What does it mean to be an Investor?
Posted by Frugal on November 24th, 2006
An investor takes positions, while for a trader tries to take advantage of short/intermediate term swings. Most people don’t have an investor mentality, and they don’t understand what it means to invest, nor what it means to have an asset allocation. For them, money means cash. If a trade turns out to be profitable, and he ends up with more cash, then it’s good. Cash is the sole meaning of money to them.
What I would like to impart on you is to have a different view on money (check out my definition of money). Yes, at the end of days when your entire portfolio is marked to market, that is its true value on that day when settled in cash. However, wealth does NOT equal to cash, which is merely a medium for exchange of goods & services.
Why do I suggest managing your portfolio by taking a view from asset allocation? Asset allocation means taking a carefully sized position in different classes of assets. POSITION means that you stand there, and don’t move. Certainly, you should choose your positions carefully and make sure it is a good one. By partitioning your net worth into different asset classes, you make sure you own different things and businesses in this material world. You own THINGS, instead of some intangible electronic record in your bank account. And you do not panic in the event when the value of your possession drops. Yes, the valuation has changed. But what you own has not changed. You own the same thing whether they are priced at $100 each, or $10 each one minute later.
Alternatively (instead of top-down approach of asset allocation), some investors use bottom-up approach by stock-picking the best stocks that they can find. Again, the keyword here is taking a long-term position. Certainly you should re-evaluate your positions when things change. However, due to efficient market hypothesis, it is quite a low probability event that you can out-perform the general market in the very long term by stock-picking. I would recommend NOT to put too much weight into this strategy (even though I do it personally quite often, 
. Most people are too confident to admit that they cannot do stock-picking. I myself is still in the discovery process. Maybe after another 20 years of investing, I will come back and tell you that efficient market hypothesis is bull-shit. But according to my today’s best understanding of investing, don’t try to pick stocks, nor time the market. (Hey, if I smoke pot, don’t smoke pot like me, ).
In summary, when you invest, make sure you understand the meaning of taking a position. And don’t just arbitrarily take a position. Carefully evaluate the position before you put your hard-earned cash into it.
More related posts:
Digg it Del.icio.us Reddit Furl BlinkList Newsvine Yahoo MyWeb
November 25th, 2006 at 7:29 am
Great post - I am not a big fan of the Efficient Market Hypothesis myself, but I realize that the basic idea is that you cannot outperform the market WITHOUT ASSUMING MORE RISK. *Theoretically* selecting fewer stocks is riskier, since you have more eggs in one basket. If that basket turns out to be leaky and the eggs fall through the bottom, you will lose far more than if you spread out your eggs into all baskets. The only problem with the spreading out theory (diversification) is that in return for having some money in baskets that will hold their eggs, you also guarantee that you have money in baskets that will not hold their eggs. As a result, you guarantee yourself down years, and those down years can kill you.
The reality is that you can beat the market (with lower risk, or at least less volatility in returns) in order to do so you need to focus your portfolio on the few best baskets. The challenge is finding them and not overpaying to put your eggs there. But this is the essence of investing - making sure that you don’t rise and fall with the tide, but that you make money no matter what happens.
November 25th, 2006 at 1:15 pm
This post reminds me of an experience I had this summer at a Fidelity Investments panel. It was held at a swanky North Michigan Avenue hotel here in Chicago. I went for the free dinner rather than the investment advice. Others were there for advice from Harvard and Yale MBA’s who got their degrees decades ago and were still riding the fumes of those brand names.
The panel consisted of four portfolio managers that were flown in from around the country. The meeting happened a few weeks after Asian stock markets took a tumble, with for example the Indian stock market dropping by 10 percent in a single day. Shares in the fund of one of the panelists who ran an emerging markets fund were down significantly.
Besides the great free food and wine, one encounter stands out in my mind of this evening. An older investor aggressively questioned the manager of the emerging markets fund, complaining loudly about its steep decline. He brushed aside the advice of his Fidelity representative to “be patient” and wanted to stem any further declines. First, he clearly failed to understand the asset class in which he was investing. Emerging markets have greater volatility than stocks on the NYSE for example. The volatility is demonstrated by occasional steep declines in these markets each year for the past decade or so. The markets often recover but there is tremendous uncertainty in the meantime. A five-year chart of this fund would have shown this. The other silliness that I saw first hand is that most investors, like this man, cannot resist the temptation to do nothing and buy and sell more than they should. The encouragement given to have patience falls on deaf ears with folks buying high and selling low. Today, about six months after this gathering, some Asian markets are at or near record highs and emerging markets funds are up smartly.
Finally, the panic in his voice suggested that he really had not thought through how and why his assets were allocated the way they were, the risk exposure of this allocation, and how this allocation would assist in achieving a particular investing goal. For someone as he was with substantial assets invested, it is far too easy not to take responsibility over one’s investments and then wonder what happened. Most mutual fund investors, I have come to realize, don’t even know what their fund invests in and decide if they would actually buy these stocks themselves. To make it to a million, I recognized a couple of years ago that it would be necessary to fully understand what I was investing in and why and what asset classes on which I wanted to focus my attention. If one is concerned about risk, don’t allocate so much money toward that position.
November 26th, 2006 at 9:44 pm
Great advice, I always do well with long term investing. I try and diversify as much as possible, this has made me great profits in the stock market. I look at investing as a long term project and don’t get to worried about daily activities. I go with strong companies or very safe picks in many different fields. This lowers my stress and keeps me focused on my long term goals.
November 27th, 2006 at 8:55 am
One of the big advantages that individuals have over institutions is the ability to hold a position for a long time. Institutions have to meet quarterly numbers, individuals can take years to ride out rough spots if they own good quality companies. Great advice for a lot of people to consider. When it comes to investing, it’s not a race, it’s a marathon.
December 4th, 2006 at 12:19 am
Doug,
Investing is a hard business. Efficient Market Hypothesis is fairly close to reality as far as I can tell.
December 4th, 2006 at 12:21 am
Kelly,
Thanks to your inputs. Yes, greater returns are always associated with greater risks. And the best way to limit the risk is to put less money into it. Too much greed usually doesn’t end up too good.
December 4th, 2006 at 12:22 am
Nationwidebillrelief.com,
Going with big cap, well-known companies is a safer way to play the market certainly. But remember that small cap out-performs large cap in the long term.
December 4th, 2006 at 12:24 am
Davis Freeberg,
Yes, investing is sort of a marathon definitely. But it’s a marathon that requires you to check your running direction on a regular basis.