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The facts of investing life

Which is more important in your world: knowledge or skills? This question is the fulcrum of an ideological battle being fought over our education system, and it’s a debate that also has ramifications for DIY investors.

  • The champions of knowledge believe we need to command certain basic facts to operate effectively in society – the essentials of science, literature, history, and geography. Without these fundamentals, you’re like a driver who can’t read road signs or markings.
  • The advocates of skill argue that a robotic recall of verb conjugations and the Kings of England should take a back seat. They favour building prowess in problem-solving, debating, hypothesising, and so on.

While the obvious answer to my opening question is “Can I have both, please?”, I believe that knowledge is far more important to a DIY investor than skill.

What most people want to know about investing

Licence to skill

I spent a long time at the beginning of my investment journey furrowing my brow over the fact that I didn’t know how to read company accounts, or work out the discount rate of future cash flows, or have the seemingly God-given ability of my peers to declare the market ‘fair value’.

Such skills were like concealed weapons – you’d only glimpse a flash, enough to let you know ‘they’ could slip through the investing maze like ninjas. But the application of these powers was as shadowy as their utterances of success.

Now, I just don’t worry about it.

Even figures in the fund management industry are happy to go on record to say that skill is so abundant in their field that the winners and losers are mostly separated by luck.

And that suits me, because whereas skill might let you play in the deep end of the pool, knowledge enables you to stay safe in the shallows.

It’s the difference between taking a couple of martial arts lessons and walking in to the wrong pub shouting “I’ll take you all on”, and knowing enough to avoid staring at the shaven-headed gentleman with a spider-web tattoo on his face.

The basic facts are much easier to acquire for an amateur than superior skills. Knowledge is an all-you-can-eat buffet in the digital age. You can stuff your face with it via blogs and books. The only question is what you choose to swallow.

Knowledge Base Alpha

My research quickly taught me to stop asking the question that all my non-investing friends ask:

“What’s hot?”

It doesn’t matter. By the time an asset class is hot, it’s probably already too late to make big money.

I don’t worry about tips from commentators or newspapers. Even if they throw the dart in the right direction, the smart money has already moved on.

The market is the consensus of expectations on the future of a stock. Only unexpected events can shift the price. How can you predict the unexpected? The short answer is: you can’t.

I know that diversification is the only free lunch going, so I load up on all the useful asset classes while resisting the siren call of ‘the next big thing’.

I understand how asset classes work. I know that equities are volatile and that nothing is truly safe. If the market crashes I won’t panic because I know it will probably recover. I won’t hunker down in cash, refusing to believe in inflation.

BRICs? Gold? Hedge funds? The Fear Index? Low vol ETFs? High yield funds? I know that keeping up with fashion and labels will cost me dear.

Behavioural finance tells me that I’m a pitiful collection of psychological defects, about as capable of self-discipline as a bonobo at a swinger’s party.

The more we learn, the less we know

In the face of all the evidence that I can’t market-time, pick winners or even trust myself, passive investing is the only strategy I feel confident enough to stake my financial future on.

Sure, I love reading yarns about the prospects for gold, timber or Lego bricks, but I now know that’s no basis for a portfolio.

My best bet is to invest in a diversified portfolio of low-cost trackers and sit tight.

Doing very little sounds too easy. In some ways it is. Portfolio maintenance costs me less than an hour a month. But it’s simultaneously the hardest part of passive investing.

Surely I should be doing something? Surely I’ve got enough skill by now to test my mettle in the market with more active investment strategies?

I’d be better off composing a passive investor’s prayer that wards off temptation.

Staying on the straight and narrow is hard, but knowledge and education are the best way to keep on track.

Take it steady,

The Accumulator

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{ 13 comments… add one }
  • 1 SemiPassive November 20, 2012, 11:10 am

    Good post, I used to be always chasing the next hot sector fund or researching companies but in the last 12-18 months I have moved entirely to index tracker funds when I realised my previous investing style was not working. Too much chopping and changing, buying into hot sectors just as they went off the boil. This change was a combination of personal experience over the last several years, backed up by a read of The Bogleheads Guide To Investing and Tim Hales Smarter Investing.

    Ok, I still have some BRIC exposure via an emerging markets tracker, but now its proportionate to my asset allocation and (credit crunch tested) risk appetite, so I won’t sell when the markets tank.
    Oh drat, I just ruined everything and bought my first individual corporate bond…one I thought would do better than a bond tracker fund.

  • 2 ermine November 20, 2012, 12:29 pm

    Are you not taking some viewpoint in terms of which sectors you are investing in, which company sizes, etc? Or ar you investing across the entire world investable universe, scaled by capitalisation. Come to think of it, why is scaling by cap such a great idea, surely you are biasing towards megaco?

    A collection of passive funds each of a subset of the investable universe is not necessarily a passive investment IMO 😉

  • 3 Drew @ Objective Wealth November 20, 2012, 6:47 pm

    Nice post, this is soothing music to my investing ears. Doing little requires a lot of courage while all around are flapping and making noises.

