As a follow up to my realisation of how money is created I became further interested in how the economy works and eventually into investing. I read to a deep enough level to be fairly confident of my understanding of the general principles but have not delved into the mathematics that sophisticated investment institutions would apply. The following is my attempt to distill what I have learned after months of reading both for clarifying my own thoughts and hopefully to spark a discussion on any points of disagreement*.
What I learned from my study of personal investing:
1) On average, over the long run, stocks produce the best returns.
Year to year the best returns can come from any one of the four major asset classes (cash, fixed interest, real estate, and stocks) but over the long run stocks generally out perform the others. This means when my goal is portfolio growth, I want to have the majority of my investments in stocks.
2) No active trader consistently beats their stock index.
Okay there are two exceptions to this but one is retired and the other is Warren Buffet. If you can get him to manage your money, go for it. For the rest of us going DIY into the stock market or even using an actively managed fund is not the way to go. On average I am better off buying the stock index itself (i.e., an index fund or ETF) rather than trying to beat it.
3) Reducing risk means reducing volatility.
Essentially, the riskiness of an investment is the same thing as its downside volatility, the chance that the investment will decrease in value. Downside volatility is bad for two reasons. One, you might lose all your money. Two, excessive volatility reduces average return over the long run. However, risk is also the basis for return. That is, investments with a higher perceived risk would be expected to produce a higher average return. Ideally, an investment portfolio needs to strike a balance between volatility and return.
4) The most effective way to reduce portfolio volatility while maintaining return is to buy assets which are not correlated
Assets in different classes do not always increase/decrease in value at the same time. For example, bonds prices might rise as stocks fall. Additionally, different segments of the same asset might increase/decrease at different time (i.e., US stocks vs Japanese stocks). Therefore I can use non-correlated asset classes to dramatically decrease portfolio volatility (risk) while only slightly decreasing the average return.
5) The most effective way to reduce asset class volatility is diversification.
By buying multiple assets of the same class I reduce the risk that the value of this class will swing wildly up and down. The value of diversification kicks in at around thirty assets of the class and tapers off after fifty. Therefore, I need to hold between 30 - 50 assets in the asset classes I build into my investment portfolio.
6) Rebalancing is the only consistent way to 'time the market'.
All else being equal, I would prefer to buy and investment when it is cheap and sell it when it was expensive, of course there is no way I can have this knowledge at the time I could take advantage of it. However, by periodically rebalancing my portfolio I will, on average, sell-more/buy-less of an investment when it is valued highly and sell-less/buy-more of an investment when it is valued low. This is dollar cost averaging. The cost of rebalancing a portfolio means I should only perform this activity once or twice a year.
That will do for now, I guess I will see if anyone is interested in further discussion on some or all of these points.
*Obviously the above is not personal investment advice.
What I learned from my study of personal investing:
1) On average, over the long run, stocks produce the best returns.
Year to year the best returns can come from any one of the four major asset classes (cash, fixed interest, real estate, and stocks) but over the long run stocks generally out perform the others. This means when my goal is portfolio growth, I want to have the majority of my investments in stocks.
2) No active trader consistently beats their stock index.
Okay there are two exceptions to this but one is retired and the other is Warren Buffet. If you can get him to manage your money, go for it. For the rest of us going DIY into the stock market or even using an actively managed fund is not the way to go. On average I am better off buying the stock index itself (i.e., an index fund or ETF) rather than trying to beat it.
3) Reducing risk means reducing volatility.
Essentially, the riskiness of an investment is the same thing as its downside volatility, the chance that the investment will decrease in value. Downside volatility is bad for two reasons. One, you might lose all your money. Two, excessive volatility reduces average return over the long run. However, risk is also the basis for return. That is, investments with a higher perceived risk would be expected to produce a higher average return. Ideally, an investment portfolio needs to strike a balance between volatility and return.
4) The most effective way to reduce portfolio volatility while maintaining return is to buy assets which are not correlated
Assets in different classes do not always increase/decrease in value at the same time. For example, bonds prices might rise as stocks fall. Additionally, different segments of the same asset might increase/decrease at different time (i.e., US stocks vs Japanese stocks). Therefore I can use non-correlated asset classes to dramatically decrease portfolio volatility (risk) while only slightly decreasing the average return.
5) The most effective way to reduce asset class volatility is diversification.
By buying multiple assets of the same class I reduce the risk that the value of this class will swing wildly up and down. The value of diversification kicks in at around thirty assets of the class and tapers off after fifty. Therefore, I need to hold between 30 - 50 assets in the asset classes I build into my investment portfolio.
6) Rebalancing is the only consistent way to 'time the market'.
All else being equal, I would prefer to buy and investment when it is cheap and sell it when it was expensive, of course there is no way I can have this knowledge at the time I could take advantage of it. However, by periodically rebalancing my portfolio I will, on average, sell-more/buy-less of an investment when it is valued highly and sell-less/buy-more of an investment when it is valued low. This is dollar cost averaging. The cost of rebalancing a portfolio means I should only perform this activity once or twice a year.
That will do for now, I guess I will see if anyone is interested in further discussion on some or all of these points.
*Obviously the above is not personal investment advice.