"Investment Mistakes Even Smart Investors Make" --A Gem

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"Investment Mistakes Even Smart Investors Make" --A Gem

Postby Taylor Larimore » Sun Nov 27, 2011 4:11 pm

Hi Bogleheads:

In clear and concise language, Bogleheads Larry Swedroe and co-author RC Balaban have identified "seventy-seven common mistakes" investors make. I have made many of them myself. Hopefully this book will help you avoid these investing pitfalls the easy way (by reading the book). These are some of the book's valuable quotes that I call "Investment Gems":
This book is not just about helping you avoid the mistakes even smart investors make, but about how to win the game of life.

Our education system almost totally ignores the field of finance and investments.

Save as much as you can as early as you can.

Unless it is for entertainment value, turn off CNBC, cancel your subscriptions to financial trade publications, and don’t visit Internet chat boards that tout great funds, great stocks, or new and interesting investment strategies.

Unfortunately, much of what is conventional wisdom on investing is wrong.

A critical part of the financial planning process is to consider a “Plan B.” This consists of the actions that might have to be taken if financial assets fail to such a degree that the investor may run out of assets.

“If you want to see the greatest threat to your financial future, go home and take a look in the mirror.” (Jonathan Clements quote)

It appears that a common characteristic of human behavior is that, on average, men have confidence in skills they don’t have, while women simply know better.

Individuals who traded the most produced the lowest net returns. (Barber/Odean study).

Overconfidence causes investors to seek only evidence confirming their own views and ignore contradicting evidence.

The Mensa Investment Club returned just 2.5% over the previous 15 years, underperforming the S&P 500 Index by almost 13% per year.

Recognizing our limited ability to predict the future is an important ingredient of the winning investment strategy.

It seems to be a simple human failing to fall prey to ‘recency’—the tendency to give too much weight to recent experience and ignore long-term historical evidence.

Morningstar tracked the performance of the least popular fund categories from 1987 through 2000. The three least popular categories of funds have beaten the average fund 70% of the time, and more amazingly, they have beaten the most popular funds 90% of the time.

Morningstar studied he performance of mutual funds and their investors and found that the returns earned by investors were below the returns of the funds themselves in all 17 fund categories they examined (primarily due to market-timing).

“Whenever some analyst seems to know what he’s talking about, remember that pigs will fly before he’ll ever release a full list of his past forecasts, including the bloopers.” (Jason Zweig quote)

There is a tremendous body of evidence that the vast majority of actively managed funds underperform their benchmarks, and the longer the time-frame the greater the likelihood of underperformance.

If you are going to use past performance to predict the future winners, the evidence is strong that your approach is likely to fail.

“It’s the big lie that, repeated often enough, is eventually accepted as truth: You can beat the market, Trounce the averages, Outpace the index. Beat the street. An entire industry strokes this fantasy.” (Jonathan Clements quote).

The average actively managed fund underperforms its benchmark by well over 1% per year on a pre-tax basis, and by far more on an after-tax basis.

Having the discipline to avoid the temptation of following the crowd and the noise of the moment is an important part of the winning investment strategy.

Today, there are about as many mutual funds as there are stocks. With so many active managers trying to win, statistics alone dictate that some will succeed.

There is no evidence of any persistence in fund performance beyond the randomly expected.

An investment policy statement (IPS) will help keep you from taking “scenic tours” of interesting investments best avoided.

It is style drift that causes investors to lose control over their asset allocation, and thus the risk and reward of their portfolio.

Risk can be defined as the probability of not achieving your financial objective.

Harry Markowitz demonstrated that one could add risky, but low correlating, assets to a portfolio and increase returns without increasing risk.

Studies have found the pain of a loss is at least twice as great as the joy we feel from an equivalent size gain.

What you paid for a security should have no bearing (except for tax consideration) on whether you should continue to hold it.

In times of global crisis, all risky assets tend to correlate highly. The only effective diversifier of equity risk is high quality fixed income investments.

The need to take risk is defined by the rate of return needed to meet the minimum financial goals set by the investor.

