Anyone else FI now but still working for a bit longer?

[eudaimonia]

@jacob: Good point regarding metacognition. A good example is that few individual investors seem to realize that financial institutional interests are setup to aggregate assets and charge fees (Vanguard is no exception). They have a vested interest in you putting your money in an index fund or mutual fund. They have provided a well-marketed story that they have your best interests at heart and that you cannot outperform the market. As a for profit business they have an implicit conflict of interest – very similar to how you shouldn’t necessarily believe climate reports published by scientists receiving money from Exxon.

Whether the Vanguard story is true or not is immaterial to this example. The point is that the average investor doesn’t even see that this conflict of interest exists. It’s this type of thinking that is necessary if one is interested in managing their own money intelligently.

[FBeyer]

1) Those who know that they can beat the market.
2) Those who know that they can't beat the market.
3) Those who don't know yet that they can beat the market.
4) Those who don't know yet that they can't beat the market.

@jacob, Thanks for those and the advice. I read through this whole thread just now and the spread between 1 and 2 is quite palpable given the discussion. I think I'd consider myself group 3...for now.

Thinking about this further it seems the most important differentiator between group 1 and the rest (but mostly group 2) is just being open to new ideas and then doing the legwork. It almost seems as simple as just having a burning interest in knowing more than those around you by just trying to stay ahead of that 50 year general information learning curve.

One of the things I have difficulty with is transitioning into more scientific/mathematical language. I started reading through the 2013 Economic Sciences Nobel paper and on page 4 I'm already seeing .

Ehhhhh???? This is where I start losing track of the topic. Not that I don't want to follow, I just can't. Coming from an IT background, its difficult to make forays into this space.

The first rule of reading mathematics is: Do not treat equations like a written sentence, treat equations like a well-structured abstract painting. Like a piece of art. You cannot glance at a large painting and immediately get what it's about. Sit down and study it.

There is a message, there is a meaning to the composition, there is sometimes a meaning in the order things are presented. There are stories to be told by analyzing the structure, the indices and extrapolating from the equation. Draw it in your head, manipulate it in your head. What does it behave like when something goes to infinity, to zero and when do certain parts converge toward 1.

Once you have the mantra of 'art' in your head. Sit back and look at the equation again.
You have to know 3 things:
What is a 2 dimensional array (or a matrix if you will)?
What is a function?
What does a sum sign mean?

I don't know what the expression covers but just looking at the indices you're looking at a sum of several terms that comprise an array.
You can see that the output P is two-dimensional. Rows are denoted by i, columns by t.
The sum sign says to sum over s. Now look for the 's' somewhere. You'll see that s is the input to three functions under the sum: pi, m and x.
So, for every possible value of s you multiply three functions and you get a single value of P_it.

In other words, if you can multiply three functions together several times, you get a single value of P_it.
When you repeat the operation for all possible values of i and t you get the entire matrix of P. It's tedious, but that's why we use computers to do something like this.

The thing to note though is that the t'th element is covered by functions that depend parametrically on t+1, so there is probably some constraint on what values of t you can calculate.
The functions of pi, m, and x also all have s elements, so they are of equal length or the sum is constrained such that s is always contained in all three functions.
There are no weights, all functions contribute to the sum equally. So you have to wonder about the range of the constituent functions. Will any of them ever be 0? If yes, under what conditions. What does that say about the behaviour?

Reading a sentence takes less than a second. Reading an equation should probably takes minutes, unless it's something you've seen so many times that your pattern recognition immediately tells you how to interpret it. Which is why you want to sit down and study the equations to begin with. In time you'll recognize the patterns.

[cmonkey]

@FBeyer, Just thinking of it in terms of art instead of sentence helps a lot, thanks for that. You wrote up a great explanation.

I think the only thing I'm fuzzy on yet is how functions pi, m and x all relate to t+1 and i,t+1. I understand s is an input into the functions, but what's going on with t+1?

[FBeyer]

I just looked up the paper.

Roughly speaking:
If you read the text you'll see that the current price (exactly at time t) is determined by future evaluations (at some later time, thus t+1)
That is why all terms used to predict the price of an asset deal with the future and the price you calculate for the asset can (logically) only relate to now.

