I’m pretty skeptical of whether researching investments is a good idea for non-professionals. Financial speculation is fun, but you are competing against specialists who have spent their whole lives studying the subject, have teams of researchers, and are betting so much that they can afford to buy the best computers, data, etc. I think almost everyone should just buy the Vanguard Target Retirement 20X0 fund.
The exception is if you’re in the startup world & you know people who you trust & respect who are doing startups, angel investing in them w/ 10%-20% of your income makes sense to me. At worst you’ll lose a little money & learn a lot about who to trust & how startups work. Another is if you know a city/region/country very well and want to own property there – ownership has advantages (ie we have done extensive customization of our cohousing community here in Mountain View) and since it’s such a big asset it’s definitely worth researching.
This is a great point.
I've been studying a lot of finance lately. One that I've really enjoyed is "The Intelligent Investor" by Ben Graham.
He draws a few important distinctions in the book.
The first distinction he draws is between "investing" and "speculating" -
What do we mean by “investor”? Throughout this book the term will be used in contradistinction to “speculator.” As far back as 1934, in our textbook Security Analysis, we attempted a precise formulation of the difference between the two, as follows: “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Graham goes on to really hammer and drive in the point that investing and speculating are not the same thing - investing looks for (1) thorough analysis, (2) safety of principle, and (3) an adequate return.
I mean, he really hammers on that point. Again and again and again and again throughout the book. You've got to do the analysis, look for safety of principle first, and then find your returns... if you want to invest. Speculating is something else.
Okay, so you've got to research. But then, first and foremost, you look to safety of principle.
One of the ways the Ben Graham/Warren Buffet school of thought does this - looking for things that are seriously underpriced simply based on assets and projected short-term profits.
For instance, if you find a company with $5 billion in assets, $2 billion in cash reserves, and turning a stable profit each year with a defensive competitive advantage... and the market cap of that company is only $7 billion... well, you've got an almost no-brainer on your hands.
In that case, your principle is preserved and protected because the underlying assets of the company are worth as much as the company is selling for. Opportunities happen at times, as recently as the '08 crash, where companies sell for less than their liquidation value - how much they'd get if they sold off all their assets and distributed the cash. That's a no-brainer time to buy (assuming you can control your emotions and act rationally, which is, admittedly, hard to do).
There's a number of other principles in Graham that are worth paying attention to - first, no matter how good a company is, it can be a bad investment if it's priced too high. Then, Graham goes through the (crazy) psychology of the rise and fall of markets, and popularity and unpopularity of different kinds of investments.
So, the first thing Graham advocates is being an investor, not a speculator. (Or at least, making sure you know the difference)
The second important distinction Graham draws is between the "defensive" and "enterprising" investor. The defensive investor does just as Patri advocates - takes a position likely to gradually increase without any need for regular monitoring or activity on the investor's part, contributes on schedule into it, and generally wins.
It's not sexy or exciting or high risk - it just winds up with you gradually building up larger and larger piles of money. It's good and totally solid.
I'd personally recommend that approach to someone who has significant opportunity costs by learning and researching finance, or to someone who just doesn't like the field.
By doing a little very basic research and very basic getting educated, you can then choose passive investments and pay very little attention to them while you work on your more important stuff. That's fantastic. That's probably what most people should do.
The opportunity costs thing is important. If someone can bill out $50/hour for contract work and has $20,000 in savings, they're going to get a much better return just doing contract work than doing financial and investment research. In 100 hours, the fellow could make $5,000 contracting, which is probably going to exceed whatever premium they were going to get researching their investments thoroughly and carefully.
Probably you shouldn't invest in an enterprising way unless you really like the field, or it's really important for you to learn. For me, finance is one of those skills I need for the path I'm walking. And I enjoy it, I get a kick out of it.
So, put me in the enterprising category. But that doesn't mean being wild and crazy and fun. Actually, financial research is, at best, kind of interesting the way reading Hacker News is interesting. You're going through financial statements and looking at numbers, and looking at the company's products, their market position, their competitors, etc.
Japanese companies on the Nikkei are kind of fun to research, since their financial reports are all big and beautiful and colorful and full of graphs and charts and visualizations. But most of the time, it's not even that fun. It's digging through numbers and doing math.