Diversification is the closest thing there is to a free lunch.

Wall Street’s product machines crank out securities that entice investors with extravagant yields, but come accompanied by great risks.

What you can be sure of is that if an investment carries a high yield there is risk, even when you cannot see it.

When the capital gains tax rates were lowered to 15% in 2003, the sales of variable annuities should have come to a screeching halt.

An astounding 15 to 20 percent of the premium paid by investors in EIAs (Equity Index Annuities) is a transfer of wealth from unsophisticated investors to insurance companies and their sales forces.

IPOs (Initial Public Offerings) have provided huge profits for the Wall Street firms that market them; they have generated very poor returns for investors.

Adding a small amount of equities to an all-bond portfolio raises returns while actually reducing volatility.

As a general rule investors with a 30-year or longer investment horizon should not withdraw more than 4% of the starting value of a portfolio.

It is hard to understand why anyone would give their hard earned assets to someone who invests those assets in a way that is not completely transparent.

The combination of the lack of predictability of returns, the low correlation, and their inflation hedge makes a strong case for including REITs as an asset class in an investment portfolio.

“A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting.” (Warren Buffett quote)

Optimists tend to be more accurate than pessimists. Keep this in mind the next time you read a doomsday forecast.

There are three types of investment forecasters: Those who don’t know where the market is going, those who know they don’t know, and those who know they don’t know but get paid a lot of money to pretend they do.

The 44 Wall Street Fund ranked as the top performing diversified U.S. stock fund in the 1970s. It ranked as the single worst performing fund in the 1980s, losing 73 percent.

Believing that the past performance of active managers is a good predictor of their future performance can be expensive.

International diversification provides us with insurance in case the U.S. capital markets and the dollar perform poorly.

It is difficult to fire an advisor who is also a friend, and even more difficult to fire one that is a relative.

While it is important to treat family wealth as a private matter, it should not be private within the family.

The broker-dealer community knows that individual investors lack sufficient knowledge about the bond market, which make exploiting them as easy as “taking candy from a baby.”

In a 2010 study, Morningstar found that expense ratios were a better predictor than its star ratings.

The average actively managed fund now has turnover about 100%, and the cost of all that turnover—commissions, bid-offer spreads and market impact costs can easily exceed 1 percent.

It is often a long way from the theoretical results of a strategy to the actual results that can be obtained.

When forecast investment returns, many individual make the mistake of simply extrapolating recent returns into the future.

The simplest way to implement the buy low/sell high strategy is to build a portfolio that is highly diversified by asset class, and then regularly rebalance.

The average Investment Club lagged a broad market index by 3.8% per year. (Odean/Barber study)

Goldman Sachs studied mutual fund cash holding from 1970 to 1989. The study found that mutual fund managers miscalled all nine major turning points.

Standard & Poor’s found that the majority of funds in 8 out of 9 domestic equity style boxes were outperformed by indexes in the negative markets of 2008. Results were similar during the bear market of 2000-02.

Jeffrey and Arnott showed the impact of taxes on returns in their study of 71 actively managed funds for the 10-year period 1982-1991. The found that while 15 of the 71 funds beat a passively managed fund on a pretax basis, only five did so on an after-tax basis.

Taxes are probably the largest expense investors incur, even greater than management fees or commissions.

Several academic studies have come to the conclusion that asset allocation determines the vast majority of not only the returns but also the risks of a portfolio.

Investors should logically avoid investing in hedge funds.

Vanguard is a highly respected firm and its funds are known for their low costs.

Good advice doesn’t have to be expensive. However, bad or untrustworthy advice almost always will cost you dearly.

(Nobel Laureate) Wm. Sharpe demonstrated that active management is a loser’s game whatever the asset class, whether markets are efficient or inefficient. The reason is simple: Costs matter.

Small companies are riskier than large companies. Therefore the market prices small-cap stocks to provide higher returns than large-cap stocks.

If you don’t have a plan, immediately sit down and develop one – and then be sure to stay the course, altering your plan only if your assumptions about your ability, willingness or need to take risk have changed.