  • 4 The Accumulator November 20, 2012, 10:17 pm

    @ Semi – Good to hear your tale and your last line made me laugh. It’s not easy doing nothing.

    @ Drew – couldn’t agree more.

    @ Ermine – Passive investing doesn’t mean you don’t think, or don’t have a view. Investing by market cap is a passive investor’s way of saying, “I can’t outsmart the market.” We’re free-riding on the coat-tails of the efficient market. Not that I’m saying it’s perfectly efficient. Marketcap investing also happens to be the lowest cost method of investing – another important tenet of the strategy.

    Then you tilt according to your taste in risk factors – small-cap, value etc because you’re convinced by the evidence that you can earn a premium for owning these equities. Taking on that extra risk (or not) is a personal decision, not an auto-generated one. As determining your asset allocation or your rebalancing criteria.

    You might even decide to stay out of bonds or at least to keep them short-term given the unprecedented interventions in that market.

    Passive is a label not a holy ritual.

  • 5 UK Value Investor November 21, 2012, 12:10 am

    “Surely I should be doing something?”

    For passive investors I think they’re best off if the idleness is enforced. So for example a pension fund in which you have no real knowledge of what they’re doing much beyond the top level asset allocation split, and no way of influencing it. There are costs involved in those funds, but they may well outweigh the cost of bad decisions by a lot of private investors.

    Another interesting point is that apparently investors in high-load funds (i.e. those with large up front entry fees) outperform investors in no-load funds! As crazy as it sounds, the high-load investors do better because the entry fee stops them buying high and selling low. Once they’ve bought the fund they’re typically reluctant to sell in a crash because they have spent that 5% fee up front and so tend to stick with the fund. That means they don’t lose the 5% per annum that other investors lose through bad buy and sell timing.

    That’s one of the reasons that Buffett has the ‘A’ class Berkshire shares at an astronomical price, so that people buy it like they buy a house, rather than as a bit of electronic paper to be flipped in a few months.

    Liquidity in the stock market is both its biggest benefit and its worst drawback.

    — John

  • 6 David Stuart November 21, 2012, 2:28 pm

    Isn’t being able to call the market(future)as fund managers say they can,a one-way bet.Your returns should be off the scale

    Yet most fail to match market

    Asset allocation with a low-fee index trackers easily win the argument

  • 7 Docwatt November 21, 2012, 3:45 pm

    Thanks for a really sensible article followed by really constructive comments. The voice of experience, and critical analysis from those not ‘in the business’ is worth a small fortune..the difficulty is being smart and staying ‘relatively’ passive.

  • 8 Paul Claireaux November 21, 2012, 6:43 pm

    Fair point about giving up on valuing individual companies.
    When Hewlett Packard apparently make an 80% error in valuing Autonomy what hope for the rest of us?
    So diversify yes but tilt things a little surely?
    And reduce/ increase exposure to risky asssets at obvious high/low points using long term valuation measures (e.g yield or CAPE)

  • 9 David Stuart November 22, 2012, 10:58 am

    Hewlett Packard v Autonomy

    KPMG/Barclays/Perella Wienberg v Deloitte

    Huge Reputations at stake

    p.s.–former C.E.O 0f Autonomy Mike Lynch sounded very confident on sky news 21/11/12

  • 10 Davy Jones November 22, 2012, 6:25 pm

    Accumulator..you hit the nail on the head when you said ” Nothing is truly safe ” , beyond diversification & asset classes has to be now the integrity of the entire financial system..as an investor my biggest concern is the unpunished criminality going on where the rules at the top are different than for the rest of us.

    The leverage is also frightening , can we have any real confidence when the likes of goldman sachs to name but one with total assets under 90 billion is allowed to have derivatives exposure of over 48 trillion , which is 545 times leverage relative to it’s assets.

    The gdp of the entire planet is only around 70 trillion , does that give it some perspective.

    Or where HFT computer programs account for 70 % of all transactions..traded in milliseconds to which the liquidity in the markets are now dependent.

    But it’s ok , everything will work out just fine , no need to worry about these alarm bells ringing all around us..let’s just keep feeding them our money card after card as the stack builds higher & these prevailing winds blow stronger.

    Solution.. ” Rip it Up & Start Again ”

  • 11 The Accumulator November 22, 2012, 7:13 pm

    Am really enjoying the comments here – thanks all (even as I shudder at the slight sense of helplessness in the face of global finance). It’s strange how we generally feel exhilarated when dwarfed by nature, yet feel scared and out-of-control when dwarfed by the man-made.

  • 12 David November 22, 2012, 7:54 pm

    Don’t just do something, stand there!

  • 13 Dale November 23, 2012, 5:34 pm

    Sometimes Wisdom (and Luck) triumph over Knowledge and Skill.

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