What does the bond cost today?
Depends on how much we expect it to yield in the future.



You have to go back and forth between the text and the equation until you at least know what the pieces represent. Then you can start figuring out what they mean.

Speaking of pattern recognition; the formula you linked to looks to be a somewhat bastardized weighted Law of the Unconscious Statistician
https://en.wikipedia.org/wiki/Law_of_th ... atistician
where pi is the probability density and X is the payout. You're calculating the expected value of the payout with a weighting term.
The total payout is composed of the discount and the future payout (m and x). The function pi regulates how likely it is those payout will actually happen.

Intuitively you'll see that even if the function composition x*m is very large for certain values of s, if the probability that such an event happens (pi is very very low) then that very unlikely scenario will not add much to the expected payout of the asset, because, well, you'd have to be VERY lucky for that scenario to occur.

So in human words: how much is the asset expected to pay in the future, what is your discount, and how likely is that particular scenario.

Or something. I spent 10 seconds looking at this, don't go and buy anything because you read this post.

[ThisDinosaur]

This "10%" estimate keeps coming up wrt what fraction of the population can consistently beat/time the broad market. (Source?) I think this is significant because, from an actuarial perspective, the odds are not in the favor of anyone who thinks he is in that 10%. You can't insure against calamities (being unknowingly ignorant) that affect the majority of your sample population(the other 90%). So, I try to learn from the winners AND from the losers, if I can.

Now, I do believe it is possible to outperform a broad market index consistently, because I don't believe investing in financial assets is magic. If you know how to evaluate what you are buying, you can tell if its worth what you're paying. So, saying "no one can do it because most can't" doesn't ring true.

But that "10%" number gives me pause about how fruitful it is likely to be to try to get into that club.
I think more about metacognition and epistemology than most people I know, and I constantly question if I know any of the things I think I know. For me, this has resulted in some recent paralysis by analysis in my investing. I'm reading everything I can get my eyes on about investing, but there is always more, and there are *always* unknown unknowns. Tyler9K says to assume that the other guy in your trade is smarter than you argues in favor of diversification. I am inclined to agree. But I'm still trying to catch up to the smartest guy.

[jacob]

It almost seems as simple as just having a burning interest in knowing more than those around you by just trying to stay ahead of that 50 year general information learning curve.

Nope. You'll note from my long post above that even professionals, who would be expected to have the required knowledge if not a burning interest, fail in 90% of the cases.

Intellectual legwork is a required condition but not a sufficient one. It's like dieting, exercise, religion, ... (list above). If all success required was knowledge, we could fix a lot of the world's problems by handing out books! However, diet, for example, requires knowledge about food but also self-discipline and personal experiental intelligence about one's body. The latter requirements aren't available via books.

Beating the market is more like being a good poker(*) player. To play requires knowing the rules. But to play well also requires knowledge about the odds of given hands and keeping track of the cards; knowledge about other players (the market itself); as well as knowledge about yourself and control/awareness of your tells(**). The latter requirements are again not available via books. However, you can learn something about other players by studying psychology or doing statistics on their facial expressions or whatever, or simply playing a lot of games and paying attention (active learning!). You can learn something about yourself using similar methods and practice as well. For poker as for finance, it makes sense to lean on your strengths whatever they are. I suspect you can be a good poker player while being completely ignorant of odds insofar you're a master of tells. There are definitely master value investors who have no clue about higher math just as there are master quants who have no clue what CSCO stands for. My point is, it's not the 50 year general information curve you have to stay ahead off. It's the other players. This is easier to do in smaller and less popular games or game types that are either extremely hard or where you personally have an extreme advantage. Knowing your personal strength and weaknesses is a big part of the game as well.

(*) Or some other game with the level of complexity and layers go deep enough for people to have written lots of books about it, e.g. bridge or chess but not ludo. The market is probably the richest game out there in terms of depth and complexity.
(**) And I presume a bunch of other stuff that I'm not aware off.

