investing

On Common Sense on Mutual Funds

I recently finished reading Common Sense on Mutual Funds – New Imperatives for the Intelligent Investor – by John C. Bogle.

Below are key excerpts from this book that I found to be insightful:

Investing is an act of faith. We entrust our capital to corporate stewards in the faith—at least with the hope—that their efforts will generate high rates of return on our investments. When we purchase corporate America’s stocks and bonds, we are professing our faith that the long-term success of the U.S. economy and the nation’s financial markets will continue in the future.

To state the obvious, the long-term investor who pays least has the greatest opportunity to earn most of the real return provided by the stock market.

In my view, market timing and rapid turnover—both by and for mutual fund investors—betray both a lack of understanding of the economics of investing and an infatuation with the process of investing.

My guidelines also respect what I call the four dimensions of investing: (1) return, (2) risk, (3) cost, and (4) time. When you select your portfolio’s long-term allocation to stocks and bonds, you must make a decision about the real returns you can expect to earn and the risks to which your portfolio will be exposed. You must also consider the costs of investing that you will incur. Costs will tend to reduce your return and/or increase the risks you must take. Think of return, risk, and cost as the three spatial dimensions—the length, breadth, and width—of a cube. Then think of time as the temporal fourth dimension that interplays with each of the other three. For instance, if your time horizon is long, you can afford to take more risk than if your horizon is short, and vice versa.

Rule 1: Select Low-Cost Funds…Rule 2: Consider Carefully the Added Costs of Advice…Rule 3: Do Not Overrate Past Fund Performance…Rule 4: Use Past Performance to Determine Consistency and Risk…Rule 5: Beware of Stars…Rule 6: Beware of Asset Size…Rule 7: Don’t Own Too Many Funds…Rule 8: Buy Your Fund Portfolio—And Hold It.

No matter what fund style you seek, you should emphasize low-cost funds and eschew high-cost funds. And, for the best bet of all, you should consider indexing in whichever style category you want to include.

There are three major reasons why large size inhibits the achievement of superior returns: the universe of stocks available for a fund’s portfolio declines; transaction costs increase; and portfolio management becomes increasingly structured, group-oriented, and less reliant on savvy individuals.

Four principal problems are created by this overemphasis on marketing. First, it costs mutual fund shareholders a great deal of money— billions of dollars of extra fund expenses—which reduces the returns received by shareholders. Second, these large expenditures not only offer no countervailing benefit in terms of shareholder returns, but, to the extent they succeed in bringing additional assets into the funds, have a powerful tendency to further reduce fund returns. Third, mutual funds are too often hyped and hawked, and trusting investors may be imperiled by the risks assumed by, and deluded about the potential returns of, the funds. Lastly, and perhaps most significant of all, the distribution drive alters the relationship between investors and funds. Rather than being perceived as an owner oi the fund, the shareholder is perceived as a mere customer of the adviser.

On a closing note, on leadership:

To wrap up this litany, I put before you—both tentatively and humbly—a final attribute of leadership: courage. Sometimes, an enterprise has to dig down deep and have the courage of its convictions—to “press on,” regardless of adversity or scorn. Vanguard has been a truly contrarian firm in its mutual structure, in its drive for low costs and a fair shake for investors, in its conservative investment philosophy, in market index funds, and in shunning hot products, marketing gimmicks, and the carpet-bombing approach to advertising so abundantly evident elsewhere in this industry today. Sometimes, it takes a lot of courage to stay the course when fickle taste is in the saddle, but we have stood by our conviction: In the long run, when there is a gap between perception and reality, it is only a matter of time until reality carries the day.

A recommended read in the areas of investing and leadership.

On The Four Pillar of Investing

I recently finished reading The Four Pillars of Investing – Lessons for Building a Winning Portfolio –  by William Bernstein.

As the title suggests, the author presents within this book four essential pillars of successful investing. Each section of the book is then dedicated to investigating and detailing each of these pillars and they are: 1) Theory 2) History 3) Psychology and 4) Business. The first section on theory, is one which the author calls “the most important part of the book”. In his words it “surveys the awesome body of theory and data relevant to everyday investing”. This section centers itself around the “fundamental characteristic of any investment is that its return and risk go hand in hand.” The second section on History postulates that “an understanding of financial history provides an additional dimension of expertise.” The third section, Psychology,  is one in which the author surveys the area of “behavioral finance”. Where one “learns how to avoid the most common behavioral  mistakes and to confront your own dysfunctional investment behavior.” Last but not least the last section – Business – exposes how “the modern financial services industry is designed solely to serve itself.”

