- Dollar-cost averaging: at the end of the investment period, the average cost will be below the average price paid for the investment.
- John D. Rockefeller: to grow wealthy you must have your money work for you—i.e. be a lender not a borrower.
- John Templeton: if 10 doctors agree you should take a medicine, you should; if 10 analysts agree you should buy a stock or asset, you should not (do the opposite because peak price will have been reached).
- Wealth growth can be illusory if the effects of taxation and inflation are not factored in. Treasury bills may lose money over time—they often produce a negative after-tax, inflation-adjusted return.
- Why do investors believe in market timing and superior managers? Because its appeal is seductive. Random series of numbers do not always look
- Trinity research against market timing: 1) since WWII, there are 1.7x as many up months as down months; 2) average bull market is up 105% vs. bear market loss -28%; 3) bull markets last 3x as long; 4) even within bear markets, 30% of months are positive; in bull markets, only 8 out of average 41-month bull duration accounted for over 60% of total return.
- William Sharpe: market-timing manager needs to be right roughly 3 times out of 4, merely to match those who don’t market-time, due to cash drag and transaction costs. Truly prophetic managers expected to add 4% alpha per year. Upside is small, downside is huge. Terrible odds to overcome as an active manager, which decrease geometrically with the length of time frame and frequency of timing interval. Best strategy is to adhere to buy and hold.
- Chua and Woodward: more important to forecast bull markets than bear markets because a disproportionate percentage of gains occur very rapidly. For market-timing to pay, manager must forecast 80% bull markets, 50% bear; 70% bull, 80% bear; 60% bull, 90% bear.
- Investors prefer predictability over unpredictability, coupled with the declining marginal utility of wealth, creates a risk premium on volatile securities. Money is made not despite volatility but because of volatility.
- Large caps outperform general bonds 57% of 1-year periods, 74% of 5-year periods, 77% of 10-year periods, 94% of 20-year periods, 100% of 25-year periods.
- Investors tend to be loss-averse than risk-averse; tend to think in terms of nominal returns than real returns.
- Historical equity risk premium (over T-bill yield): 6.5%.
- Real estate investments that require appraisal valuation probably understates pricing volatility and therefore overstates its diversification potential. REIT’s, similar to closed-end funds of real estate properties, are better proxy for real estate asset class.
- Broadly diversified portfolios tend to give marginally better returns but with considerable risk reduction. Best to evaluate performance over longer time periods since no guarantee that diversified portfolios will outperform in any short-term period.
- Simple average return is best estimate of single-period expected return, and standard deviation statistic is measured relative to simple average return, not compound return. Compound return is less than or equal to simple average because it takes a larger above-average return to offset a given below-average return.
- Optimization programs are too sensitive to inputs and small changes. Gibson does not use for creating asset allocation policies. However, significant shifts around the optimal allocation mix may produce surprisingly little change in the portfolio expected return/ volatility characteristics.
- Asset class input variables are hard to specify with a high degree of confidence and therefore should keep in perspective broad, rather than specific, allocation amounts.
- Advisers should design asset allocation policy near the upper-end of a client’s volatility-tolerance range. Maximize expected return subject to the client’s need to sleep well at night.
- Money management is simple but not easy. The principles of successful investing are relatively few in number and are easy to understand.
- The two most important risks are inflation and volatility of returns. To the extent that a portfolio is structured to avoid one, it’s exposed to the other. Time horizon best determines which risk is more important.
- Client involvement and understanding of the investment process is important because it leads to equanimity and staying power—both which are essential to the realization of investment objectives. Casino example—there is always someone winning and these people will stand out from the crowd. Don’t let short-term fads distract from long-term strategy.
Finished: Aug-2006