[ThisDinosaur]

Warren Buffet's folksy wisdom always makes winning in the market seem so simple. "Buy good businesses at a good price. Ignore Mr. Market." Jacob and the 10%ers make it into a high stakes poker game where knowing everything is necessary but insufficient. 90% will fail?!?! Is it even worth it to try? I am NOT arguing against continued learning, and doing what you can to know what Shiller and Dalio know. But just because Michael Jordan attributes all of his success to working harder than everyone else, it doesn't mean all of us should quit investing and try to make our fortune in the NBA. Americans love stories about the winners who beat the odds. "Dave Thomas was a high school dropout!" "Mark Cuban says diversification is for sissies!" There is clear survivorship bias in these stories, and that argues in favor of using the strategy that works for the MOST people, not trying to become a 10%er. FWIW, I fully intend to change my mind about this once I have learned "the secret."

[jacob]

@ThisDinosaur - For retail - http://papers.ssrn.com/sol3/papers.cfm? ... id=1952850 ... there aren't that many studies of retail investors because of the problem of getting the data(*). This one was the only one I could easily find. However, for mutual fund advisors (the ones that receive the brunt of Malkiel's "attack"), it's getting widely acknowledged that many of them are closet-indexers ... that is, they charge active fees but in reality, their fund is 85% index and only 15% active or somesuch. Here, if you look at fund advisors with higher fractions of "real activity", you'll find them doing better. Another way of looking at it is to only consider "conviction" picks from those advisors. Again they're doing better than the market. Other research involves looking at performance streaks where the real data shows a much greater incidence of streaks than one should expect if the performance was entirely random. E.g. rolling a dice, you should expect to see four or more sixes in a row no more than 1/6^4=0.077% of the time ... but in reality you see the equivalent much more often than that for some investors suggesting that their particular "dice" is loaded.

(*) Access to data, especially for academics and their publications, thwarts most studies in finance.

For professionals, I only have anecdotal knowledge from asking around in industry (I know quants, discretionary traders, and value investors) what the general success rate is for traders. ~10% is the general answer---which you should read like "a couple of people in a class of 20" and not "exactly 10.00%". The actual (real data) performance distribution looks a lot different from the Gaussian curve (50/50 binomial converging on the limit---most pros make far more choices than retailers, so you get a confident answer much faster because N is higher) that the random/no prediction model theoretically predicts. What you have instead is a strongly positively skewed curve (with a FAT tail to the right) where the median is negative but only slightly so and 90% of professionals lose a little money (until they are laid off) while the 10% is pulling the average much more positive that "the market" i.e. we're talking 20%-100% APY for private equity. Similar to eudaimonia's story above. It's possible to "prove" that this is no mere random outcome using a chi^2-test.

Lots more discussion here ...
http://www.retailinvestor.org/activeVSpassive.html

In particular, I like the following analogy which is similar but better written than the student one I've used in the past, so I'm just going to quote directly.

Situation: Your kid needs grades in the top half of the class to get into college. He comes home one day and announces...
Kid: I'm not going to study any more. There is no point. My teacher is 'marking to the curve'. Half the kids will do better than average by definition. It is just luck which half I end up in.
Parent: It is not luck, it is talent. Studying changes your personal probabilities. Kids who study most often get top scores. Slackers most often do poorly.
Kid: Nah. They don't do well because they study. Binomial probabilities predict that some kids will repeatedly get good scores just by chance. So their success is due to luck, not talent.

Most of the "debate" in this thread has to do with whether studying the market changes your probabilities or whether the market is so complex as to render everyone's attempt at studying pointless.

Indeed the analogy extends pretty far insofar you imagine that the subject was pretty hard, e.g. lets take those 10th graders and throw them directly into a college class in Differential Geometry instead. Actuarily speaking, the random 10th grader should probably not bother trying. However, the few 10th graders who are already on the math-team will probably get something out of the college level class.

More importantly. In terms of the the debate in this thread ... asking whether it's worth trying IS VERY DIFFERENT from asking whether it's possible to succeed. In particular, while "Buy good businesses at a good price. Ignore Mr. Market." seems like a simple statement, it covers an incredible amount of skill that takes years and years to master. That would be like Michael Jordan summarizing his basketball skills with "Just jump. Shoot the ball and hit the hoop." What is "a good business"? What is "a good price"? How do you ignore Mr Market when your portfolio is bleeding? Learning the answers to these questions is far from trivial.

