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Financial Wisdom 101 (draft FAQ)
Old 11-18-2007, 05:07 PM   #1
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Financial Wisdom 101 (draft FAQ)

I propose we draft a FAQ for the new FAQ board that would be more or less a capsule summary of the received wisdom of FIRE types. There could be arguments pro or con for some of the assertions, book or web cites, etc.

Here is a proposed draft:

1. Most people, even financial professionals (stock pickers, newsletters, brokers, etc.) can't beat the market. By extension, neither can anyone trying to follow their systems or by using their own, for that matter.

Overall, the best you are likely to do, is to get average market returns. For most people, these returns are best found in very low cost index funds (that model their target market index) or their first cousin, the ETF.

2. Winning performance is usually only claimed in retrospect. Most, if not all, apparent investment success can be adequately explained by simple statistics: out of any very large group (e.g. stocks, mutual funds, or advisors) there will be some with spectacularly successful records. There is ample evidence [insert cites] that picking today's or recent winners offers little to no assurance of future successes.

The above also holds true for the so-called master investors of legend -- such as a Buffet or a Lynch. To a large degree, their success is "right time, right place." Luck, pure and simple.

It's OK to play with your money, but use common sense. Avoid some of the more glaring errors. Diversify your bets. Avoid trading too much. Don't put all your money into just one strategy. For example, you might own at any one time, 10 to 20 stocks. If they're from diverse industries, you are probably well diversified, no matter whether you picked the stocks via careful research, a stock screen on MSN, or with an Ouija Board. Long term, your portfolio will probably do -- average. Sorry, but that's how it works.

3. Financial services (newsletters, web sites, brokers, advisors, etc.) AS A GROUP or ON THE AVERAGE add no net value to investing decisions. In fact, they impose a small loss on the expected (average) return of a market, simply due to trading, advising, other costs, as well as commissions.

The cost of the middlemen varies widely (mutual funds, investment advisors, etc.) but 2-3% (including hidden fees) is probably about the minimum for most people.

Cynic: If these guys are so successful, then why are they pitching their system to me via junk mail, infomercial, or writing a book, when they should be sipping champagne with their blonde supermodel girlfriend, in their Yacht off the coast of France? In other words, if you had a system that could reliably beat the markets, you would become as rich as you wanted. The only logical conclusion is that these people make more money selling a book or other item, than they have true investment success.

These issues are well covered in the following books:

Edesess, Michael. The Big Investment Lie.
Edelman, Rick. The Lies About Money.

Contrary views: Money management has a legitimate place for many people. For example, to manage the accont for a minor, an incompetent, or simply for a person who doesn't want to be bothered with the details. In those cases, a few percent of assets may be an acceptable price to pay for the service -- but it's a losing bet to think Advisor X will give you outsized results, long term.

Contrary View: It is, of course, true that you or anyone COULD beat the market, using System X or Advisor Y, or what-have-you. But this is the same thing as saying that someone will eventually hit the Lotto. Of course they will -- plain old boring statistics, probability, chance, again! Most people will lose, though. Your luck might be exceptional, but odds are your outcome will be just average. Sorry, but that's how it works!

4. There is much disinformation in the financial industry. Most money is made on selling advice or commissions for money managed or product sold. The average "salesman" has nothing to gain from telling a prospective customer the awful truth: "You're unlikely to get anything but average results from me, and you're paying a commission to get that; cheaper options exist."

Corollary to (4): The average individual deceives himself in many ways. These are well studied in fields such as behavioral finance. The main problem is the human ego. I love to think that I'm above average, that my ideas are sounder, my plans more likely to succeed than the average sucker. Ah, if only it were true! The truth is that a little humility here will likely lead to better overall gains, long term.

5. If you accept the wisdom of the Cheap Index Fund, you can manage your own money with just a few hours a year and little effort. That's a pretty good pay-off if you can fire the middlemen who are costing you 1-3% of your assets per year, otherwise.

Not surprisingly, you may have trouble finding a "professional" to help you do it ... why should he, since he won't be making any money off you But plenty of resources exist; books and on the web.

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Old 11-18-2007, 08:17 PM   #2
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Quote:
Originally Posted by pedorrero View Post
I propose we draft a FAQ for the new FAQ board that would be more or less a capsule summary of the received wisdom of FIRE types. There could be arguments pro or con for some of the assertions, book or web cites, etc.
Earlier today I used this phrase, "received wisdom". It is usually intended as irony.

