Philosophy Differs From Strategy

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Rick Ferri
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Philosophy Differs From Strategy

Post by Rick Ferri »

Want to be a successful investor? Have a sound investment philosophy before trying to create an investment strategy. Your core beliefs about investing should drive strategy and also keep you disciplined in difficult markets. Without a sound philosophy, discipline erodes quickly and strategy goes down the drain shortly thereafter.

Philosophy Differs From Strategy

Rick Ferri
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Re: Philosophy Differs From Strategy

Post by Rodc »

A word of caution at this point: I find that newly enlightened self-managed investors can spend a considerable amount of time and energy trying to figure out a perfect portfolio by seeking a perfect asset allocation, perfect products, perfect tax-efficiency and a perfect maintenance methodology. Don’t bother.

There is no such thing as a perfect portfolio. We’ll only know what was perfect in retrospect. There is, however, a portfolio strategy that will meet your needs. It’s conceived from your financial situation, your understanding of risk, your time horizon and your desires.
That is a hard to come by but powerful lesson.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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"A perfect portfolio."

Post by Taylor Larimore »

Rick:

We see this nearly every day:
I find that newly enlightened self-managed investors can spend a considerable amount of time and energy trying to figure out a perfect portfolio by seeking a perfect asset allocation, perfect products, perfect tax-efficiency and a perfect maintenance methodology. Don’t bother. There is no such thing as a perfect portfolio. We’ll only know what was perfect in retrospect.
There is more than one road to Dublin.

Thank you and best wishes.
Taylor
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Re: Philosophy Differs From Strategy

Post by asif408 »

Good piece, Rick.

I have to admit when I first started out in index investing I started out with a more complex (7 fund) lazy portfolio, thinking at the time that more complex was better. The more I read the more I realized that I don't know how much all the additional slicing and dicing will get me.

I've since simplified my investments and settled with your "Core Four" portfolio. I find it to be simple and fundamentally sound.
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Re: Philosophy Differs From Strategy

Post by plymster »

I had a similar "aha" moment when I first read the wiki here. Index fund investing allowed me to think of each asset class as a different investment. Once I understood different investment asset classes and built a philosophy about them, investing in market indexes made a lot more sense to me.

For example, I can invest in a Total Stock Market index, but why should I invest in equities as an asset class versus something else (ie: commodities, or collectibles like art, stamps or beanie babies, or financial instruments like bonds)?

For me it came down to a generalized understanding of the underlying asset class:
  • Equities represent companies that add value through labor and ingenuity. The labor and ingenuity of people is ever-growing, and I would guess helps to explain why equities generally grow at ~10% anually.
  • Bonds represent a financial instrument used to borrow capital (again, to add value through labor and ingenuity). Bond investors have better recourse than equity purchases, since they're loaning the money, instead of purchasing a part of the company. This helps to explain why bonds expand at greater than inflation, historically speaking, but less than equities, and why they are less volatile.
  • Commodities and collectibles represent a purely speculative play. I can gamble that oil or gold will be more valuable in the future. I'm not saying they don't have a place in a portfolio (it's perfectly reasonable for an airline to buy fuel futures, or Starbucks to buy coffee futures to hedge commodity shocks), just that they don't have a place in an individual investor's portfolio. Viewed this way, it explains why commodities tend to track inflation.
  • Foreign investments are something I've struggled with. I can see the purpose of international diversity, though I think that any Total Stock Market investor is very well exposed to the the global economy already, and probably gets very little benefit by adding direct investments with the the vaguaries of currency arbitrage, geopolitical events, and the whims of various nations' laws and financial booms and busts. As long as I have faith that the US is where I plan to live, and it is not significantly overvalued over other nations (like Japan was during the 80s), I should not need the international hedge.
Basically, by developing a basic shorthand for each market and simplifying each asset class, it helps me to think of investing more generally and feel more confident in my investments. This helps me look at equities as the main driver of my portfolio, and using bonds as a stabilizer. I view international equities/bonds as a souped up engine (just as powerful, but a bit more costly in terms of attention with dubious additional payoff), and commodities/collectables as racing stripes, streamers, or baseball cards to put in my spokes.
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Index Fund Portfolios.