Also, you're allowed to condition your random samples. I don't know Jordan's biography, but I bet he wasn't the lucky one in a sample of ten thousand people who were randomly sampled off of the street. I suspect his (or if not his, then most NBA players) chance of success was conditioned on being picked out of the NCAA which is again conditioned on being picked from some high school team, which again is conditioned on a childhood full of shooting hoops ... My point being that you're allowed to---in fact you should---update your probabilities/odds of success as the process is filtered, to use a technical term. For example, you didn't end up at ERE randomly if you followed a chain of links from somewhere (a multiply conditioned resampling or a filtration) to get here or you used a search engine (same thing but automatically). The only way you could have ended here completely random would be to type in the website's IP number directly.

In any case, whether attempting to beat the market is worthwhile given the odds is an entirely different discussion than whether it's possible. Here the decision also depends on the level interest, some X-factor, yet to be discovered, which most people turn out to lack, and how much you can leverage your skill if you have any, that is whether your n% alpha times your investment is actually a significant amount of money.

Much like the questions you need to ask yourself should you decide to pick up guitar playing as a hobby. Is it "worth it" to practice? Do I know myself well enough to acknowledge buying a more expensive instrument won't make me a better player? Do I realize that despite lots of practice, I still might not be able to get people to pay me?---That insofar I've never played an instrument before, the odds that people will ever pay to listen to me regardless of how much I practice will be under 10%? That even if I believe I'm a good player, I might not be able to acknowledge that by the fact that nobody is paying me and thus keep wasting money on upgrading my equipment in the hopes that this will finally make the difference.

[steveo73]

Warren Buffet's folksy wisdom always makes winning in the market seem so simple. "Buy good businesses at a good price. Ignore Mr. Market." Jacob and the 10%ers make it into a high stakes poker game where knowing everything is necessary but insufficient. 90% will fail?!?! Is it even worth it to try? I am NOT arguing against continued learning, and doing what you can to know what Shiller and Dalio know. But just because Michael Jordan attributes all of his success to working harder than everyone else, it doesn't mean all of us should quit investing and try to make our fortune in the NBA. Americans love stories about the winners who beat the odds. "Dave Thomas was a high school dropout!" "Mark Cuban says diversification is for sissies!" There is clear survivorship bias in these stories, and that argues in favor of using the strategy that works for the MOST people, not trying to become a 10%er. FWIW, I fully intend to change my mind about this once I have learned "the secret."

This is what I've been getting at. There has been some statements that don't ring true within this thread:-

At it's worse it goes like this:-

1. I can beat the market.
2. If you don't believe point 1 it's because you don't have sufficient understanding of the market compared to me.

The problem is that most people don't beat the market. As you state it might be 10% of people who beat the market consistently but I'm not even sure that it is an accurate figure. It could be a lot less. Are people really self-aware enough to realize that they probably won't be that 10% and even if they are by how much will they outperform the market.

I mentioned earlier the phrase "fooled by randomness". Another concept to grasp in this whole process is survivorship bias.

Everyone gets to make their own assessment however I inherently don't trust the data that states this portfolio will perform like this in the future or that this approach to purchasing stocks will outperform in the future based on the data. We do not have perfect data to utilise to predict the future. There is another thread on gold just now. Gold may not perform the same in the future as it has in the past.

I do like the idea of using principles that should hold true now and in the future to guide your investing though. Diversify across asset classes and within asset classes. Stocks tend to outperform other asset classes. I think this is because you are investing in businesses that have a goal to make a profit.

[ThisDinosaur]

I don't have a problem, conceptually, with the idea that educated investors can outperform broad market indexes. In fact, I have the opposite problem of trying to explain why doing so is apparently so difficult. Taking the 10% number at face value, why should this be so? As Shiller says, it doesn't make sense that there is no penalty for ignorance.

Imagine that I start with VTSAX. Then I use a stock screener to get rid of everything with a PE ratio over 15, and that's the only thing I know. I buy one share of every single one of those stocks. I will have a few losers in that bunch, but shouldn't I perform better than VTSAX over the next two or three business cycles? Lets say, I then learn about PB, earnings growth per share, equity to debt ratios...and I just buy single shares of each of those stocks. Won't I do better again over the next few business cycles even if I never read a 10K?