For instance, I'm in Mongolia right now, and I'm pretty sure the country is on the verge of some serious economic success. But that doesn't necessarily translate to good investments.
Brokerage houses and mutual fund companies often tout the stocks of emerging-market nations, such as Brazil, Russia, India, and China (the so-called BRIC countries) because of their rapid economic growth. But beware: Share dilution, and often outright theft because of lax security laws, vaporizes a lot of this growth by the time it reaches the per-share level. For example, China’s economy has been growing at a blistering 9 percent real rate per year for more than two decades. Yet between 1993 and 2008 investors actually lost 3.3 percent per year in Chinese stocks, even with dividends reinvested. You read that right: Over this 16-year period, even before expenses, the investor in Chinese stocks lost 41.5 percent of value. (The loss of 3.3 percent per year before inflation calculates out to a loss of 5.7 percent per year after inflation.)
Graham's definition of investing, rather than speculating, requires thorough analysis, safety of principle, and an adequate return. Just because Mongolia is set to boom economically doesn't mean you've got safety of principle or likelihood of an adequate return.
In order to look for safety of principle, I started looking at Western-managed companies operating here. One of them, Ivanhoe, got the contract on a huge metals deposit here.
For the speculator, that's enough. It's exciting! It's hot! It's Mongolian, the "Asian Wolf" economy that's set to grow! Get in!!!!
Well, no, that's foolish. I went through their financial statements
In 2010, they lost $211 million on about $80 million of revenues. They've got (according to their own financial statements) $3.2 billion in assets. Their market cap right now is $17.4 billion.
So, that's a highly, highly speculative buy. You've got to assume their own self-valuation of their assets is on the liberal and high side, because that's generally what people who are still raising capital do. They've lost money the last few years while exploring and investing.
Are they going to make profits in excess of $14.2 billion? If not, it's going to turn out to be a terrible investment for whoever buys at this price. But even if yes, then there's other questions like - How fast? Does it justify the risk and opportunity cost?
Since I can't answer those questions and don't know much about mining, I don't invest there. The time I spent learning about their business and going through their financials doesn't amount to anything in the immediate term.
Does it make sense for non-professionals to research their own investments?
A lot of professionals are beholden to stupidity. They have to buy and sell when requested by the individuals or organizations that put their cash in and pull it out. If their investors cash out en masse because of panic, or an investment isn't popular, it'll be underpriced. If you can do research, understand business, and can understand and go through financial statements, you might be able to find better performing assets than by taking a passive approach.
I think I'll be able to. I'm wandering around the world, looking at shipping facilities and docks and border crossings and businesses and the people in different countries. I know a bit about business. I read lots and study lots.
And then I'll just wait. I'll be patient until I see a ridiculously obviously good buy - something sell for no premium or a slim premium over their assets, cash on hand, and very predictably stable profits.
Should other non-professionals research and choose their own investments?
No - if the opportunity cost of your time in learning about investing slows you down from developing professionally or creatively.
No - if you don't like and enjoy learning about finance and really digging.
No - if you're unwilling to take the time to learn accounting.
No - if you're unwilling to go through financial statements.
No - if you don't have a decent grasp of basic math and statistics.
No - if you get emotional and can't keep your head in a panic.
No - if you're unwilling to study history.
No - if you don't enough about the business to understand whether there's a durable competitive advantage and what the risks and threats for the business are.
No -if you'd rather spend your time elsewhere.
If any of those are true, a person is probably better off getting a very hands-off investment mix and looking at only every year or two, at most, and never ever buying or selling on emotion.
But for someone who fits all of the descriptions above, the researching and choosing your own investments can make sense. Finance and investing are two things I need to learn and develop in anyways, I get a lot of enjoyment out of the subject, and I'm willing to put in the hard hours learning about the relevant business, finance, math, history, and assorted details, and then to remain clear-headed and not buy at a high or sell at a low.
For most people, it probably doesn't make sense to research your own investments. You need to know a lot of different topics in order to not get burned and lose. Like Patri says, there's a lot of professionals in the field.
Now, I reckon most intelligent, hard working, emotionally strong people could learn to invest well. But then, it takes a lot of time that might pragmatically be spent better developing your personal craft/profession/skill, or otherwise working on things that are very meaningful to you.
