Swimming Upstream

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One of the exhortations I find myself writing most frequently in this blog, is “read some books.”

Specifically, this comes up when I am talking about the importance of reading books on investment theory in order to develop your own personal investment strategy and portfolio.

What’s the thinking behind this?

It’s not just that reading is nifty and good for your brain.

It’s not simply a flippant expression of caveat emptor (buyer beware.)

It’s not even me selfishly trying to absolve myself of any responsibility for your future financial performance.

It really has to do with the disconnect between the simplicity of a good investment strategy, and the difficulty of actually executing it.

What is an evidence based, simple, and winning investment strategy?

In one sentence, I would say it is “to invest in a broadly diversified, low-cost, passively managed collection of funds, and rebalance unerringly at regular predetermined intervals.”

Why is it difficult to execute such a simple strategy?

Because it requires swimming upstream against conventional wisdom.

And it requires doing things that feel terrible.

And most of all it requires faith.

Why swimming upstream?

Because having a plan and sticking to it means that at some point you will have significant tracking error. In simple terms, there will be periods when the rest of the investment world will outperform you for uncomfortably long stretches of time. And that does not feel good.

In the long run, this will be a positive. For if you stick to your guns and keep on investing in your asset mix when it is not doing well, then almost inevitably it will revert to the mean and start outperforming the rest of the market in the future. And you will maximally reap this benefit by having been in on the ground floor.

What actions will you have to take that will feel nerve-racking and painful?

Mostly rebalancing. In practice rebalancing means you’re pulling money out of perfectly good performers and dumping it into the hopeless asset classes that lose you money every time you look at them.

This recent negative history for the asset class that you’re purchasing is, after all, why it’s so cheap in the first place.

It’s why you’re able to buy low and sell high.

And don’t forget that all the while, every talking head you see on CNBC and article you read in Money magazine will continually tell you how good the outlook is for asset classes that are currently performing well, and how only a sucker would invest in the poorly performing asset classes.

William Bernstein describes that rebalancing “feels like throwing money down the rathole,”which I think is a pretty great description.


Don’t Forget to….Rebalance

Which is where faith comes in.

You’ve simply got to come up with a plan that is true to your identity as an investor and as a person.

If you’re a cheapskate like me, it’s likely that a value strategy will be attractive to you.

If you’re a “let it ride on the underdog” type, perhaps you will tilt more towards small stocks.

Whatever mix you ultimately select, if you really believe in your final portfolio and it’s underlying philosophy, then you will be more likely able stick to your guns in hard times, and reap the subsequent benefits of the inevitable rebound.

The investor who bounces around from one investment philosophy to another is almost guaranteed to “buy high and sell low.”  This is the opposite of a good plan;  a constantly shifting one.

Which is where reading comes in.

How can you come up with a philosophy that is true to yourself without understanding the history and implications of the choices that you make?

I would argue that you can’t.

The knowledge that you collect with your reading will give you a deeper understanding of what different asset classes signify, and how they behave.  Most importantly the education will act as ballast when the seas are rough, and as armor when the flak is flying.

If you find that reading about this stuff is dead boring. And you find yourself falling asleep every other day when reading my early retirement/investment theory posts, then I would recommend just saving more and putting your money into a betterment account. You will do very well without lifting a finger.

But if you like reading about this stuff, even better.

You’re going love poring over the books. And you’ll enjoy putting your knowledge into practice by designing portfolios. And you are going to get a real kick out of following your portfolio, and living up to the challenge of doing what you know to be right at the time when it is the hardest thing to do in the world.

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