Post by Taylor Larimore »

Bogleheads:

This is one of my favorite quotes:
Do not mistake simple index fund portfolios as simplistic. They are actually quite sophisticated--standing on the shoulders of decades of peer reviewed market research, a few Nobel prizes, and cold hard undeniable evidence of success." --Boglehead Sunny Sakar
Best wishes.
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Re: Philosophy Differs From Strategy

Post by Roy »

Rodc wrote:
A word of caution at this point: I find that newly enlightened self-managed investors can spend a considerable amount of time and energy trying to figure out a perfect portfolio by seeking a perfect asset allocation, perfect products, perfect tax-efficiency and a perfect maintenance methodology. Don’t bother.

There is no such thing as a perfect portfolio. We’ll only know what was perfect in retrospect. There is, however, a portfolio strategy that will meet your needs. It’s conceived from your financial situation, your understanding of risk, your time horizon and your desires.
That is a hard to come by but powerful lesson.

Well said. And a good piece.
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Re: Philosophy Differs From Strategy

Post by bertilak »

Rodc wrote:
A word of caution at this point: I find that newly enlightened self-managed investors can spend a considerable amount of time and energy trying to figure out a perfect portfolio by seeking a perfect asset allocation, perfect products, perfect tax-efficiency and a perfect maintenance methodology. Don’t bother.

There is no such thing as a perfect portfolio. We’ll only know what was perfect in retrospect. There is, however, a portfolio strategy that will meet your needs. It’s conceived from your financial situation, your understanding of risk, your time horizon and your desires.
That is a hard to come by but powerful lesson.
The greatest enemy of a good plan is the dream of a perfect plan. -- Carl Von Clausewitz (1832?) -- via John C. Bogle (1999)
I see two symptoms of missing that wisdom, both involving the anxiety of being less than perfect:
  1. Analysis paralysis and its opposite, constant plan changes.
  2. Overly complex plans. Taylor's "Majesty of Simplicity" signature addresses the same thing.
At least those are tendencies I think I have learned to control. (I can't say outgrown! Once a plan-a-holic always a plan-a-holic!)
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Re: Philosophy Differs From Strategy

Post by nedsaid »

Rick, this was a very good article. I would add one thing to your article. An investor should consider their personality type and temperament first because that really shapes one's investing philosophy. What good is it to say "I am an aggressive investor" when your personality type doesn't allow for that investing style. That is you will panic in down markets. Basically this is an exercise of "knowing thyself" as an investor.

Investor personality and temperament-->Investment Philosophy-->Investment Strategy-->Investment Tactics. And of course, you put this on paper with your Investment Policy Statement.

How about that??
A fool and his money are good for business.
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Re: Philosophy Differs From Strategy

Post by Rick Ferri »

It's easy to be brave in a bull market.

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Re: Philosophy Differs From Strategy

Post by Peculiar_Investor »

Expanding on the quest for the perfect plan, a blast from the past The Dream of A Perfect Plan, Jack Bogle, THE INVESTMENT FORUM AND EXPO, MARCH 18, 2000. The punchline (and last line of the article),
Jack Bogle wrote:So never forget this maxim: “The greatest enemy of a good plan is the dream of a perfect plan.”
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Bull Market Bravery is followed by Bear Market Fear

Post by Taylor Larimore »

Rick Ferri wrote:It's easy to be brave in a bull market.

Rick Ferri
Rick:

Truer words were never spoken.

I have experienced 25 bear markets during my lifetime.

In one bear market my dad lost his restaurant business. My grandfather, a millionaire who was 100% invested in stocks, became bankrupt in an unexpected bear market. Bull market bravery quickly fades in bear markets when we don't know how much more money we will lose staying in stocks.

This is why Benjamin Graham warned investors: "Never hold less than 25% in bonds," and it is why Jack Bogle recommends "age in bonds" as a rough guideline. I have never recommended 100% stocks. Diversification is essential.

History Of U.S. Bear & Bull Markets Since 1929

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Philosophy Differs From Strategy

Post by abuss368 »

Rick Ferri wrote:It's easy to be brave in a bull market.