What sets this book apart from other investing books is the breadth of areas covered, and also the writing style which is both “understandable and entertaining”. A highly recommended read for any investor regardless of level.

Below are key excerpts from the book, that I found particularly insightful:

1) “The highest returns are obtained by shouldering prudent risk when things look the bleakest.”

2) “Most small investors naturally assume that good companies are good stocks, when the opposite is usually true.”

3) “Sine you cannot successfully time the market or select individual stocks, asset allocation should be the major focus of your investment strategy. because it is the only factor affecting your investment risk and return that you can control.”

4) “Bubbles occur whenever investors begin buying stocks simply because they have been going up.”

5) “Buying assets that everyone else has been running from takes more fortitude than most investors can manage. But if you are equal to the task, you will be rewarded.”

6) “There are really two behavioral errors operating in the overconfidence playground. The first is the “compartmentalization” of success and failure. We tend to remember those activities, or areas of our portfolios, in which we succeeded an forget about those areas where we didn’t…The second is that its far more agreeable to ascribe success to skill than to luck.”

7) “By indexing, you are tapping into the most powerful intelligence in the world of finance – the collective wisdom of the market itself.”

8) “Rebalancing forces you to be a contrarian – someone who does the opposite of what everyone else is doing. Financial contrarians tend to be wealthier than folks who like to simply follow the crowd.”

9) “Risk and return are inextricably enmeshed. Do not expect high returns without frightening risks, and if you desire safety, you must accept low returns.”

10) “This book should be seen as a framework to which you’ll be continuously adding knowledge.”

11) “The overarching message of this book is at once powerful and simple: With relatively little effort, you can design and assemble an investment portfolio that, because of its wide diversification and minimal expense, will prove superior to most professionally managed accounts.”

Regards,

Omar Halabieh

The Four Pillars of Investing

Wall Street Demystified

I recently read the book Wall Street – How it works and for whom – by Doug Henwood. This book can be downloaded (for free) from its website.

As the title indicates, this book is an introduction to Wall Street – how it works and for whom. The book is composed of seven chapters as follows:

1- Instruments: This chapter covers the range of instruments traded on Wall Street, such as stocks, bonds, derivatives, currencies etc.

2- Players: This chapter covers the main stakeholders including households, nonfinancial business, financial institutions, the government etc.

3- Ensemble: This chapter discusses how the markets are intertwined, with a focus on credit, finance and the economy, allocation etc. It also includes a sample trading week to put these concepts into action.

4- Market Models: This chapter presents the numerous financial models that have been devised to simulate the market. It also discusses features of these markets, namely efficiency, disinformation, noise, fads, and bubbles.

5- Renegades: This chapter discusses in detail the Keynesian view of the markets, as well as those of Marx.

6- Governance: This chapter is about Corporate Governance, with a section on the relation of Wall Street and the government.

7- What is (not) to be done?: This last chapter includes the author’s thoughts on a number of economic issues such as social security, the Fed, investing socially, taxation, corporate transformation.

The breadth of topics discussed within this book is commendable, backed by a plethora of references for further reading in areas of interest. Chapters 1 and 2, serve as a great introduction and primer on the financial markets. The insight, stories and practical example presented make this book accessible. A final, and important comment to keep in mind, is that the author presents the content of the book (particularly the later chapters) from a leftist perspective.

Regards,

Omar Halabieh

Wall Street

Wall Street

On The Money Game

I recently finished reading The Money Game by George Goodman (pseudonym Adam Smith).

This is a classic about the stock market and investing. George covers a breadth of topics in that area based on his insider experience. This includes the psychology of the investor (“you”), IT systems and their impact on the investing field, the professional money managers and their role in the Game etc. The concepts are introduced in an accessible, and often humorous style. While the author does not offer direct investing advice, he does expose what he calls “the biases” that exist in the market – that are essential to take into account to be successful together with good judgment.

