A financial education (my ideas) - Luca Bolognese

A financial education (my ideas)

Luca -

☕ 4 min. read

When I came to US, I wanted to get an in­tro­duc­tion on per­sonal fi­nance. I needed to know what to in­sure, when, how to buy an house and all this sort of ba­sic things. At the time I read Personal Finance for Dummies. I then dis­cov­ered that very many US folks don’t know about these things ei­ther and I found my­self rec­om­mend­ing this sim­ple book to plenty of peo­ple. You can find it for a few bucks in used book-stores. It might be too ba­sic for you, but again, it might not.

Investment is a sub­set of per­sonal fi­nance and by far not the most im­por­tant one (the most im­por­tant prob­a­bly be­ing how to save the most — which means pay­ing you first). Nevertheless, un­der­stand­ing how to in­vest the money that you do save is im­por­tant. The fol­low­ing rep­re­sents a very con­densed sum­mary of my views on the topic. There are dozens of oth­ers very good books that I could have sug­gested in­stead.

The first thing I would do is to get a de­cent un­der­stand­ing of the re­la­tion­ship be­tween risk and re­ward that is so per­va­sive in fi­nan­cial mar­kets. Good books on the topic are The Four Pillars of Investing or A Random Walk Down Wall Street. A new book that I haven’t read, but sus­pect quite good (and short) is The Little Book of Common Sense Investing. This books try to con­vince you that it is not pos­si­ble to beat the mar­ket’ and the best you can do is to de­cide on an as­set al­lo­ca­tion that rep­re­sents your risk/​re­ward pro­file. If you be­lieve that, then it is worth get­ting to the next step by un­der­stand­ing the con­cept of mean vari­ance op­ti­miza­tion. Good medium level books on that are All About Asset Allocation and the Intelligent Asset Allocator. There are ad­vanced books on the topic as well, but I won’t men­tion them here. An ad­vanced ser­vice in this area is IndexInvestor.

With time, an­a­lyz­ing the amount of ev­i­dence, I came to be­lieve that it is in­deed pos­si­ble to beat the mar­ket. But it is not easy and 99% of the meth­ods out there are bunk. Moreover it does re­quire a lot of work and a cer­tain pas­sion for the in­vest­ment field. So, if you don’t have time or pas­sion you are prob­a­bly bet­ter off stick­ing to the strate­gies de­scribed in the afore­men­tioned books. If you have a small amount of time, but you still want to try and beat the mar­ket, an av­enue open to you is the se­lec­tion of mu­tual funds. Even then, you need to have some strong held view of which kind of in­vest­ment strat­egy and char­ac­ter traits are more likely to bring about su­pe­rior in­vest­ment re­sults so that you can pick the right man­ager (or most likely set of man­agers) for your money. I de­scribe be­low what are my per­sonal views on the mat­ter. They are all very de­bat­able. A good ser­vice that gives sane in­for­ma­tion about mu­tual funds, how to se­lect them and as­sem­ble them in your port­fo­lio is Morningstar. I cer­tainly sug­gest you sub­scribe to it, if you in­vest in mu­tual funds.

A time hon­ored and gen­er­ally suc­cess­ful stock pick­ing method is value in­vest­ing. The fa­ther of value in­vest­ing is Benjamin Graham and two books writ­ten by him are ever­last­ing clas­sics of in­vest­ment. They are The Intelligent Investor and Security Analysis. Aficionados dis­agree on which re­leases are the best, the links pro­vided rep­re­sent my opin­ion. Please start with the for­mer, as the lat­ter is long and com­plex. They are both quite dated, but plenty of folks be­lieve that not much has been dis­cov­ered af­ter their pub­li­ca­tion. I dis­agree. Another, maybe bet­ter, in­tro­duc­tory book is The Little Book of Value Investing. There are won­der­ful mu­tual funds out there that in­vest in the spirit of value in­vest­ing. Among oth­ers, I like Third Avenue, Pinnacle and Royce.

Warren Buffett ex­panded on Graham by putting more em­pha­sis on the qual­ity of the com­pa­nies he in­vests in in­stead of mostly the price. A good book de­scrib­ing his ap­proach is The Warren Buffett Way. You can ob­vi­ously go and read Buffett’s let­ters di­rectly here, but that is bet­ter suited as a sec­ond step af­ter read­ing Graham or the afore­men­tioned book. There are plenty of dis­ci­ples of this method of in­vest­ing. If you want to have some of them man­ag­ing your money, my pre­ferred are Longleaf, Fairholme,  Weitz and Clipper among oth­ers. A good ser­vice that sug­gest stocks based on this style of in­vest­ing is the stock sec­tion of Morningstar. You also can in­vest in brk.b di­rectly to buy the ser­vices of Buffett him­self. I per­son­ally be­lieve it is quite un­der­val­ued at the cur­rent junc­ture.

