Should People Listen to Investment Advice Part III

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Should People Listen to Investment Advice Part III

The next aspect of using investment advice is understanding your own capabilities.  It comes down to what you understand, and what you have time for.

Some investment advice requires constant attention, even assuming that it is right.  Does your job afford you that flexibility?  If it doesn’t, you need to look to longer-term strategies.

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There was a period in my life when I did small company deal arbitrage.  More profitable, more volatility, more blowups.  It took a lot of time to do the daily research.  I really felt I was cheating my family in that era.  Value investing does not take nearly that amount of time.

Do you know enough about the investment advice that you can be an intelligent amateur critic?  You don’t have to be an expert but to follow the strategies of others, you have to be intelligent to the point where you can differentiate between strategies that work and those that don’t.

What, that’s a tall order?  Really, it depends on your time horizon.  Value investing will deliver over a decade-long horizon.  Momentum investing will deliver most of the time, so long as too many people aren’t following it.  Value has the advantage that adjustments are infrequent, that’s not true with momentum.

Beyond those two primal strategies, I’m not sure what else works, aside from indexing.  Indexing has its own issue: as long as money is flowing into indexing, indexing tends to outperform.  This is less obvious with stocks, but if you have ever been a bond manager, index bonds trade special (expensive).  They have lower yields because there is a class of investors that has to own them.  If the money flow ever reverses, indexing will not do well.

You are your own best defender.  No one can protect yourself more than you can.  That is why it pays to be skeptical of unusual claims of investing expertise.  If they were really that good, they would invest for themselves, and not solicit outside investors.

After all, in this modern era, if anyone has an infallible investment method and limited capital, they will do best by setting up a hedge fund.  Those who proclaim to you that they have methods that border on miraculous should be questioned closely, because in investing, there are no miracles — only cash flows, and the market’s anticipation of future cash flows.

Now, there are some things with investment advisors that can give you some comfort.  Smaller managers tend to do better, because they haven’t reached the boundary of how much money their ideas can accommodate.  Beyond that, in my opinion, managers that don’t beg for business do better as well, they aren’t spending time on the marketing; they are managing.  Also, managers with a clean revenue model “fee only” aid investors.  The costs are clear from day one, and there are no conflicts of interest.

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Taking it back a step, can you critique yourself?  Where have your biggest successes and losses come from?  It might be good to keep a journal, so you can see if your successes stemmed from things you foresaw, or were accidental, and if your losses stemmed from neglect of discipline in following your ideas, or whether the idea itself was wrong.

My personal conviction is that most investors lack patience.  That’s why we sell at the bottom, and buy at the top.  But to be a patient investor requires strong balance sheets, because bad things do occur, and we want to avoid a permanent impairment of capital.

Do you know your weaknesses?  It took me 10 years to wash fear out of my system.  Greed wasn’t a problem.

Understand yourself, and learn self-control.  Don’t compare a stock to where it was, compare it to where you estimate it should be, once you are realistic.

More in Part IV

By David Merkel, CFA of alephblog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.