000, you would have an extra $1,046 with the index funds.

Comparison from Vanguard Mutual Funds Website

Disclaimer: these are my opinions and I accept no liability for the content of this blog, or for the consequences of any actions taken on the basis of the information provided in the blog.

1 comment:

  1. Totally agree. I discussed this principle with a good friend in Mexico that dedicated successfully 2-3 years of his life in the stock market there. As a reference, the IPC index in the Bolsa Mexicana de Valores has registered a 5% loss in the past year, but in five years it has gained more than 250%
    Erickson

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