A financial education (my ideas)


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.