Here is a definition of the phrase:the conventional/received wisdom --knowledge or information that people generally believe is true, although in fact it is often false. The conventional wisdom is that marriage makes a relationship more secure, but as the divorce rates show, this is not necessarily true.

I agree that if what you are seeking is a distillation of the conventional wisdom of this board, academic finance, and the financial planning industry you have done an excellent job. And I suppose that is what you are supposed to do. However, with respect to the assertion that no one can beat the market, except in retrospect (ie. the 10,000 monkeys at their keyboards), see Warren Buffets well known speech "Super Investors of Graham and Doddsville".

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Old 11-18-2007, 08:41 PM   #3
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However, with respect to the assertion that no one can beat the market, except in retrospect (ie. the 10,000 monkeys at their keyboards), see Warren Buffets well known speech "Super Investors of Graham and Doddsville".
Ha
I didn't see where pederro asserted that no one could beat the market. People win the lottery, some doctors/lawyers/financiers get very rich while the vast majority don't. I agree with what he says that most people don't beat the market.
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Old 11-18-2007, 09:22 PM   #4
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I didn't see where pederro asserted that no one could beat the market. People win the lottery, some doctors/lawyers/financiers get very rich while the vast majority don't. I agree with what he says that most people don't beat the market.
Obviously msot people cannot beat the market, because they are the market. That says nothing about you, as someone willing to do some work and explore offbeat paths.

Try reading the speech I referenced, if you welcome new information on this topic.

Ha
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Old 11-18-2007, 09:50 PM   #5
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Of course some people will beat the market. That's just the bell curve. Some people are high achievers, most are average, and some people (not mentioned in polite company!) are just plain LOSERS!!! Not to say that some things are common sense ... like don't give money away or whatever. However, for every Buffet or Lynch you could show me, I'm sure could be found ten, a hundred, or a thousand similar men (they usually are men, BTW) who, from similar starting conditions, either lost everything, or (most likely) had moderate success in their careers -- "average" in other words!

And ... even if somebody did get a perfect system for winning ... everybody would copy it, so eventually it would no longer be an advantage. The world is a big place: broadly speaking, the local Little League team and any Major League team of your choice both play baseball. But there's a world of difference in the stats and the expected performance of those respective teams (even if you could keep the steroids out of it!)
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Old 11-18-2007, 10:01 PM   #6
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Hey, you guys win, although you seem to have ignored my specific point. I guess no one can stand the cognitive dissonance of reading what Buffet has to say about it. But no matter, the more people who believe as you do, the better off I will be. I suggest that you turn this FAQ into a book and see to it that it is widely disseminated.

Ha
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Old 11-18-2007, 10:14 PM   #7
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I read the "Superinvestor" speech. Here is a link to it.

The Superinvestors of Graham-and-Doddsville

Perhaps this isn't the place to dissect the article, but my main criticism from skimming it is this: it reads to me as coming from an author who cherry-picked the examples he presents. This is understandable, it is also a very common psychological game we play with ourselves. Maybe I'm missing something, but this seems far from a representative set of the long-term performance of (in this case) disciples of the Graham school of value investing.
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Old 11-18-2007, 10:27 PM   #8
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Pedorrero, it sounds like you basically want to summarize the wisdom of guys like Bogle. Why not let Bogle do it for you?

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Old 11-18-2007, 10:49 PM   #9
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Originally Posted by pedorrero View Post
Perhaps this isn't the place to dissect the article, but my main criticism from skimming it is this: it reads to me as coming from an author who cherry-picked the examples he presents. This is understandable, it is also a very common psychological game we play with ourselves. Maybe I'm missing something, but this seems far from a representative set of the long-term performance of (in this case) disciples of the Graham school of value investing.
You're missing the fact that the list of guys who have routinely beat the market is a darn short list. Buffett didn't cherry-pick, he stripped the entire tree of its fruit. The only "psychology" Buffett alludes to is attempting to eliminate any biases when he makes investment decisions.

What you're missing is that all HaHa is trying to point out, in his inimitable curmudgeonly way, is that there are people who can and do beat the market. It's not random chance. They are not coin-flipping monkeys because they have managed to rack up results in excess of the 2^^16 odds or so necessary to beat the flips.

Following Graham's school of value investing doesn't guarantee success any more than reading the Bible guarantees a pass through the Pearly Gates. Even Buffett has foregone the cigar-butt style at the core of Graham's value investing, and Graham never perceived the "value" of a brand/franchise the way Buffett has...

