Curated Content from 25 Years of Writing

Achieving Your Investment Goals

My first piece of investment research was published back in early 1988, when I was at Chase Manhattan, writing about the potential for investing in Latin American equity markets. Since then, I have continued to write regularly about two investment management areas, as a hobby not a career. Most of my writing has appeared in The Index Investor. The first focus of my research has been on asset allocation, asset class valuation, and portfolio risk management. My views have been based on the doubtful long-term efficacy of prediction in complex adaptive systems (such as financial market), as well as the simple mathematics of achieving long term investing goals (in which avoiding large losses is more important than achieving large gains). As such, I have advocated broad diversification across multiple (and broadly defined) asset classes, as well as the value of using a combination of macro/phase change and valuation analysis to avoid downside surprises.

Yes, I recognize this is a form of prediction. But experience has taught me that situations where large losses are likely are significantly easier to identify than those where large gains are possible, despite the fact that you'll rarely get the exact timing right. In the case of gains, that is yet another critical limitation when it comes to prediction; in the case of avoiding large losses, perfect timing is much less important. For more on these issues, see "
Anticipating Investor Behavior", and "Learning from the Past, Anticipating the Future, and Adapting in the Present", a year end review and outlook written at the end of 2009.

I authored a chapter on
asset allocation methodologies in Bloomsbury's QFinance Ultimate Resource Guide to quantitative finance, as well as two articles that provided timely warning before both the 2000 and 2008 financial market crashes. More recently, I've written about the Gordian Knot facing the world economy, and The Growing Political Legitimacy Crisis, and their implications for asset class returns. On this last issue, ten years ago I wrote a short history of the terms "liberal", "moderate", and "conservative", including how they have changed over time, and how they relate to more complicated political typologies that different authors have proposed. It still makes for an interesting read.

In my writing on investment management issues, I am constantly stimulated by a number of writers, including Philip Coggan, Jerker Denrell, Andrew Haldane, Mark Kritzman, Andrew Lo, James Montier, and Russ Wermers. While this site is primarily intended to curate my own content, I can't help but include a copy of Haldane's engrossing speech on "
Tails of the Unexpected." It is a great complement to another paper I wrote, "Before You Begin Your Intro to Economics Course", which provides a helpful guide for new students to the shortcomings in the way intro economics is too often taught today.

The second issue on which I've researched and written a lot over the years is the debate over whether one should implement an asset allocation strategy using actively or passively managed investment vehicles. In fact, almost ten years ago, I wrote a book on this, "The Trial of A Prudent Investor" (soon to be republished as an ebook), that I'd hoped would be accessible to a general audience that needed to hear its message, that the probability of achieving an investor's long term goals is almost always maximized by investing in a diversified portfolio of broadly defined asset class index funds. Since then, my views on this issue haven't changed.

To sum them up: (1) it is next to impossible to make consistent, accurate predictions about future returns in the complex adaptive system that is the world's economy and financial markets. (2) It is equally difficult for most investors to separate out the roles of skill and luck in the track record of any investment manager who claims to have this rare predictive skill. (3) While it is easy to identify Warren Buffett, in the absence of a long track record it is extremely difficult, if not impossible, to identify in advance his successor. (4) Regardless of whether it is based on skill or luck, a manager with a track record of consistently beating a benchmark return will attract a large inflow of funds, which will make the continuation of the winning streak exponentially more difficult. (5) Over time, the combination of trading costs, manager fees, and taxes will overwhelm the additional gross returns generated by a lucky or skilled active manager.

As noted above, I strongly believe that the strongest ground we have for making accurate predictions in financial markets is that, as Herbert Stein famously noted,
"If something cannot go on forever, it will stop." Put differently, extreme overvaluations will eventually return to normal, usually very quickly and at a very high cost to investors' long term goals. To the extent that anyone chooses to practice active management, their best advice is to focus on avoiding the downside losses that are associated with extreme asset class overvaluations. In investing as in management, we ignore risk management at our peril.