The Ignorant Investor

Every now and then I need to remind myself, in writing, just what I'm trying to do with my retirement money these days. To accomplish this I've written a series of notes that I'm recording here for future reference. This post is directed at some future me, which is why I frequently address "you" throughout the document. If you are reading this post and are not me, don't think of it as being addressed to you in particular, but rather to you generally, as if you were me. Which you aren't, obviously:

1. There is always an investment out there that will pay off more than the ones you're holding now. Problem is, you don't know what they are until a few years from now. That's when there will be some other investment that will be the new high-flyer and which, again, you will not recognize until years afterwards. Come to grips with this fact, dude. Just because you don't shoot the biggest deer in the forest doesn't mean the one you bagged doesn't have enough meet [those that are offended by the idea of hunting can insert their own metaphor here]

2. There is a cottage industry, or rather, a mansion industry, in rendering investment advice. Brokerage houses tend to be permanently bullish, gold fund managers and short sellers are perennially forecasting a depression. Others consider themselves as sophisticated players of the market. They have only one thing in common: none of them can say for certain what Mr. Market will pay for a stock at any given time in the future. Their views should be taken as evidence of market sentiment, or as the description of one potential outcome of many possible outcomes in the market's future. In any case, I'm not paying for any of it. Newsletters will charge annual fees of $200 and up for stock picks that also appear in magazines, on CNBC, on various investment blogs or websites, or are screamed by the crazy bag lady who has been camping outside Trinity Church near the New York Stock Exchange.

3. The temptation to beat yourself up for failing to buy a given stock that's gone up 70% or 100% or 300% in the past year makes no more sense than beating yourself up for failing to pick the winning numbers in the week's lottery. You have to think about what you were doing at the time the purchase should have been made. That the pick would have seemed too risky even had you heard of the stock is eminently reasonable. You must think of it like this: you would be willing to jump snake canyon on a rocket bike if you knew that you would make it. The bragging rights alone would be worth it. But what about if you couldn't know one way or the other? Would you hope on a rollercoaster if the guy at the ticket booth mentioned that the cars frequently leapt the rails, allowing passengers to drop to their doom in a bloody mass of flailing limbs and deathly screams? Prudence is not a character flaw outside of Hollywood movies and advertisements for brokerage houses.

4. Unless it's fun to read balance sheets or discuss companies, no more than an hour or two a week should be spent on investing or talking about investing. There's no reason for someone who is buying stocks and holding them for a year or more, or putting money into fixed income funds, to look at the market more than once a week. It's too easy to get caught up in endless commentary, worrying about what's going to happen in the next month, the next year, the next decade. On the other hand, if a stock or investment opportunity pops into your mind or appears in the press, there's no reason to ignore it. Stay aware without becoming obsessed (by the way, if you begin to have dreams that, say, IBM is ready for a big move upward- it's time to step back from the edge).

5. Make a list of great companies you'd like to own for the long-term. Stocks that are, as a group, likely to outperform the S&P for the foreseeable future. Then keep an eye on them to see if they fall out of fashion or the market as a whole gets cheap. Then buy and hold. That way, you get good performance without having to always worry about whether you should sell them.

6. Limit the amount of material you read on investing to a few classic, widely respected books, the business pages of the New York Times or Wall Street Journal, and a couple of magazines like Forbes, Businessweek, Kiplingers, or Smartmoney. If you must, review the weekly commentaries of the brokerages to see what the current story being sold to retail investors is. This reading probably won't help you at all in the long run, and can be ignored entirely with index investing, but it does give you the sense of what the conventional wisdom or mood of Mr. Market is. Reading market-related blogs could be helpful if every single one didn't conflict with all the others. Everyone has an opinion, it appears, including me.

7. Stay away from technical analysts. If you read financial blogs and the internet sites, you find that they like to talk to each other in their own complex jargon. Lots of it. They use charts and lots of screens with flashing numbers. It all looks so scientific. But science has been unable to confirm their theories on why stock prices move the way they do, nor can science bear out their claims to use charts of past stock performance to predict future movements in the price. To me, the idea of technical analysis resembles the promises of phrenology ("Look, I know you're an angry person because of heightened nodules on the perinatal lobe here"). Which would be harmless if their schemes didn't require a lot of trading to maintain. But they do sound convincing. Always.

8. Write a small memo outlining the goals and methods to be used in picking stocks and managing the retirement portfolio. This will allow you to retain knowledge gained by reading investment books and magazines without being burdened by the difficulty in remembering what you thought at the time you came up with it. Revise it as events prove it wrong, but note what went wrong so you don't find yourself proposing the discarded theories as new theories later on.

9. Managed mutual funds can provide you with allegedly better stock picking skills than your own, but the manager's fees will cut into returns. Only invest in one if you think (because of course you can't know) the manager will substantially outperform the S&P over the long term. Keep in mind that if the fund isn't held in a tax sheltered account, the fund's turnover has to be kept low if you don't to surrender a large share of your gains to the government through taxes every year.

10. Treat the stocks you hold the way a head salesman treats employees of a successful company. It's not enough that they grow if the S&P is growing as well. You could always go out and hire an average salesman like the S&P to do the sales job, and without the risk of having made the wrong choice. What the sales department expects is for a company to do better than average. Problem is, most companies, like most salesmen, are going to have trouble meeting their numbers from time to time. Then is becomes a question of whether the company is in a temporary slide because of a bad divorce or torrid love affair, or because it's just lost the skills it needs to succeed in whatever market is in existence it the moment.

11. Consider whether the skills of successful stock picking, assuming such a thing exists, are not distributed unevenly through the population. We are told by brokerage houses, magazines, newsletter writers, and authors of very successful books, that anyone is capable of picking out the good from the bad. Why not make big money, the subtext reads, simply by the exercise of a few brain cells from time to time? Yet if we look around at other skills possessed by people, beyond a few basic ones like breathing and going to the bathroom, talent in each isn't something that everyone shares. Pro basketball players make millions of dollars because they can place the ball into the net while complying with the rules of the game. That's a skill which we all don't share. I can't dunk. I can't shoot. I can't dribble. A similar situation occurs with chess. Or solving complex math problems. Singing and acting. Interpretive dance. Fishing. These are all activities where people with great talent can find a career and make good money. But we all don't expect to become great chess players, dancers, or fishing guides by the simple process of reading a few books . We wouldn't even consider the possibility. But because stock picking is a mental process and holds a certain element of chance, we assume that we're capable of applying our skill to it to become wealthy, simply because we've seen or heard of other people doing the same.