In the past 15 years or so, there has been a lot of in­ter­est­ing work done on purely quan­ti­ta­tive in­vest­ing sys­tems. They have sev­eral ad­van­tages over judg­ment based ones (essentially the hu­man brain is not wired cor­rectly to fight a com­plex adap­tive sys­tem as the stock mar­ket). There are two cat­e­gories of sys­tems I feel I can rec­om­mend in this area: fun­da­men­tal based and mo­men­tum based. This is a very com­plex math­e­mat­i­cal topic at the high end, but it is pos­si­ble to get a prof­itable un­der­stand­ing of it by read­ing WWOWS and The Little Book That Beats The Market. These books de­scribe fun­da­men­tal based sys­tems, for a purely mo­men­tum based one the best bet is FundX. The web site is not too in­for­ma­tive, but if you go to the li­brary and ask the li­brar­ian they have a lit­tle book writ­ten by the FundX guys that de­scribe their sys­tem in a great level of de­tail. The best quan­ti­ta­tive mu­tual funds I can think of are from Bridgeway (there are also oth­ers). Like all the other funds I sug­gested, they are man­aged by won­der­ful peo­ple that takes the share­hold­ers in­ter­ests very se­ri­ously.

You can also try to tac­ti­cally switch be­tween dif­fer­ent as­set classes (i.e. stocks and cash) based

on some in­di­ca­tors. I have mixed feel­ings about this. It might work, but it is de­bat­able how much do you re­ally gain by do­ing it, af­ter con­sid­er­ing taxes and com­mis­sions. It is some­thing I could in­ves­ti­gate more. Two good books on the mat­ter are The Only Three Questions That Count and The Research Driven Investor. Good mu­tual funds that do this (with very dif­fer­ent risk pro­files) are Hussman and CGM.

A cou­ple of notes to close. Reading these books is an ex­er­cise in crit­i­cal think­ing. There are huge amount of con­tra­dic­tory state­ments on very ba­sic and im­por­tant con­cepts. The only way around it is to do your own re­search and make up your own mind. Even then, you won’t be in a sit­u­a­tion of per­fect in­for­ma­tion/​clear de­ci­sion. This can­not be so be­cause the mar­ket changes con­stantly. As soon as some­thing is dis­cov­ered it gets priced in. This is why it is such an ex­cit­ing field of study (for some peo­ple at least). Also I have my own key rule about in­vest­ing: I never in­vest in any­thing that I don’t un­der­stand com­pletely. Every time I’ve done that, I’ve re­gret­ted it. If this is the only thing that you re­mem­ber af­ter read­ing this, I’ll be very happy.



Charlie Calvert's Community Bl


Visual Studio Orcas Beta 1 is available for download . Though quite similar to the March CTP in terms

If you haven't read any of Motley Fool stuff (at www.fool.com), that's worth a bit of your time. I've been a subscriber to their stock advisor newsletter for a couple of years, and it's been money well spent.
For most people, to "beat the market", you have to beat the mutual funds out there, and that's not that hard, because of the structural limitations that they have.
And yes, I agree with you - there are tons of really stupid investment ideas out there. I have a friend who in the last year has progressed from selling puts and calls all the way to having most of his money in index funds.

Hi Eric,
I like the newsgroups on fool (i.e. the mechanical investing ones). I've never tried the newsletters because I got turned off by the quality of the books they wrote (which I deem very low).
But Whitney Tilson writes for them, so maybe I've been too skeptical ...

Jim Savarino


Regarding the practical application of asset allocation models.  Be careful! The theory is perfectly correct but in practice it is difficult to apply.  
The problem is that most discussions of the subject assume that you know the expected returns, the risk (std deviation) and the pairwise correlations between security returns.  In practice these elements need to be estimated and can contain large estimation error.  If one attempts to apply the usual deterministic quadratic programming algorithm to select the investment weights for a security population, one gets nonsense.  
First and foremost, the estimation error in the expected return and risk of large mutual funds is much less than that of individual securites do to diversification
Second, you are selecting from a smaller population of investment objects so the impact of estimation error on the assect allocation algorithm is reduced.
Sorry, couldn't resist putting in my 2 words.  Asset allocation was my research expertise in my prior life as an instructor of finance at Pacific Lutheran University.  My current life entails programming simulation models using C# which is how I came here....
Jim Savarino
Group Health Cooperative
Seattle WA

I agree with you. I don't use optimizers because of that. I do think the theory is useful as a framework to understand the importance of diversification.

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