Stealing articles again because I have a lot to do--1,500 miles to go in a UHaul takes your mind off money. And you should take your mind off money too by making investing a habit, not a gamble. See below--pretty dry but makes a lot of sense. An article called Taking A Gamble On Ignorance by Kebin Bailey, an Aussie.
A FRIEND of mine recently told me with great confidence that investing in shares was gambling.
I took offence and assured him that if you use a scientific approach you can wash out most of the speculative risk and be left with ownership of good quality businesses that produce good earnings year after year.
His opinion about the market is not unique -- and is borne out of an ignorance of the evidence that backs up sound portfolio theory.
He has only experienced the hype of stock tips and timing calls of when to get in and when to get out of the market. In a word, his only experience of shares was speculating.
Empirical research has shown that stock selection and market timing techniques contribute virtually nothing to the total return of a broadly based investment portfolio over time and in many cases detract from the overall portfolio performance.
Research conducted by Brinson, Hood and Beebower in several well documented studies showed that over 94 per cent of the long-term return of broadly based investment portfolios were attributable to the asset allocation decision.
Only the remaining 6 per cent was attributable to stock picking and market timing.
However, stock picking and market timing (sometimes called tactical asset allocation) are the very areas that generate the bulk of the revenue for the investment industry.
Many shareholders have failed to match the market return, despite taking far greater concentration risk by picking a relatively small number of shares that they think will be winners.
They tend to blame their broker for poor stock selection without realising the futility of the exercise in the first place.
Most of us rarely compare the total performance of our portfolio relative to the market as a whole and we are often unaware of our poor relative performance.
Some of us are like the gambler who only remembers the wins at the track but conveniently forgets the losers. During a rising or "bull" market when a "rising tide lifts all ships", share clubs spring up and there is a sense that investment is easy and fun.
Interest begins to flag when losses start to accumulate during a prolonged downturn. Nothing substantial is learned about the nature of investment markets and a belief is usually formed that share investment is speculative and dangerous.
The famous author Benjamin Graham used a precise formula to differentiate between investment and speculation. His description has stood the test of time.
"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
Often, the unsuspecting public is led into purchases that they think are investments when they are in effect, speculations.
The evidence of how to achieve better results is available but ignored by the majority of participants in the advice industry for commercial reasons.
Prior to the advent of the computer, work was already being done on the efficiency of markets.
Some of this research dates back to the work of French mathematician Louis Bachelier, who presented his dissertation in 1900 on "The Theory of Speculation" for his degree of Doctor of Mathematical Sciences at the Sorbonne in Paris.
In this paper he stated that "the mathematical expectation of the speculator is zero." He described this condition as a "fair game".
Bachelier arrived at his conclusion because "it seems that the market, the aggregate of speculators, at a given instant can believe in neither a market rise nor a market fall, since, for each quoted price, there are as many buyers as sellers."
The logic is irrefutable: "Clearly, the price considered most likely by the market is the true current price: if the market judged otherwise, it would quote not this price, but another price higher or lower."
Over time, of course, prices will move in either direction, when the market as a group changes its mind about "what the price considered most likely" is going to be.
My friend who thought investing was about second guessing the market should read Bachelier. He should ignore short term fluctuations, diversify as broadly as possible and focus on the long-term dividend producing potential of every purchase.
And you should read Category 12--All You Need To Know