George is very successful at immersing the reader into the culture, the psychology and way of thinking that dominates the financial markets and its participants. While this book is dated, most of the concepts discussed still apply to the financial industry today. A recommended read for anyone looking to gain more insight into the Stock Market.

Below are excerpts from the book that I found particularly insightful:

1) “If you are a successful Game player, it can be a fascinating, consuming, totally absorbing experience, in fact it has to be. It it is not totally absorbing, you are not likely to be among the most successful, because you are competing with those who do find it absorbing.”

2) “The irony is that this is a money game and money is the way we keep score. But the real object of the Game is not money, it is the playing of the Game itself. For the true players, you could take all the trophies away and substitute plastic beads or whale’s teeth; as long as there is a way to keep score, they will play.”

3) “In short, if you really know what’s going on, you don’t even have to know what’s going on to know what’s going on.”

4) “You must use your emotions in a useful way…Your emotions must support the goal you’re after…You must operate without anxiety.”

5) “The strongest emotions in the marketplace are greed and fear. In rising markets, you can almost feel the greed tide begin…the greed itch begins when you see stocks move that you don’t own.”

6) “If you know that the stock doesn’t know you own it, you are ahead of the game. You are ahead because you can change your mind and your actions without regard to what you did or thought yesterday.”

7) “Who makes the really big money? The inside stockholders of a company do, when the market capitalizes the earnings of that company.”

8) “What you want is the company which is about to do that (compounding earnings) over the next couple of years. And to do that, you not only have to know that the company is doing something right, but what it is doing right, and why these earnings are compounding.”

9) “What I have told you is a set of biases so you can make your own judgement.”

10) “It is an informal thesis of charting that there are roughly four stages of stock movement. These four are: 1) Accumulation: To make a perfect case, let us say the stock has been asleep for a long time, inactively trade. Then the volume picks up and probably so does the price. 2) Mark-up…Now the supply may be a bit thinner, and the stock is more pursued by buyers, so it moves up more steeply. 3) Distribution. The Smart People who bought the stock early are busy selling it to the Dumb People who are buying it late, and the result is more or less a standoff, depending on whose enthusiasm is greater. 4) Panic Liquidation. Everybody gets the hell out, Smart People, Dumb People, “everybody.” Since there is “no one” left to buy, the stock goes down.”

11) “Does this mean that charts can be ignored? Perhaps charts can be a useful tool even without inherent predictive qualities. A chart can give you an instant portrait of the character of a stock, whether it follows a minuet, a waltz, a twist, or the latest rock gyration. The chart can also sometimes tell you whether the character of the dancer seems to have changed.”

12) “The computer is going to sanctify charting. The Chartists are on their way.”

13) “The characteristics of performance are concentration and turnover. By concentration, as I said before, I mean limiting the number of issues. Limiting the number of issues means that attention is focused sharply on them, and the ones that do not perform well virtually beg to be dropped off…Furthermore, you are going to be scouting for the best six ideas, because if you find a really good one it may bump one of your other ones off the list. Turnover means how long you hold the stocks…All that turover has doubled the volume in the last couple of years, and the brokers are getting very rich.”

14) “The further we come along, the more apparent becomes the wisdom of the Master in describing the market as a game of musical chairs. The most brilliant and perceptive analysis you can do may sit there until someone else believes it too, for the object of the game is not to own some stock, like a faithful dog, which you have chosen, but to get to the piece of paper ahead of the crowd. Value is not only inherent in the stock, it has to be value that is appreciated by others…It follows that some sort of sense timing is necessary, and you either develop it, or you don’t.”

15) “The aspiration of the people are a noble thing and no one is against jobs. But it does seem easy to produce them with currency rather than productivity. Central governments soon learn the utility of a deficit. It is convenient to take the views of the economists who followed Keynes and spend money during recessions. There are even problems on that side of the equation, because even with the breadth of statistical reporting and with computer, speed, this kind of economics is still inexact, and the central government can find itself pressing the wrong lever at the wrong time.”

16) “The love of money as a possession – as distinguished from love of money as a means to the enjoyments and realities of life – will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.”

Regards,

Omar Halabieh

The Money Game

The Money Game

On Market Wizards

I just finished reading Market Wizards – Interviews with Top Traders by Jack D. Schwager. As the title indicates this book consists of a series of interviews with some of the best most successful traders in the world.

