Most of us know that keeping our hard earned cash in our savings account these days is not a really good thing. We all know about that elephant in the room, inflation, caused by ‘too many dollars chasing too few goods,’ as President Jimmy Carter so aptly put it.
But the investing world is a tough one. Assaulted by a deluge of often conflicting advice from newspapers, blogs, and hot-tempered commentators on cable TV, how do you decide where to actually park those dollars?
We have been giving a lot of thought to this question since graduating from Wharton and JHU earlier in our careers. After spending a number of years working at well known financial institutions, we’ve started our own company, Appian Road, which promotes better understanding among the investing public, and offers a unique solution—‘risk parity’—for achieving a stable return amidst economic turbulence. We know how difficult it can be for members to balance the demands of career and personal life, let alone the complexities of understanding and profiting from financial markets.
As Warren Buffett once said: “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ.” Similarly, we believe that keeping one’s head and learning not to be taken in by flashy marketing are worth a lot more than overwhelming brain power. When asked what advice we could offer to members of IVY who are interested in investing, we offered the following:
- There is no free lunch: There is only one risk-free investment, Treasury Bills guaranteed by the U.S. government. Anything that is not a T-bill is most decidedly not risk free, including bank Certificate of Deposits, other bonds, stocks, etc. There is no return without risk, or to put it in other words…
- …The more the promised return the higher the risk: When you compare an investment to another you always have to consider what kind of risk you are taking. It is true, for example, that Stocks over the years have performed better than Bonds in absolute terms, however this is not true on a risk-adjusted basis. What does this mean? Stocks have been much more riskier than Bonds historically. In any given year you could be up 15% while you were up only 5% with Bonds, but the year after you could have been 20% down with Stocks, while only perhaps 3% with Bonds. In the long-run you should, and generally will, be compensated for that higher risk.
- Buy Indexes, not Individual Securities: When investing your money you should try as much as possible to remove what is called “specific risk.” This is the kind of risk that comes from the idiosyncrasies of a single company—litigation, CEO resigns, etc. So, if you don’t know any better, you should be buying an index rather than individual stocks. This type of investing is called Beta investing (or Passive Investing) and there are several different economic theories that suggest that in the long run Passive investing will always outperform Active Management (i.e. stock picking, or ‘Alpha’ investing).
- Don’t try to master the market: We often hear commentators on cable news shows recommending one stock or another. Or we might have views that Apple or Facebook will keep growing and the stock price will increase. However, when we buy an individual stock and try to profit in the short term from its moves we enter the Alpha world, where we chase the fool’s gold of beating the market. There are a number of empirical studies showing this is impossible, and there is overwhelming evidence that the vast majority of actively managed mutual funds and hedge funds fail to beat the market. Don’t get greedy!
- Diversification is a big deal: Don’t put all your eggs in one basket. You want to make sure that you are holding as many asset classes (indices) as possible in your portfolio. If you play it right, when a few have a bad year, a few others will have a good one.
- Be disciplined: As we said previously, there is no free lunch, and if you want to achieve a higher return, you should accept more risk. The key to achieving these kind of returns, however, is captured in one simple word: Discipline. Your strategy should be consistent and unaffected by short-term swings, whether positive or negative. As Rudyard Kipling put it in his famous poem”If”: “meet with Triumph and Disaster / and treat those two impostors just the same.”
Some of the core principles of IVY include creative collaboration and camaraderie. One of the best parts of investing is the ability to tap into wider communities and share wisdom and experiences. We hope that the teachings above might inspire some IVY readers to learn more and reach out with their own questions and ideas. Perhaps together we can enrich our understanding and skills. And who knows, you might even have fun while you’re at it!