Thursday, July 24, 2014

Buffettology and How Its Magic Applies or Doesn't Apply to Us Mere Mortals .... How the World of Personal Finance and Investing Really Works and Why It Is Important to Each of Us

Studying, and then, if possible, replicating Warren Buffett's winning investing formula would obviously be a good way for each of us to approach the do's and don'ts of personal investing over time.

So let's take a few minutes and consider just how the "formula" really works and whether we should even try to do the same thing with our own investments. And if not, what we can learn from the way the "Oracle of Omaha" does things.

You can't be Warren Buffett, but you can be a better investor is subtitled '7 market myths that make investors poorer:'
"Financial markets are complex dynamic systems, populated by irrational and biased participants. Because of this, we have a tendency not only to misunderstand how the financial markets function, but we tend to buy into myths that often harm our financial well-being....                                       

Here’s what investors need to watch out for:

1. You can’t be Warren Buffett

Over the past 30 years, the world’s greatest investor has come to be idolized. But the way Warren Buffett has amassed enormous wealth is often misunderstood. . . .
Make no mistake — Buffett is not a simple value-stock picker. What he has built is far more complex and resembles something that few retail investors can even come close to replicating.

Berkshire Hathaway, Buffett’s firm, essentially acts as a multi-strategy hedge fund. Berkshire engages in sophisticated insurance underwriting, complex fixed-income strategies, multi-strategy equity approaches and tactics that more resemble a private equity firm than a value-based brokerage account. Replicating this isn’t just difficult — it might well be impossible.

2. You get what you pay for

Few things are more detrimental to portfolio performance than fees. Most mutual funds underperform a highly correlated index, yet they charge 0.8% more in fees on average than a highly correlated index. That might not seem like much, but when you compound this at 7% over 30 years, your total return gets reduced by 23%. At that rate of return, an investor who buys $100,000 of a closet index fund and one who buys a highly correlated, low-fee index will amass, respectively, $590,000 and $740,000 over that 30-year period. Millions of investors are stuck in mutual funds that don’t outperform a benchmark index.

In finance, more expensive doesn’t necessarily mean better.

3. You should focus either on fundamentals or technical analysis

A great battle rages in financial circles between fundamental analysis and technical analysis. Fundamentalists believe you need to understand corporate fundamentals to predict how an asset might perform; technicians believe an asset’s past performance is the key to its future.

But this debate is like trying to determine whether it’s better to drive looking through the windshield or also utilizing the rear-view mirror. The truth is somewhere in-between . . . .

4. The myth of ‘passive’ investing

There’s no such thing as a “passive” investor. No one can realistically replicate the performance of a truly passive index over the long-term. Accordingly, we’re all active portfolio managers in some sense, whether it’s establishing a lump-sum portfolio at initiation, rebalancing, reinvesting, reallocating, and the like. We need to be aware of how these actions can be positive or negative.

It’s important to reduce fees and frictions, but not at the risk of oversimplifying the portfolio to the point where it’s counterproductive. The concept of passive investing is built on useful and sound principles, but often overlooks the fact that portfolio management is a process, not a passive undertaking.

5. The stock market will make you rich

Most market participants tend to think of their financial situation in nominal terms. But when you are looking at your portfolio performance, it’s imperative to think in real terms. . . . That means backing out inflation, taxes, fees and other frictions that reduce nominal return. . . . 

The stock market can protect your wealth and help you maintain purchasing power, but it’s not the place where most of us are likely to make our fortunes.                                         

6. You have to beat the market

It’s hard to avoid the allure of trying to beat the market — to outperform on a consistent basis by simply picking stocks. In truth, most of us are not going to strike it rich in the stock market and most of us shouldn’t even try.

You don’t need to beat the market. Attempting to beat the market means taking risks that are probably not appropriate. Instead, you need to allocate assets in a manner consistent with your financial goals of beating inflation, without exposing your portfolio to disruptive levels of risk....

7. ‘Stocks for the long run’ is the best strategy                                        

You’ve probably heard about “stocks for the long run” or “buy and hold.” These concepts are usually sold to investors using misleading nominal historical returns, or the promise of climbing on the financial roller coaster at age 25 and getting off at age 65, whereupon you stroll into the sunset years.

Of course, this isn’t remotely how life works, and our financial lives should reflect that. Our financial lives are a series of events. You get married, buy a house, have children, send them to college, plan for retirement. Life happens, and investment portfolios should reflect this."

Summing Up

Personal financial matters are important to all of us. Even, or perhaps especially, to those of us who don't want to be bothered or believe we will never understand how all this "investing and financial stuff" really works.

Financial matters matter to us throughout our lives, and knowledge about how things really work is helpful to us along life's way --- extremely helpful, in fact.

Such things as getting a solid education without going deeply into debt, avoiding or minimizing student loans while getting that solid education, avoiding, minimizing or prudently managing credit cards, home purchases and mortgages, insurance policies, home equity loans, 401(k) investments, personal savings and retirement planning and funding issues are each and all important matters to each of us and our families as well.

In that spirit, we'll pass along our own personal financial and investing experiences from time to time.

So while we don't pretend to be an investment pro like Warren Buffett or anything close thereto, we do try to learn from him and others like him.

If you haven't already, you should consider doing so as well.

That's my take.

Thanks. Bob.

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