For the vast majority of people, I agree with Patri and think that was a great comment by him. I'll ping him and ask if he has a recommended very basic investment guide for people who want to save and invest wisely without putting in the time. In the meantime, Patri's blog is here and pretty consistently has some good stuff on it - thanks for commenting Patri.
You don't need to engage any professionals who earn commissions. Just buy low-cost Vanguard index funds, and free-ride off all the pro stick pickers in the world.
Oh! And by the way. (Sorry I'm back) Don't get intimidated by their so called "profesionnal" titles. The stock rise on down are in the unknow (in the future) therefore they know as much as you do. Yes they have fun toys to play with but with the Internet and all the information that there is out there, you are not left behind. And since this is a Strategy blog, here is the strategy part: those professionals are big. Therefore they have the weakness of their size: they're slow, everyone see them coming when they move and, they are scrutinized by the regulators. You are swift, movable, you can hit and run... doesn't this sound like guerria strategy? Just get to know what you're doing, practice, and trust your judgement.
I haven't read the entire post already but I jump directly to the coments. One SHOULD learn how to invest and therefore make his/her own choices. Professionals are interested parties and are not in the game for solely your benefit. There in the game for their benefits first. I mean lets get honest guys! How would enter an industry if the premisses was: "you will help people make a profit, and may be, in the process, make money too." I don't say they are sneaky and all. I just say that they, themselves, have an interest in the game. Their comission is based on the money they bring thats the problem. So if you loose money, they'll still get their commissions on the amount of money they brought from you. I will trust only a professional to which his commission will be linked to MY profit: I make money, he does, I don't he doesn't. Period. I could go for hours on this topic. But I'll spare you... I will only say this to finish: profesionnal are also bind by a set of laws. Therefore they cannot sell you everything that would be in your interest. There are stuff they can't mention to you. And there is types of stocks and type of trades that they are forbidden to do for you. Would you trust a hunter that has his hands bind in his back to bring you food? I don't.
This is really well thought-out, thanks for sharing! I've been doing a lot of research in the past year or so and I've often wondered about this. (And still do!)
The downside for those do answer 'no' to those questions is that you still have to figure out who to trust. I think a lot of people shy away from investing because of this. You either do it yourself, or give up control and trust someone else. Even after you do the basic research, there's still that feeling of "wait, did I miss something?" It's tough to know when to stop researching and start trusting.
The ever insightful Patri Friedman has commented on "My Spending Over the Last 8 Days." Very good insight on the pros and cons of investing in assets for compound interest or investing in your own personal development -
It's tricky, because on the one hand, there is all the magic of compound interest you refer to, and OTOH, if you love working and will be making good money the rest of your life, then you have ample opportunity to make it later. For people who want to retire as early as possible, working hard for max savings makes sense. The difference between saving HARD (and researching a minimal cost retirement in another country) vs. saving just 10% a year can easily mean retiring at 35 vs. 60.
Bur for those with valuable skills who like to exercise them (which it seems like is the case for you), who like to always have a hand in the game, the value of saving is less.
One unfortunate thing is that when you are young, you tend to have both rapidly growing savings and career, it is the time when investing in savings yields the most l ong-term returns...and so does investing in yourself. Both of them compound.
Personally, my net worth has gyrated insanely over my adult life, so making good spending decisions has always been hard!
UPDATE: I've posted lots of updates since I originally wrote this blog 2 years ago. If you want to go deeper down the rabbit hole, check out this post comparing Betterment vs. Wealthfront ETFs and this one on Peer to Peer lending.
My wife Sue and I have been mulling over how to most effectively deploy cash in the current economic climate to generate decent returns without taking outsize risks. We've honed in on six main strategies, which I outline below in descending order of risk.
Since everyone has a varying amount of cash to invest, I'm going to specifically call out ways to deploy small amounts of cash in some of these strategies, as I want this post to be really actionable for anyone. The most important part is to just get started, and the biggest barrier to doing that is you thinking "I don't have any money to invest." So get yourself out of that mindset and jump into the world of being an investor, even if it's just with $25 (yes it's possible, below), $100, or $1,000 or $10,000, or whatever. I also recommend putting money aside every month to invest; that's a great way to get started.
Riskiest: Angel Investing