[BRUTE]

just because it's random doesn't mean humans can't beat the market somewhat consistently. if 1/10th of all participating humans beat the market consistently for just 10 years and then never again, that's enough for many of them to become filthy rich and retire. and those chances are a lot better than, say, becoming a top-dollar actor in Hollywood or starting the next Facebook.

so even if the 10% is completely random, that's still a worthy game plan for many people, brute would imagine, especially when playing with other people's money (=hedge funds etc), where the potential payoff is much higher, yet the personal risk smaller.

it is also true that "most people who play poker lose money". yet there are professionals who make a lot of money doing it. of course the market/poker analogy is flawed, but under scrutiny, even the "most people don't beat the market" saying is flawed.

while the rules for poker are pretty much the same, every human participating in a game is playing the same game, the same is not true for the stock market (or most markets). people play "market" by vastly different rules, with vastly different goals. they are playing different games. large hedge funds can't beat "the market" because they ARE the market. institutional investors have to follow certain regulations and rules that others don't have to follow. certain players have access to securities and deals others can't access. some humans don't play with their own money. some humans want to maximize profit over the long run (30+ years), others want to preserve their wealth when SHTF. yet others are in the game for only 5-10 years, and play a super high risk strategy, that leaves 10% of them millionaires.

saying that "most don't beat the market" when they are playing vastly different games is unhelpful. maybe they're not trying to beat the market. maybe they define "beating the market" differently. or even "the market". maybe their measure of beating the market is different, or maybe they have access to different moves.

[jacob]

@ThisDinosaur - It's hard because these days there's little to no signal (alpha value) in the blanket application of stock screeners using a single generic ratio as a cut-off. You're essentially not suggesting doing anything that thousands of wannabes aren't already trying thanks to the easy availability of stock screeners on the internet.

Outperformance? Sorry, there's no app for that.

Now, if you've had that insight in 1935, then yes, you'd done really well because back then fundamental analysis was a truly novel idea (the reason Graham is still famous even if his discovery is now Finance101 knowledge) and you'd have had almost no competitors. However, back then, you'd have had to 1) have the original idea that P/B ratios are significant; 2) go through to 10Ks and build a database to do the research; 3) build a stock screener; 4) build a way to test whether your trading decisions based on your idea were actually predictable; 5) Put your money on the line; 6) Stick with your strategy long enough to verify and validate it.

Indeed, if you had done the statistical analysis and published it as a paper back then, you would have won the Nobel Prize.

Now, what are the odds that you would have thought of that AND done all the work? Why isn't winning Nobel Prizes as easy as it is to understand the papers written by the winners? Because it's much harder to have the original thought in the first place than it is to understand it and replicate it once someone else has discovered and explained it. Now, it's certainly not as hard to discover worthwhile investment strategies as it is to discover Nobel prize winning insights ... however, it's still hard.

The other point which you might be missing is that the market is never fully efficient. However, it is always converging on efficiency. The reason it never reaches 100% efficiency is that the world of economy which the market is trying to describe is changing underneath it.

In 1935, the market was quite inefficient when it came to book values. There was very little fundamental analysis going on. Thus the first people who started to invest based on fundamentals could make a lot of money. However, as it became common knowledge low P/B stocks were bid up so that most of what remains today are either value traps or misreported numbers. In particular, unlike building a brick house or ERE, where you could copy me resulting in two brick houses or two people doing ERE, if you copied my investment strategy, you're essentially eating into the pie that I discovered .. and if too many people join you, the pie will be gone. (This is also why investment companies don't publish any ideas insofar they're still working!)

The 10% are the people who are continuously able to find new pies when the old ones are eaten away as they are discovered or rediscovered by others as well. Anyone can be lucky once or twice ... but being "consistently lucky" takes skill.

PS: Just to remphasize the point. It's not just about originality. It's also about behaviour e.g. discipline, and so on. Maybe your edge is that you can stick with your idea for three+ business cycles (i.e. the next 30-40 years). Are you capable of this? Very few people are ... even hardcore buy and hold index believers demonstrated significant doubt in 2009 ... and that took less than 1 year!