Not only does this book cover a wide variety of trading techniques, it also covers a wide variety of markets as well (treasuries, futures, commodities etc.). The book also sheds light on the personal traits and characteristics of successful traders. By reading the different interviews one starts to see the commonalities but also the differentiators between them. It is very intriguing to read one very successful trader present opposite techniques than the next trader being interviewed.

A must read for any serious investor. This book is filled with wisdom from start to finish – for both novice and advanced traders. One will also find that much of this wisdom applies to any career.

Below are excerpts from this book that I found particularly insightful:

1- “You also have to follow your own light. Because I have so many friends who are talented traders, I often have to remind myself that if I try to trade their way, or on their ideas, I am going to lose. Every trader has strengths and weaknesses…As long as you stick to your own style, you get the good and bad in your own approach. When you try to incorporate someone else’s style, you often wind up with the worst of both styles. I’ve done that a lot.”

2- “Don’t ever feel that you are very good. The second you do, you are dead.”

3- “What are the traits of a successful trader? The most important is discipline – I am sure everyone tells you that. Second, you have to have patience; if you have a good trade on, you have to be able to stay with it. Third, you need courage to go into the market, and courage comes from adequate capitalization. Fourth, you must have a willingness to lose; that is also related to adequate capitalization. Fifth, you need a strong desire to win.”

4- “I have two basic rules about winning in trading as well as in life: (1) If you don’t bet, you can’t win. (2) If you lose all your chips, you can’t bet.”

5- “The stock market is neither efficient nor random. It is not efficient because there are too many poorly conceived opinions; it is not random because strong investor emotions can create trends.”

6- “I don’t see how you can invest in American steel without understanding what is going on in Malaysian palm oil. As I explained before, it is all part of a big, three-dimensional puzzle that is always changing.”

7- “Although the styles of the traders are very different, many common denominators were evident:

1- All those interviewed has a driving desire to become successful traders – in many cases, overcoming significant obstacles to reach their goals.

2- All reflected confidence that they could continue to win over the long run. Almost invariably, they considered their own trading as the best and safest investment for their money.

3- Each trader had found a methodology that worked for him and remained true to that approach. It is significant that discipline was the word most frequently mentioned.

4- The top traders take their trading very seriously; most devote a substantial amount of their waking hours to market analysis and trading strategy.

5- Rigid risk control is one of the key elements in the trading strategy of virtually all those interviewed.

6- In a variety of ways, many of the traders stressed the importance of having the patience to wait for the right trading opportunity to present itself.

7- The importance of acting independent of the crowd was a frequently emphasized point.

8- All top traders understand that losing is part of the game.

9- They all love what they are doing.”

Regards,

Omar Halabieh

Market Wizards

Market Wizards

On One Up On Wall Street

I just finished reading the book One Up On Wall Street by Peter Lynch and John Rothchild. This book is one where Peter, one of America’s number one money manager shares his investment wisdom learned while running Fidelity’s Magellan Fund. His advice for the most part call for a return to the basics, and aims at demystifying investing in stocks for the layman. He ensures to explain each concept in plain language, and avoids getting too technical or using a lot of jargon (unless explicitly explained). The book is divided into three sections: the first one entitled “Preparing to Invest” serves as a general introduction to the dynamics of the investment world. The second section focuses on “Picking Winners”. This section is all about identifying winning stocks and the required associated homework. Finally the last section is entitled “Long-Term View” and focuses on portfolio management.  This section is all about how to build a portfolio, when to buy, when to sell etc.

Some of the key learnings are that winner stocks are all around us, and sometimes as amateurs it is easier for us to locate them.  In addition, the basic classification  of companies and their respective stocks into 5 categories: Slow growers, stalwarts, cyclicals, fast growers, turnarounds. This classification helps us determine how we valuate these stocks. Finally once the valuation is made, the key is to ignore short-term fluctuation and stick with the stock as long as the fundamentals aka “the story” is intact. On the criticism side, the book was originally written in the late 80s so the x

A very educative read in the area of investment. For more details on Peter’s investing strategy, here is a great article: http://www.investopedia.com/articles/stocks/06/PeterLynch.asp . A further book recommendation in this area is Jason Kelly’s The Neatest Little Guide To Stock Market Investing.

Regards,

Omar Halabieh

One Up On Wall Street

One Up On Wall Street