Rick Ferri
This is so true. The older I get, the more I realize we may not be as brave as we think when Mr. Bear shows his head!
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Bull Market Bravery is followed by Bear Market Fear

Post by abuss368 »

Taylor Larimore wrote:
Rick Ferri wrote:It's easy to be brave in a bull market.

Rick Ferri
Rick:

Truer words were never spoken.

I have experienced 25 bear markets during my lifetime.

In one bear market my dad lost his restaurant business. My grandfather, a millionaire who was 100% invested in stocks, became bankrupt in an unexpected bear market. Bull market bravery quickly fades in bear markets when we don't know how much more money we will lose staying in stocks.

This is why Benjamin Graham warned investors: "Never hold less than 25% in bonds," and it is why Jack Bogle recommends "age in bonds" as a rough guideline. I have never recommended 100% stocks. Diversification is essential.

History Of U.S. Bear & Bull Markets Since 1929

Best wishes.
Taylor
Hi Taylor,

Thank you for that excellent perspective. Your experiences are amazing and we can all learn from them.

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Philosophy Differs From Strategy

Post by abuss368 »

Hi Rick,

Thank you for that excellent article on your website.

One of my favorite parts: "Having the right portfolio leads to the final link in the chain. It’s called discipline. Strategy breaks down when there is no discipline. Discipline breaks down when a strategy doesn’t follow a philosophy."

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Philosophy Differs From Strategy

Post by noyopacific »

Rick Feri's article examines an important piece of the puzzle that I hadn't considered very much. In helping family & friends to understand and adopt the passive approach to investing, I think I neglected to explain the philosophical foundations very well. Rick explains this lesson in clear and engaging terms. In the future, I'll use Ricks article to make this point.

I've long admired Rick's ability to take his knowledge of the subject of investing and deliver it in a way that is digestible for normal people. (Those who do not find the subject of investing to be endlessly fascinating.)

Thanks Rick, you really hit this one out of the park !

Dave
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Re: Philosophy Differs From Strategy

Post by Rick Ferri »

I've long admired Rick's ability to take his knowledge of the subject of investing and deliver it in a way that is digestible for normal people.
:happy

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Re: Philosophy Differs From Strategy

Post by BroncoCountry »

Rick and Taylor-

I purchased and read both your books over the weekend (All About Asset Allocation and the new Bogleheads Guide to Investing.) Thank you for helping me see how my current "advisor" is taking 1% of my assets every year and then investing in actively managed funds with 1% expense ratios (when I went and looked at what she was doing, I really couldn't believe it). Fortunately I'm seeing this ruse in my 40's while there is time to make a change.

I am using these two books to learn about asset allocation. Since Taylor's book was published last week, I'm assuming he's sticking with the model portfolios listed. Since Rick's book was published in 2010, my question for Rick is this:

On page 255-6 of AAAA 2nd edition (tables 12-3 and 12-4), you give a "basic" allocation for the mid-life accumulator which looks like the "Core 4" I read about all over these forums, as well as a" mulit-assest" allocation with eleven funds. Do you still see a benefit to the brain damage of eleven funds versus four? I've read lots of what you have written here and on your blog over the interim years and can't tell if you have changed your position significantly on this topic. I'm young enough to take on the challenge of rebalancing a more complex portfolio if there is a reasonable chance of better returns or lower risk (or both).

This looked like the best thread in which to post this, but forgive me if it wasn't. I'm not asking for investment advice, just a clarification of your previous work.

Thanks again for all the helpful information.
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Model Portfolios in "Bogleheads Guides to Investing"

Post by Taylor Larimore »

Bronco Country:

Welcome to the Bogleheads Forum!
Since Taylor's book was published last week, I'm assuming he's sticking with the model portfolios listed.
You are correct. We discussed "tweeking" the suggested allocations in our first book, but we decided not to change what has worked well.

Best wishes.
Taylor
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Re: Philosophy Differs From Strategy

Post by Rick Ferri »

Do you still see a benefit to the brain damage of eleven funds versus four? I've read lots of what you have written here and on your blog over the interim years and can't tell if you have changed your position significantly on this topic.
3 is fine, 4 is fine, 10 is fine; 20 is too much.

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Re: Philosophy Differs From Strategy

Post by BroncoCountry »

Rick-

Thanks for the direct reply!