[ThisDinosaur]

@jacob
So, all good ideas get bid up in price until the market approaches efficiency. The Heisenberg Uncertainty Principle of investing; as soon as you measure a strategy, it collapses the wave function.

Perhaps its too much to ask you to divulge your own, closely held, original ideas.(Come on, give us a hint.) So, what is the ERE "building a brick house" equivalent in investing?
You're reputation for being "anti index fund" is well supported by a lot of your writing, despite your protests to the contrary. If 1)90% of us will not beat the market, 2)most of us will not meet your three criteria for trying, and 3)index funds are an "old idea" ripe for collapse, what alternative are you recommending to your acolytes here?

[jacob]

Yes, the Heisenberg principle of market efficiency. That's exactly it. I'm going to steal that for later use

I'm not anti-index funds. I'm anti-ignorance or more specifically, I think that the popular "nobody can beat the market"-slogan actively promotes ignorance in investors and that continued promotion of ignorance could eventually hurt and implode the market if the lack of strategy-diversification reaches critical mass.

I don't hate index funds. I use index funds myself for some things, but I no more believe that EMH should serve as an excuse for investors to be ignorant about their investments than I think that grading on a curve should serve as an excuse for children not to study. It might be fine if you recommend one child to copy his homework to get into college, but if that piece of advice becomes widely followed, we end up with an entire class of stupid. One tapeworm in a dog is a good survival strategy for the tapeworm. A thousand tapeworms in the same dog is not! I think students should be well-aware of the risks of not studying, index investors should be well aware of the strengths and weaknesses of their strategy compared to other strategies, and the tapeworms should keep track of the number of fellow tapeworms and plan their exit strategy because they're all leaving through the same door.

My not so very closely held investment secret or edge is that I've read widely about finance, the economy that underlies it, and the natural world that underlies the economy---all categories to a level where other people either considered me informed enough to pay me a salary or put me at the top of google searches. Aside from that I've spent a lot of time thinking about systems theory and lattice work on how to tie things together. Thus when I read news, I have a fairly good idea of what's important and how things are going to change inside the world-system based on variables that aren't part of a single public narrative from a given newspaper article. For example, it was clear to me a couple of years that the Fed would hold off raising interest rates far longer than they initially said they would because of constraints in the unemployment numbers (not being accurately reported compared to reality), that QE went on so long, and that raising rates would actually hurt US companies through currencies because of the repatriation of dollars. That's not the only reason. There are a consilience of reasons. But I positioned myself in a way that would benefit from general acceptance of that understanding ... and this came around February this year. You can think of this way of intuition as using graphed networks instead of analysis (I seldom analyse/reduce), statistics, or algos. Luckily for me, this is an area where computers likely won't catch up until near human-level AI is realized, so I figure I have couple of decades left of edge in me. This edge is also hard to copy because it takes a particular mode of thinking combined with lots of reading and a continued interest in big picture issues in the world.

I am loath to give specific actionable advice to the general population(*). That's like instructing everybody in how to start your car or fire a gun and then leaving your keys or gun at a height where your five year old can grab them. What could possibly go wrong? Actually I have given advice a few times, both intentionally and unintentionally, so I know exactly what will go wrong. People will contact me several years later with an analysis of how "my portfolio" has performed only for me to tell them that I sold most of the holdings years ago. Or maybe I mention that I'm looking at a particular stock. Bam! Ten people go out and buy it because "jacob" mentioned it. No, I didn't buy it after all. Still my fault though. For structured portfolio setups, I've seen people only follow half of my advice because they "didn't believe" in parts of it and figured themselves smart enough to modify it (e.g. similar to leaving cash out the permanent portfolio w/o understanding why it's in there in the first place) only to blame me for the failed results. Many are also fair-weather followers and will instantly turn on you insofar your idea hasn't worked out yet in the past 12 months even if you're been right every year in the 10 years before that. (That's probably the same performance chasers who actually should buy & hold index funds.) This is why professional advisers often ask that you tie up their money with them to avoid you flip-flopping in your support.

Sorry, but I'm not getting paid nearly enough for that kind of abuse. I might not give some people a lot of credit, but I also have the experience to justify not doing it.

