It is nearly impossible for active managers to beat the market over the long term after taking management expenses, transaction fees, taxes, and risk into account. Individual investors don’t have the time or resources to compete with institutional investors. The only rational path for individual investors is to invest in passively managed index funds. Continue reading Investing for Retirement: Actively Managed Investing
How can the financial markets be simultaneously both efficient and, occasionally, investors behave so irrationally? How is it possible for speculative bubbles to form? In the first week of a microeconomics course, college students are taught about supply, demand, and equilibrium pricing. For every investor buying a stock, betting that it will go up from a particular price per share, another investor is selling the stock, essentially making the opposite bet. Or, more likely, a computer algorithm. Continue reading Investing for Retirement: Financial Market Efficiency
Introduction Behavioral Finance spans a number of fields including economics, history, psychology, sociology, epidemiology, and communications. As far back as 1841, Charles MacKay described the “madness of crowds”. [ROBERT SCHILLER AND RICHARD THALER] Robert Schiller, a Nobel prize winning economist at Yale University, defines a speculative bubble as: a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person … Continue reading Investing for Retirement: Behavioral Finance
A highly liquid market like the stock market functions as a gigantic prediction market. It reflects the combined judgment of all buyers and sellers based on all publicly available information about each stock. For all the investors that choose to overweight a stock, other investors must have an equal amount of underweight positions. Therefore, stocks trade at their fair value on exchanges. That isn’t to say that stocks trade at their correct price. The correct asset price is only known in hindsight. At any point in time, investors can be collectively mistaken: overly optimistic or pessimistic. Continue reading Investing for Retirement: The Efficient Market Hypothesis
The greater your investment costs associated with financial intermediation, the less you ultimately receive in savings. These costs may include brokerage commissions, sales loads, management fees, financial advisory fees, bank trust department fees, advertising costs, and lawyers’ fees. You cannot beat the market because it is a zero sum game. Financial intermediation means that beating the market is a loser’s game. Continue reading Investing for Retirement: Controlling Your Costs
No, you cannot definitively predict the future of financial markets, especially in the short term. However, you can project future outcomes in terms of their probability. These forecasts permit you to be better prepared for possible risks. A Monte Carlo simulation permits you to model real-life systems including the probability (i.e. the odds) of a variety of possible outcomes given specific assumptions about future conditions (i.e. constraints). Continue reading Investing for Retirement: Predicting the Future
Even if you aren’t a history buff, you should have a basic understanding of financial history so that you aren’t surprised by ‘unexpected’ financial downturns. When these downturns inevitably occur, you will be able to stick to your long-term financial plan. Limiting your research to just the past 100 years, financial history evidences significant volatility for both stocks and bonds. Using recent history as a rough guide, you should assume that similar downturns will happen again in the future, even if you don’t know exactly when they will happen.
Continue reading Investing for Retirement: Recalling the Lessons of History
Time is transformational. The longer the time that you hold your investments, the closer your portfolio’s actual returns will approximate their expected average. If your investment time is short, then higher return investments may be too risky due to variation in your actual returns. But, if your investment time is long-term, then you can consider higher-return, riskier investments because the variation in your actual returns will be closer to the expected average. Continue reading Investing for Retirement: Time
But in the long run, whether for an individual stock or the total stock market, the market return must equal the investment return. Speculative return becomes statistical noise. Basic economics governs. Therefore, you do not need to forecast the speculative return; you only need to compute investment return. Continue reading Investing for Retirement: Return
Previously, we discussed market risk. In addition, there are longevity & mortality risk, health risk, event risk, and tax & policy risk. Continue reading Investing for Retirement: Other Types of Risk
Risk and reward are inextricably intertwined. In the long run, you are compensated for risk. But, don’t expect higher returns without higher risk. And don’t expect safety without correspondingly lower returns. Continue reading Investing for Retirement: Risk
What is most important is not the dollar amount but the purchasing power of the money that you save. In other words, what your savings will buy when you retire. Expect inflation to destroy the purchasing power of your savings almost as fast as you build wealth, depending on your asset allocation. Continue reading Investing for Retirement: Compounding, Inflation & Real Returns
Your first goal is to not spend more than you earn. In particular, do not carry credit card debt month to month. There is no point in trying to figure out how to maximize return for a given level of risk if you are in debt beyond your home mortgage (~4%) and low interest (1-2%) car loans. The reason for this is that you likely are spending more on interest for your loans and, particularly, credit card debt than you ever would recoup by investing an equivalent amount minus fees, taxes, and your high interest debt. Continue reading Investing for Retirement: Building Your Net Worth by Budgeting, Saving & Investing
Every investor Is unique. Their current and projected future income will differ. The amount of assets they have acquired will vary. Their potential inheritance from others will vary. Their living expenses (pre- and post-retirement) will differ. In addition to leaving an inheritance for their dependents, their philanthropic goals will vary. Their investment experience and risk tolerance will differ. Finally, depending on when they start saving and when they need to retire, their investment time horizon will vary. Continue reading Investing for Retirement: Defining Your Investment Objectives
I began writing this book after several family members asked me for my perspective about investing for retirement. I shared a number of links to dense financial books and online financial management sites. For some reason, they didn’t have the time or inclination to read several bookshelves of books on investing. Instead, they asked me to distill all that information into something more straightforward. This book addresses investing for the typical individual investor. The information herein reflects the financial and investment knowledge that I believe everyone should possess. Continue reading Investing for Retirement: Overview
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