So do you still like the allocation from page 256 of AAAA?

You are a gentleman and a scholar for interacting with your fans this way. BTW I really enjoyed the Morningstar interview podcast.

Shawn
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Gentleman Rick Ferri

Post by Taylor Larimore »

You are a gentleman and a scholar for interacting with your fans this way. BTW I really enjoyed the Morningstar interview podcast.
BroncoCountry:

You are very perceptive. I'll tell you a story about Rick Ferri that I have never told on the forum before:

It was in 2002, before our third annual reunion which was held in Chicago at the same time as a Morningstar Investment Conference. Jack Bogle was the Keynote Speaker. Our famous Panel of Experts had been selected and there was no more room at their table with its microphones.

Two very qualified advisers subsequently offered to sit on the Panel. We explained that the Panel was full. One of the advisers became very angry when told we had no more room and we could not add him to the Panel. The other adviser, Rick Ferri, wrote that he was sorry that there was no more room but that he would help any way he could.

At the reunion I was surprised to see Rick sitting in the back of the room quietly paying attention to Boglehead questions, and answers from the Panel of Experts from which he had been excluded.

Rick has been a valuable contributor on our Panel of Experts, and on this forum, ever since. We are very grateful.

Best wishes.
Taylor
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Re: Philosophy Differs From Strategy

Post by Reb Tevye »

Hi.
I'm in the category of the "newly enlightened."

I'm on board with the message of the linked article.

But got hung up on the "don't bother" part.
To the extent that it means don't chase perfection for perfections sake, the advice makes perfect sense.
But to another extent, some people like me want to more fully learn how the whole machine works. The philosophy can't exist in a vacuum absent some understanding of real behavior and composition of the underlying assets.

I don't want to be kept from making some small mistakes. I want to understand both the choices I'm making, and roads I'm not taking.
I don't want to be steered away from sticking an emerging toe into murky International waters.
With dozens and dozens of completely valid investment choices and options the newly enlightened MUST do some exploring. I find that it's impractical to really understand important and useful nuances without "getting some skin in the game" as they say. Sure, I can read all day long about the differences between I-Bonds and individual TIPs and a synthetic TIP fund, but maybe it will take a $1000 TIP in my taxable account to cement my understanding of why I don't want it there. And those kinds of learnings play out across the continuum of investment options... What's in the fund? What's the correlation? Why does or doesn't it work for me.

The seasoned veterans here know what they know for a reason. Experience. And I want that too.

So rather than "Don't bother," what works for me is to learn by increment. And to play with Backtesting scenarios to see why the standard advice is what it is.

I'd encourage people to taste from across many dishes at the Chinese Investment Buffet of Risk. How spicey can you really handle? And while sometimes a soup tastes pretty good at first... then you read up on it and find out what's REALLY in it. Yuk. And with so much information to digest, it takes time to gather this experience.

As Albus Dumbledore once said, "Youth cannot know how age thinks and feels, but old men are guilty if they forget what it was to be young."

Anyway, thanks for putting all your wisdom and well-researched advice and conclusions out there. I find it very helpful as I work my way to down the buffet line, with most of my plate already filled with TSM, TISM and TBM.
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Re: Philosophy Differs From Strategy

Post by pkcrafter »

Rick, thanks for an excellent article, which has produced a very good discussion. Sounds simple to explain, but we need to appreciate the fact that one does not simply come up with great ideas out of thin air.
Attaching yourself to a sound philosophy requires deep thought. It usually starts with a disappointment, a detailed investigation in the root of the disappointment, the analysis of data, confirmation through the writings and experiences of others, and then an epiphany
.

Reb wrote: I'm in the category of the "newly enlightened."
I'm on board with the message of the linked article.

But got hung up on the "don't bother" part.
"A smart investor learns from his mistakes, a wise investor learns from the mistakes of others." unknown, but may have been Taylor Larimore.

There is no perfect portfolio, and you need to understand that before deciding on what your particular strategy is going to be. At any rate, what you are thinking about is strategy, not philosophy, and we all agree that is something you have to develop. Spend your time researching and learning, not playing with your portfolio. If you are interested in trying investing approaches other than indexing, you haven't yet adopted a philosophy. Philosophy first, strategy that reflects the philosophy second.