(*) Even if I said something like "I think the next big idea will be in X", we'd have a bunch of people going out buying the ETF that covers X w/o any consideration of whether this idea will affect the companies in X, e.g. positively, negatively, differentially, ...

My advice to my acolytes is the same as it's been all along and what is also written down in the ERE book: Understand what you're investing in! I think in particular ERE folks should have a level of education when it comes to investing that's on par with at least a freshman course in finance along with a few supplemental readings and some "continuous education" to go along. See the links to the Bodie or Riley books I gave above for starters. Indeed, I recommend that anyone who intends to live off of investing for 40-60 years need a somewhat more formal grounding than a handful of popular non-fiction level books on the most recent popular strategy coupled with blind faith that those books contain the ultimate solution. This formal grounding will help in choosing a strategy and rechoosing if it collapses.

Basically same recommendation as for every other single aspect of ERE. You gotta be knowledgeable enough to make informed decisions.

There's no shame in index investing and there is no shame in not beating the market, but I think there is shame in deliberate ignorance.

The best thing a person can do to up their investment game is to focus on how to ask the right questions instead of looking for the right answer. This requires a leap in metacognition though (see thread above). The problem with searching for answers rather than questions is that people miss their unknown-unknowns. They don't know what they're missing because they never even thought to ask. This is the danger of mental short cuts. This is why the "hack" or "guru pick"-approach to investing is the dumbest strategy out there. It is the concept of "being able to ask questions" that I've been trying to bang into people's heads throughout this entire thread. The difference in focus is the biggest difference between good investors and bad investors. Good investors question what they know and think about what they don't know all the time. This way they learn more. Bad investors think there's nothing more to know.

[eudaimonia]

@Jacob: Well said. I also will not divulge my secret sauce because as you mention, while the market is not perfectly efficient it is mostly efficient. In other words all edges will erode over time once they are discovered (and even sometimes if they aren't). In other words no one can give you the answer to a one-size fits all edge.

@ThisDinosaur: That said there are currently two general methods that may have ways to exploit them (even though they are well known): 1) Momentum, and 2) Implied Volatility (IV) tends to be mean reverting. My recommendation to any newbie would be to research what these are exactly. Also, since both of these are very well known there are some well known problems that one must solve to find a useful edge for each. For momentum you must solve the problem of low volatility periods and the tendency to be whip-sawed. For IV you must find a way not to get destroyed by black-swan events. These problems aren't insurmountable. I personally use both of these types of tendencies in the market as a starting point to develop several of my edges.

Lastly, regarding the 90% of traders failing - this statistic is remarkably similar to the failure rate of a new business in the first 5 years. The key to keep in mind is that you can risk relatively little while learning to invest and there is a large upside potential. Do the math on what it is like to compound 20%-100% annually for 10 years to give you an idea of "whether it is worth it".

[steveo73]

just because it's random doesn't mean humans can't beat the market somewhat consistently. if 1/10th of all participating humans beat the market consistently for just 10 years and then never again, that's enough for many of them to become filthy rich and retire. and those chances are a lot better than, say, becoming a top-dollar actor in Hollywood or starting the next Facebook.

It depends. If you get awesome returns and obtain enough money to retire on and then invest it in a safer fashion then yes you could be right. The problem is that often an up run is then followed by a down run. Also getting 10 years of great returns isn't that easy.

[steveo73]

@ThisDinosaur - It's hard because these days there's little to no signal (alpha value) in the blanket application of stock screeners using a single generic ratio as a cut-off. You're essentially not suggesting doing anything that thousands of wannabes aren't already trying thanks to the easy availability of stock screeners on the internet.

Outperformance? Sorry, there's no app for that.

Now, if you've had that insight in 1935, then yes, you'd done really well because back then fundamental analysis was a truly novel idea (the reason Graham is still famous even if his discovery is now Finance101 knowledge) and you'd have had almost no competitors. However, back then, you'd have had to 1) have the original idea that P/B ratios are significant; 2) go through to 10Ks and build a database to do the research; 3) build a stock screener; 4) build a way to test whether your trading decisions based on your idea were actually predictable; 5) Put your money on the line; 6) Stick with your strategy long enough to verify and validate it.