Never have more than a very small percentage of your assets in the stock of any one company, especially your employer.

When the cost of a negative outcome is greater than one can bear, the risk should not be taken, no matter how great appear to be the odds of a favorable outcome.

“I’m a big believer in diversification, because I am totally convinced that forecasts will be wrong.” (Paul Samuelson quote)

Chasing the latest fad or hot asset class has proven to be a losing strategy and the result of confusing strategy and outcome.

In 1989, the Nikkei index hit a peak of almost 40,000. Twenty-two years later, it was still down about 75%.
“History teaches us that things that never happened before do happen.” (Nassim Taleb quote)

If your investment horizon is very short, then the way to control risk is to increase your allocation to short-term fixed-income assets.

If you start with an investment of $100 and it rises 90% in the first year, and it falls 45% in the second, your annualized return is only about 2% per year.

Locate your most tax-efficient asset classes in your taxable accounts, and your least tax-efficient asset classes in your tax-deferred accounts.

It is important for you to avoid making purchases of a taxable mutual fund just prior to the ex-dividend date. You will be taxed on income you didn’t really earn.

You should generally avoid intentionally taking any short-term gains. Simply wait until the long-term holding period is achieved.

Tax-managing a portfolio is a very important part of the winning strategy.

Good risk is the type you are compensated for taking. Bad risk is the type for which there is no such compensation. Thus, it is called uncompensated or unsystematic risk.

In finance, a “black swan” refers to a large-impact, hard-to—predict, rare event beyond the realm of normal expectations.

“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.” (Peter Lynch quote)

Mark Hulbert, publisher of Hulbert’s Financial Digest, studied the performance of 32 of the portfolios of market timing newsletters for the 10 years ending in 1997. Here’s what he found: None of the market timers beat the market.

“This time it’s different.” Those are the four most dangerous words in the English language for investors.

The best solution to the unpredictability of the market is to build a globally diversified portfolio of index-passive asset class funds that reflects your unique ability, willingness and need to take risk.

Thank you Larry Swedroe and RC Balaban

More Investment Gems

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby cinghiale » Sun Nov 27, 2011 4:26 pm

Wow! Taylor, instantly out of the starting gate with "gems" from Larry Swedroe's new book on common investment mistakes. A thread entitled "Larry Swedroe's new book" just got up and going a scant few hours ago.

As always, thanks for the sample of the cooking.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Sun Nov 27, 2011 4:34 pm

Glad you enjoyed the book Taylor.

For those interested the book is an updated and greatly expanded version of Rational Investing in Irrational Times. That book covered 52 mistakes even smart people make. This one covers 77. You can search inside the book here.
http://www.amazon.com/Investment-Mistakes-Smart-Investors-Avoid/dp/0071786821

Best wishes
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby GregLee » Sun Nov 27, 2011 4:38 pm

Taylor Larimore wrote:
Today, there are about as many mutual funds as there are stocks. With so many active managers trying to win, statistics alone dictate that some will succeed.

I don't understand how "statistics alone" can do that. Maybe "chance alone" is intended.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Sun Nov 27, 2011 4:44 pm

Greg
Statistics show that chance is very likely to explain the persistence that does exist, in other words it is not greater than randomly expected.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Padlin » Sun Nov 27, 2011 4:47 pm

Does the forum still get a stipend for sales made from Amazon via http://www.amazon.com/s/?search-alias=aps&tag=bogleheads.org-20&field-keywords=Bogleheads the Boglehead link? If so it's a good time of the year to keep it in mind when ordering Larry's book or anything else.
Regards
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby LadyGeek » Sun Nov 27, 2011 4:48 pm

It's now in the wiki: Taylor Larimore's Investment Gems and Larry Swedroe

Padlin wrote:Does the forum still get a stipend for sales made from Amazon via http://www.amazon.com/s/?search-alias=aps&tag=bogleheads.org-20&field-keywords=Bogleheads the Boglehead link? If so it's a good time of the year to keep it in mind when ordering Larry's book or anything else.