Paul
Last edited by pkcrafter on Tue Sep 02, 2014 1:14 pm, edited 1 time in total.
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Re: Philosophy Differs From Strategy

Post by FelixTheCat »

I’ve been writing and presenting on this philosophy for decades and continue to do so with a passion. However, my learning curve about teaching this approach to investing was slower than my knowledge of strategy. At first, I approached the concept from the product perspective – just buy index funds because they’re better for you. I’d then jump right into the mechanics of the strategy: fund recommendations, asset allocation, ways to implement, etc.

This nuts-and-bolts-centric advisement process worked fine as long as the markets cooperated. Problems occurred when the markets went down. I found that some clients jumped ship. This isn’t good for anyone.
Rick, did you figure why client's jumped ship?

In my case, I found out I was too sensitive for my asset allocation. I thought I could handle more risk but I can't. My AA was a lot more on the stock side during the 2008/09 crash. I sold out due to fear of losing more. I did get back in the market when I saw Buffett buying a lot. When I recovered my pre-crash amount, I dialed back my AA to a lot less stocks. I am very happy at 40/60 and figure I can ride out any storm.
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Re: Philosophy Differs From Strategy

Post by Reb Tevye »

pkcrafter wrote:"A smart investor learns from his mistakes, a wise investor learns from the mistakes of others." unknown, but may have been Taylor Larimore.

There is no perfect portfolio, and you need to understand that before deciding on what your particular strategy is going to be. At any rate, what you are thinking about is strategy, not philosophy, and we all agree that is something you have to develop. Spend your time researching and learning, not playing with your portfolio. If you are interested in trying investing approaches other than indexing, you haven't yet adopted a philosophy. Philosophy first, strategy that reflects the philosophy second.
Peace.

A sound strategy that you'll sustain rests on the solid foundation of your philosophy.
But what does your unwavering philosophy rest upon?

On the shoulders of giants. Of course.
Deep reflection in a comfortable arm chair. Sure.
As they say, "it is chiefly through books that we enjoy intercourse with superior minds." I guess some Wikis and some blogs fall in the same camp nowadays. (Though I think Harry Dent demonstrates that this maxim doesn't apply to ALL books)

All I'm saying is that I also believe that any philosophy about anything will be even more immutable if it's been tempered in the crucible of experience.

And for the newly-minted Boglehead still learning the canon, what's wrong with a little Rumspringa?

Now, back to my books. And Wikis. And spreadsheets.
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Re: Philosophy Differs From Strategy

Post by YDNAL »

Rick Ferri wrote:Want to be a successful investor? Have a sound investment philosophy before trying to create an investment strategy. Your core beliefs about investing should drive strategy and also keep you disciplined in difficult markets.....
A "sound investment philosophy" certainly is NO Science.

Investment philosophies can morph, and many different "strategies" can attempt to "capture the [commensurate] return of all stocks", some even with an attempt to lower volatility in our investments.
I'd buy an S&P 500 index fund in a pinch
The 500 constituents that make up the index represented about 80% of the US equity market by capitalization, according to S&P. In contrast, the total US stock market includes nearly 4,000 stocks, according to the Center for Research in Securities Prices, better known as CRSP. Since I’m trying to capture the return of all stocks, I prefer a total stock market index fund over one that tracks the S&P 500.
Last edited by YDNAL on Tue Sep 02, 2014 4:00 pm, edited 1 time in total.
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Re: Philosophy Differs From Strategy

Post by trueblueky »

plymster wrote:commodities tend to track inflation
I'm trying to imagine a world in which that isn't true. One in which, for instance, the price of oil triples without raising other prices through its effect on transportation and manufacturing costs.

I buy commodities for personal consumption (gas for the car, pork bellies for breakfast), not for investment. :)
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Re: Philosophy Differs From Strategy

Post by ftobin »

trueblueky wrote:
plymster wrote:commodities tend to track inflation
I'm trying to imagine a world in which that isn't true. One in which, for instance, the price of oil triples without raising other prices through its effect on transportation and manufacturing costs.
Probably depends on whether the commodity is consumable. For example, consider gold peaking in 1980 at $2508/oz (in 2012 dollars). Gold in 2000 was around$400/oz in 2012 dollars. Inflation was happening over that 20-year period, but gold fell 80%.
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Re: Philosophy Differs From Strategy

Post by postingname »

As a non-Boglehead investor, my ultimate style will be different, obviously, but I still use the same technique of identifying philosphy first (particularly keying on temperment), then defining the actual strategy.