Indeed, if you had done the statistical analysis and published it as a paper back then, you would have won the Nobel Prize.

Now, what are the odds that you would have thought of that AND done all the work? Why isn't winning Nobel Prizes as easy as it is to understand the papers written by the winners? Because it's much harder to have the original thought in the first place than it is to understand it and replicate it once someone else has discovered and explained it. Now, it's certainly not as hard to discover worthwhile investment strategies as it is to discover Nobel prize winning insights ... however, it's still hard.

The other point which you might be missing is that the market is never fully efficient. However, it is always converging on efficiency. The reason it never reaches 100% efficiency is that the world of economy which the market is trying to describe is changing underneath it.

In 1935, the market was quite inefficient when it came to book values. There was very little fundamental analysis going on. Thus the first people who started to invest based on fundamentals could make a lot of money. However, as it became common knowledge low P/B stocks were bid up so that most of what remains today are either value traps or misreported numbers. In particular, unlike building a brick house or ERE, where you could copy me resulting in two brick houses or two people doing ERE, if you copied my investment strategy, you're essentially eating into the pie that I discovered .. and if too many people join you, the pie will be gone. (This is also why investment companies don't publish any ideas insofar they're still working!)

The 10% are the people who are continuously able to find new pies when the old ones are eaten away as they are discovered or rediscovered by others as well. Anyone can be lucky once or twice ... but being "consistently lucky" takes skill.

PS: Just to remphasize the point. It's not just about originality. It's also about behaviour e.g. discipline, and so on. Maybe your edge is that you can stick with your idea for three+ business cycles (i.e. the next 30-40 years). Are you capable of this? Very few people are ... even hardcore buy and hold index believers demonstrated significant doubt in 2009 ... and that took less than 1 year!

This post is much more in sync with reality.

The bolded part is still a guestimate to me though. I'm not sure how many people do this and if they are it isn't necessarily based upon figuring out an edge analytically.

[cmonkey]

I have a fairly good idea of what's important and how things are going to change inside the world-system based on variables that aren't part of a single public narrative from a given newspaper article.

Perhaps a very simplified version of this this would be moving on automobile stocks when the price of oil crashed, assuming that consumers would rush out and start buying expensive vehicles? Looking at how different parts of the world system might affect one another in that way. Then when you get good at it you can take it a few steps further. I had this run through my head last summer but never did it and I'm glad I didn't since auto stocks didn't do much.

The general gist of what I think jacob is talking about is that he basically lives and breaths being somewhat omniscient about the entire world system, not just part A, B or C, and having an ability to read between the lines and then read between the "lines between the lines" and projecting those lines into the future while understanding how X affects Y affects Z. I have seen him mention before how video games are no longer interesting because doing this kind of thing can almost be thought of as a game of sorts.

[jacob]

Haha, I'm not omniscient and I do make mistakes. However, your description of the way of thinking is correct. I think this is how INTJs think in general by the way, at least if you let them.

"Knowing where the trap is - that is the first step in evading it. This is like single combat, Son, only on a larger scale - a feint within a feint within a feint... seemingly without end." --- as Leto said to Paul.

Despite several attempts I have completely lost interest in video games. I just find the real world (the entire world) to be a much richer game(*) than e.g. Civ and investing is a way to play that never-ending and always evolving game.

(*) For the same reason, I'm not really that interested in basic research or any kind of specialization anymore. It's funny because I started very much in the opposite camp.

Speaking of games and the world: http://mud.co.uk/richard/hcds.htm it's interesting to consider how these four different player types (as applied to real life) might pick and argue pro/cons for different investment strategies. Especially note how explorers interact with other player types (killers and achievers) and you'll see how predictable this entire thread is. I'm an "explorer" through and through by the way.

[BRUTE]

interesting. brute is mostly an achiever. few things give brute as much pleasure as watching arbitrary integers slowly increase, especially if they're labeled "XP" or "gold".

what investment strategy lends itself to being an achiever? brute would expect something where he can optimize a single, or just a few, very easy to obtain numbers, like SWR, net worth, average return. also maybe a strategy where instead of spending most of the time picking the strategy, one can spend the majority of the time "executing" it better than the next human.