So it seems hypocritical to claim that no one can beat the market, and then to further complain that Buffett should include Graham's failures when he lists the Graham-disciple investors who have indeed beaten the market. While I'd agree that beating the market is extremely difficult, one should not flatly state that it's impossible.
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Old 11-18-2007, 10:51 PM   #10
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Originally Posted by pedorrero View Post
I read the "Superinvestor" speech. Here is a link to it.

The Superinvestors of Graham-and-Doddsville

Perhaps this isn't the place to dissect the article, but my main criticism from skimming it is this: it reads to me as coming from an author who cherry-picked the examples he presents.
It would be impossible to know all the users of Ben Graham's approach, so in that sense it is no doubt cherry picked.

On the other hand, this is a small group of people who came out of The Columbia School of business during a short time window, and compiled amazing records of success as investors. I have never even seen anyone assert a similar list of momentum investors, or macro investors, or any other kind of investors who came from the same little spot in time and space, and achieved anything like this record of success.

I agree, some things can always be questioned. Personally I am too practical-minded to hold out for levels of certainty that would far surpass levels of certainty that I might hope to find anywhere else in my life. Also, since I have personally done this myself, I am inclined to accept the method. My record is not anywhere near Buffet, but it is in the ballpark of some of the others. And I have had income and time constraints that they don't have. Plus they are better educated with more resources.

I am always interested in other approaches. Since I came to this board I have learned quite a bit about portfolio theory, asset allocation, etc. I think it is a good default for someone who either can’t make a decision, or won’t invest time, or can’t deal with the feeling of being out of step with received wisdom. But I don’t think it qualifies as a superior description of reality. Ask yourself- why are almost all the funds or managers with very long term superior records value investors? To me, the obvious answer is that value investing is a superior long term method. I do think it is hard to practice without a decent working knowledge of accounting and GAAP. It is also hard to practice without some business experience and understanding of drivers of sales and margins and competitive advantage- as well as a lot of other things. But you can get it done for you at a cost only slightly above the very lowest cost index funds. I know these value managed funds can be picked in advance, because I have never invested in a mutual fund that didn’t have subsequent performance better than similar risk profiles but invested differently.

But like I said above, I have no need to convert anyone. I just saw these bold assertions which to me at least are ludicrous, so I thought I might have a different say.

Ha
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Old 11-18-2007, 11:11 PM   #11
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Looks like the train wreck has begun.

Likely there will be so much disparity of thought on what constitutes "Financial Wisdom 101", it may be impossible to get agreement on what to included for a FAQ of that title.

And if all the pros and cons and disagreements are included in the FAQ---well what use is it to the newbie reader? Probably confuse them no end. Why not let them wade though individual posts to glean their desired "financial wisdom"?

That said, I would agree "Diversification" is one main element of "financial wisdom 101".
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Old 11-18-2007, 11:24 PM   #12
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Why not let them wade though individual posts to glean their desired "financial wisdom"?
The point of the FAQs is to link the best examples of those individual posts into one location in a coherent summary for the new posters to browse. Then guys like me won't have to keep searching for all our pearls of wisdom every time the question comes up. It's a nice benefit for the new posters but it's an even better benefit for us grumpy old posters who still want to pontificate help out.

Sure, building a FAQ on this topic is gnarly & confusing & controversial, but we're better at explaining investing than most and I'm happy to quote Bogle & Buffett in the same FAQ. I think Pedorrero and the rest of this thread's posters deserve credit for pursuing this initiative-- not armchair-quarterback kibitzing kvetching.

Diversification-- yeah, good idea. Now cough up some links and I'll include them in the FAQ.
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Old 11-18-2007, 11:40 PM   #13
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Sure, building a FAQ on this topic is gnarly & confusing & controversial, but we're better at explaining investing than most and I'm happy to quote Bogle & Buffett in the same FAQ. I think Pedorrero and the rest of this thread's posters deserve credit for pursuing this initiative-- not armchair-quarterback kibitzing kvetching.

Diversification-- yeah, good idea. Now cough up some links and I'll include them in the FAQ.
Well, if your going to be so critical of my constructive comments, I don't know if I want to add any links.

