How you should invest in a world of ignorance? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 12 September 2014
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Ouzilly, France

Dear Diary,

First, gold was unchanged in yesterday's trading. Stocks lost a little ground, but not much.

Yesterday, we did a reddit interview, related to our latest book, Hormegeddon. Reddit is new to us; the interview was all done in writing...in real time...via internet. Many thanks to all those who 'tuned in.' And many more thanks to all those who had cheerful words of encouragement.

One of the questions to come to us yesterday was: what happened to our old, tattered 'Crash Alert' flag? Well, we had to take it down. The ol' Black n Blue flag had been up for so long - battered by wind, rain, sun...trampled by the bull market - that there was barely anything left of it. It was becoming embarrassing. But it should be flying now...signaling the danger of a surprising bear market shock. October is coming. And according to one of our favorite macro researchers, Richard Duncan, the risk of 'volatility' is rising as excess liquidity disappears from the marketplace. Beware.

Meanwhile, let's continue with our look at how you should invest in a world of ignorance and irrationality. Should you put your money in a company, just because you like the product? Should you buy companies with rising earnings? Should you trade in and out? What if the market is 'too high?' Or, should you not try to 'beat the market' at all...contenting yourself with simply being 'in the market' all the time?

Most likely, the answer to these questions will be far more important than any stock selection you ever do.

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First, consider this from Forbes:

    According to the latest 2014 release of Dalbar's Quantitative Analysis of Investor Behavior (QAIB), the average investor in a blend of equities and fixed-income mutual funds has garnered only a 2.6% net annualized rate of return for the 10-year time period ending Dec. 31, 2013.

    The same average investor hasn't fared any better over longer time frames. The 20-year annualized return comes in at 2.5%, while the 30-year annualized rate is just 1.9%. Wow!

    The average investor exclusively investing in just fixed-income funds has had an even worse experience. The annualized return is 0.6% over 10 years, 0.7% over 20 years, and 0.7% over 30 years.

    Investors may only have themselves to blame. According to Dalbar's QAIB, investors make poor investment choices that hurt their investment returns. These decisions, including when to buy and sell, are often driven by emotion.
By contrast, almost any investment sector or category did better. Over the last 10 years, the S&P 500 rose 7.4%. International stocks rose 6.9%. Bonds went up 4.6%. Only commodities underperformed, with a negative 0.8% annual return.

Academics and financial theoreticians have confronted these facts in the context of the Efficient Market Hypothesis. The evidence, say its advocates, proves it is right: there is no point in trying to 'beat the market.' You won't win.

"Nothing of the sort," critics - led by Warren Buffett - reply. There's plenty of evidence that 1) both individual stocks and the whole market are frequently mis-priced, and that 2) many people, using old-fashioned Graham and Dodd value investing techniques, do beat the market, regularly.

More evidence on this point came yesterday. Our old friend and colleague, Chris Mayer, had his own track record, from his newsletter 'Capital and Crisis,' verified by outside auditors. Chris reports:
    The report is not perfect. They exclude dividends, which is ridiculous. But even so,annualized return for C&C is 16% over the last decade vs 4.8% for the S&P.

    I count dividends, so my figures are a touch higher, 17% for C&C... But pretty close.
So you see, you can 'beat the market.'

But as we pointed out yesterday, both EMH advocates and detractors exaggerate. It may be true that prices are never 'perfect'...in the sense that they perfectly reflect the real value of the underlying investment. But it is also true that investors can never be sure they have discovered a more perfect price. Mr. Market is never 'wrong;' he just changes his mind.

For us, the EMH is better regarded as a moral rule. It is not exactly true. But it is not exactly false, either. Warren Buffett would be a much poorer man today had he believed it. But most investors are probably better off taking it as Gospel...just as they are better off believing they will go to Hell if they disobey the Ten Commandments.

For most investors, riding along with the market will be far more rewarding than trading in and out trying to beat it. There may be dollars lying on the street, in other words, but most investors probably won't find them.

EMH tells us to be humble...and realistic about what we can expect from stocks. For most people, investing is not a good way to make a fortune. It is just a good way to keep...and maybe grow...a fortune. You make your real money by providing real goods and services to others. It is not realistic to think you can make much money, while you sleep, from the hard work and enterprise of others.

That is revealed in the figures above.

Another way to look at this is to think of investing as a 'losers' game.' A good amateur investor realizes that he is not likely to beat the pros. He doesn't try for home runs or grand slams. He just wants to get on base. He assumes the market is fairly efficient...and that he's not likely to beat it. He avoids buying expensive stocks (how does he know they'll go up?) He avoids investment themes he doesn't understand (how does he know they make sense?) He aims only to not lose, by sticking with the very, very basics.

That is the point of the STS. And it's what we spend most of our time doing in our new newsletter, our 'Bill Bonner Letters.' We're not really trying to find things that will work (how do we know?). We're just trying to identify those that probably won't.

Here's our investment philosophy:
  1. Think a lot. Do a little.
  2. Always buy low. And for safe measure, very low.
  3. Never believe anything a salesman says about an investment. There's a good chance that he is ignorant, dishonest or stupid. Or all three.
  4. Be reasonable. But take a swing at a grand slam pitch from time to time. Heck, it's not just about the money; it should be fun, too.
  5. Remember, the investment world is like the rest of life. Patience, modesty, and hard work pay off. Vanity, weakness, and cupidity do not.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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