Yes. Either go through the link on the home page or click on any book reference in the wiki.

(Updated post to include Larry Swedoe's wiki page.)
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Luck or talent? -- The coin-toss analogy

Postby Taylor Larimore » Sun Nov 27, 2011 4:55 pm

GregLee wrote:
Taylor Larimore wrote:
Today, there are about as many mutual funds as there are stocks. With so many active managers trying to win, statistics alone dictate that some will succeed.

I don't understand how "statistics alone" can do that. Maybe "chance alone" is intended.


Hi Greg:
It is impossible to give a good explanation of what is behind short quotes. This is a portion of Larry's explanation in the book's Chapter 7 titled: "Do You Confuse Skill and Luck":

Imagine the following scenario: 10,000 individuals (or 10,000 mutual fund managers) are gathered together to participate in a contest. A coin will be tossed and they must guess whether it will come up heads or tails. Anyone who correctly guesses the outcome of ten consecutive tosses will be declared a winner and will receive the coveted title of "coin-tossing guru."

Statistically we can expect that after the first toss, 5,000 participants will have guessed right and 5,000 guessed wrong. After the second round, the remaining participants will be expected to be 2,500; and so on. After ten repetitions we would expect to have 10 remaining participants who would have guessed correctly all 10 times and earned their guru status.

What probability would you attach to the likelihood that those 10 gurus would win the next coin-toss competition? Would you bet on them winning? The answers are obvious. What does this have to do with investing?

Best wishes.
Taylor
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby bob90245 » Sun Nov 27, 2011 5:51 pm

This would be mistake number 78:

Larry Swedroe wrote:Adding a small amount of equities to an all-bond portfolio raises returns while actually reducing volatility.

Yeah, maybe over the very long run. But not over the intermediate term like 10 years. There were several 'lost decades' (shown in red bars) where adding any amount of equities to an all-bond portfolio would have reduced returns.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Beagler » Sun Nov 27, 2011 5:53 pm

Thank you so much for taking the time to post these gems, Taylor. I know it takes a lot of effort on your part. It is much appreciated.
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby jimkinny » Sun Nov 27, 2011 6:01 pm

Beagler wrote:Thank you so much for taking the time to post these gems, Taylor. I know it takes a lot of effort on your part. It is much appreciated.


yes, thanks

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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Taylor Larimore » Sun Nov 27, 2011 6:02 pm

Beagler wrote:Thank you so much for taking the time to post these gems, Taylor. I know it takes a lot of effort on your part. It is much appreciated.


Thank you, Beagler.

Mr. Bogle's crusade to give ordinary investors "a fair shake" and our Boglehead forum participants are worth it!

Best wishes.
Taylor
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Sun Nov 27, 2011 6:29 pm

Bob
Just for fun I went and looked at data for one of the periods you cite, 65-74 and added 10% S&P to an all LT Treasury portfolio and guess what I found, while S&P underperformed 1.25 vs. 2.19
All Treasury: 2.19 return and 8.38 SD but add 10% S&P returned 2.2 and SD of 8.1, so higher return and lower SD.

I ran it for another period, 30-39 and S&P lost about 1% with SD of about 38, while LT Treasury was 4.9/5.4, yet adding bit of terribly underperforming S&P gave you bit higher return at 5% though bit higher SD.
Those were with monthly rebalancing.

So just because you have negative ERP doesn't mean that adding bit of equities reduces portfolio returns, correlations and volatility also matter.
Now of course there is no guarantee that you will get the higher return and lower SD or even the higher return, but the evidence suggests that it is likely, and thus one can be too conservative, especially if one has the ability and willingness to take the risks, and perhaps the need1

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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby bob90245 » Sun Nov 27, 2011 6:40 pm

larryswedroe wrote:Now of course there is no guarantee that you will get the higher return and lower SD or even the higher return, but the evidence suggests that it is likely, and thus one can be too conservative, especially if one has the ability and willingness to take the risks, and perhaps the need

The above would be a more nuanced statement I can live with. And it is supported by my chart. Meaning, as you say, the evidence suggests that there is an increased probability that adding a small amount equities would increase returns. But no guarantees that this will occur every time (assuming 10-years periods).
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby GregLee » Sun Nov 27, 2011 6:55 pm

larryswedroe wrote:Now of course there is no guarantee that you will get the higher return and lower SD or even the higher return, but the evidence suggests that it is likely, ...