First off, I was raised to believe:

1. Asset allocation is a scheme by the financial industry to extract money from clueless retail investors. :)
2. Don't be in the market at all times; i.e, do some trading
3. When you accumulate capital gains, take some profit and lock it away

The above beliefs were based on an aggressive approach to the market, tempered by safety. That suited my own termperment just fine.

After experimentation with that and reading more conventional opinion, my main investing tenets became:

1. I don't want to be in the market at all times, i.e., I still want to trade
2. Asset allocation is important, but can be overdone (time spent perfecting colorful pie charts can be put to better use)

Later tenets I added:

1. I feel more comfortable with an income component to my investing
2. I feel more comfortable with sentiment-based investing than with either momentum or value-based investing

All of the above eventually got folded into a broad trading strategy concentrated on income-producing securities with high total returns -- concentrating on CEFs, where sentiment trading can be used to maximum effect. I don't anticipate too much alternation of this strategy in the future since my temperment hasn't changed any. But eventual interest rate hikes, past a certain point, may affect my trading in leveraged fixed-income CEFs. Snce my core tenet is trading, I will simply adapt by looking at other types of investment vehicles. If there's one thing I feel confident about, it's the ability to make money in any kind of market. That's probably the main issue I have with Boglehead investing. You ride the markets up, but are required to give back considerably and not add to portfolio value during long periods of bear markets.

I hope my background helps explain some of the contrarian remarks I make on this board from time to time. :)
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Re: "A perfect portfolio."

Post by abuss368 »

Taylor Larimore wrote:Rick:

We see this nearly every day:
I find that newly enlightened self-managed investors can spend a considerable amount of time and energy trying to figure out a perfect portfolio by seeking a perfect asset allocation, perfect products, perfect tax-efficiency and a perfect maintenance methodology. Don’t bother. There is no such thing as a perfect portfolio. We’ll only know what was perfect in retrospect.
There is more than one road to Dublin.

Thank you and best wishes.
Taylor
Hi Taylor & Rick,

I could not agree more. The older I get, the more I have learned this!

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Philosophy Differs From Strategy

Post by abuss368 »

Rick Ferri wrote:
Do you still see a benefit to the brain damage of eleven funds versus four? I've read lots of what you have written here and on your blog over the interim years and can't tell if you have changed your position significantly on this topic.
3 is fine, 4 is fine, 10 is fine; 20 is too much.

Rick Ferri
Hi Rick,

I remember a Jack Bogle interview where he replied "You simply do not need 8 mutual funds".

Thank you Jack!

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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abuss368
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Re: Gentleman Rick Ferri

Post by abuss368 »

Taylor Larimore wrote:
You are a gentleman and a scholar for interacting with your fans this way. BTW I really enjoyed the Morningstar interview podcast.
BroncoCountry:

You are very perceptive. I'll tell you a story about Rick Ferri that I have never told on the forum before:

It was in 2002, before our third annual reunion which was held in Chicago at the same time as a Morningstar Investment Conference. Jack Bogle was the Keynote Speaker. Our famous Panel of Experts had been selected and there was no more room at their table with its microphones.

Two very qualified advisers subsequently offered to sit on the Panel. We explained that the Panel was full. One of the advisers became very angry when told we had no more room and we could not add him to the Panel. The other adviser, Rick Ferri, wrote that he was sorry that there was no more room but that he would help any way he could.

At the reunion I was surprised to see Rick sitting in the back of the room quietly paying attention to Boglehead questions, and answers from the Panel of Experts from which he had been excluded.

Rick has been a valuable contributor on our Panel of Experts, and on this forum, ever since. We are very grateful.

Best wishes.
Taylor
Hi Taylor,

That is a great story and I thank you for sharing. I have always enjoyed interacting with Rick!

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Philosophy Differs From Strategy

Post by RPS »

Excellent post, Rick, with applications far beyond investing.
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