Maybe I'll just give you two, and save the really good ones for myself:
http://www.gfoa.org/downloads/cashdiversification.pdf

Diversification
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Old 11-18-2007, 11:43 PM   #14
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I would add another 101 Wisdom bit-----the magical power of compounding/time is your ally/invest for the longterm----however one wants to phrase the idea of perserverance over time.
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Old 11-18-2007, 11:51 PM   #15
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And for tonight I'll throw in another 101 Wisdom bit: Asset Allocation
Assets allocation accounts for 94% of investment return. Stock selection and timing a account for less than 6% of return.

See all the links you need, and a complete course in the currently running thread----"Asset Allocation Tutorial" initiated by member LOL! (Thanks LOL! for the tutorial, some very fine and very useful reading material and investment concepts there.)
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Old 11-18-2007, 11:59 PM   #16
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One thing that people forget about Buffet is that he is not an 'investor' like we are... I doubt there is anybody on this board that can buy enough of a company to be able to influence what they do..... Buffet can and does all the time.. so he can buy a company that is not doing well, insert talent and change the value... we are just tag-a-longs to whatever other people think of the stock....
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Old 11-19-2007, 12:10 AM   #17
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One thing that people forget about Buffet is that he is not an 'investor' like we are... I doubt there is anybody on this board that can buy enough of a company to be able to influence what they do..... Buffet can and does all the time.. so he can buy a company that is not doing well, insert talent and change the value... we are just tag-a-longs to whatever other people think of the stock....
Buffett got to where he is, however, by starting just like the rest of us. Being that big does have its advantages, as well as making it difficult to find enough value to soak up all the excess cash.

While he can buy a company and do what he used to call "work outs", his current criteria for buying companies specify that the company should have "Talent-- because we can't supply it." Lampert and the Danahers won't hesitate to sweep through one of their acquisitions like a winter storm, but Berkshire apparently doesn't bother to make the effort.

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Well, if your going to be so critical of my constructive comments, I don't know if I want to add any links.
Try to remember waaaay back to when you were a new poster, and see if you can find any constructive criticism in the suggestion that new posters should wade through individual posts to teach themselves the investing basics. If we're trying to make new posters welcome here, then perhaps we should make it easy for them to find what they want. Heaven forbid we should also do it in an atmosphere at least relatively tolerant of their efforts to make their own contributions.

It's a common complaint from both new & old posters that the size of this board makes it difficult to locate material, and the search feature doesn't work very well at locating it. Rather than continuing to kvetch about it like a noodge, though, I got off my assets to do something about it. Another poster has chosen to make a contribution and still others are helping to refine it.

Meanwhile I'm not sure how to glean "constructive" from the verbiage "train wreck". But, hey, it's a big board so feel free to make your own original contribution rather than criticizing the efforts of others.

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Maybe I'll just give you two, and save the really good ones for myself:
Thanks, and if you don't have anything nice to say further to contribute then we'll fumble along without you somehow.

You have a nice life now.
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Old 11-19-2007, 12:31 AM   #18
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Meanwhile I'm not sure how to glean "constructive" from the verbiage "train wreck".


Thanks, and if you don't have anything nice to say further to contribute then we'll fumble along without you somehow..
Hey Nords, have a sip of wine or something, will you?

The "let the train wreck begin " comment was first made by---pedorerro. Did you notice that? Seems not. I was teasing pedorero by just repeating his/her comment after all the arguments about Buffet started. Humor maybe? That possibility never entered your thick head?

Then I proceeded to add in some elements of fiancial wisdom to add to the FAQ----three in fact---diversification, power of compounding, asset allocation, and provided links as requested.

Then you respond to my posts with your comments as above, and harp about who is not being "constructive"?

My next financial wisdom 101 will come later. Thank you Nords for your "constructive" whatever.
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Old 11-19-2007, 12:47 AM   #19
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RR, I enjoy your contributions to the forum. Keep 'em coming, and feel free to throw a few punches at Nords, too. He can take them. So far, nobody has been able to knock him off his high horse.

Here's a random bit of wisdom. Watch out for the classic signs of poor investor behavior:

The greatest Wall Street danger of all: you. - By Henry Blodget - Slate Magazine
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Old 11-19-2007, 01:21 AM   #20
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Here's a random bit of wisdom. Watch out for the classic signs of poor investor behavior:

The greatest Wall Street danger of all: you. - By Henry Blodget - Slate Magazine
A good piece of writing. But I presume I am not the only one to find irony in Henry Blodget being given a podium to lecture us on investing. For many people back in bubble-time, Henry Blodget himself along with Mistress Abby were the major dangers to investors.

Ha
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