"Likely" meaning the probability is greater than 50%? What evidence suggests that?
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby bob90245 » Sun Nov 27, 2011 7:25 pm

OK, when we define "a small amount of equities" to be 10%, I was able to modify my chart. Stocks are S&P 500 and bonds are 5-year Treasuries. The 10% stock / 90% bond portfolio is rebalanced annually. Red bars show when adding 10% stocks failed to increase returns.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Sun Nov 27, 2011 7:25 pm

Greg
The data shows that very clearly. Even the chart that Bob showed made that clear and he was wrong in his assumption that just because the ERP is negative over a ten-year period that the result will be the adding small amount of equities to a portfolio will make it less efficient
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Sun Nov 27, 2011 7:27 pm

Yes bob, and if you use even shorter periods you will obviously find more such periods, and the longer you go the fewer you will find
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Fundhunter » Mon Nov 28, 2011 12:50 am

Taylor, how long did it take to copy all those quotes?? Preaching to the choir here!

Do I need to buy the book now?

I particularly like the one about how worthless CNBC is!!
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby GregLee » Mon Nov 28, 2011 1:16 am

larryswedroe wrote:Greg
The data shows that very clearly.

I just re-read your post several times, and I see that you examined two periods (and presumably other periods that aren't mentioned here). But I don't see how any conclusion about probability can emerge from this sort of evidence. Two periods conform to your generalization out of a universe of, what, three periods? Two in three would be more than 50%. Am I taking you too literally?
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Invest-her » Mon Nov 28, 2011 12:27 pm

Investment portfolio diversification is the most fundamental rule of investing. Overconcentration of any one product in your portfolio is risky. You shouldn't invest a major portion of your investment portfolio into a single investment or sector of the market or asset class.http://www.investorprotection.com
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Fallible » Mon Nov 28, 2011 12:49 pm

Thanks Larry for another good book I'll plan on reading; and thanks Taylor for the "gems."

One gem gave me pause for thought: "Risk can be defined as the probability of not achieving your financial objective." "Probability" seems a bit strong. There's always a possibility of failing to achieve that objective, but probability seems to say it will likely happen, whereas possibility means it may happen. It's a subtle difference, but IMHO a significant one.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby GregLee » Mon Nov 28, 2011 1:32 pm

Fallible wrote:One gem gave me pause for thought: "Risk can be defined as the probability of not achieving your financial objective." "Probability" seems a bit strong. There's always a possibility of failing to achieve that objective, but probability seems to say it will likely happen, whereas possibility means it may happen.

You're commenting on an oddity of language. Sometimes an adjective means having what is referred to by the corresponding noun to a high degree. An article is "pricey" not just when it has a price, but only when it has a high price. To say that an event has some probability of occurring is not to say that it is "probable", because that means that it has a high probability of occurring.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby yobria » Mon Nov 28, 2011 1:41 pm

bob90245 wrote:This would be mistake number 78:

Larry Swedroe wrote:Adding a small amount of equities to an all-bond portfolio raises returns while actually reducing volatility.

Yeah, maybe over the very long run. But not over the intermediate term like 10 years. There were several 'lost decades' (shown in red bars) where adding any amount of equities to an all-bond portfolio would have reduced returns.


Yes, since stocks and bonds are uncorrelated, there must be a linear relationship btw % equities and risk ex ante. No expected free lunch with a small stock allocation, I'm afraid, whatever you might find in the historical data.

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Adding stocks to reduce bond volatility ?

Postby Taylor Larimore » Mon Nov 28, 2011 2:42 pm

Bogleheads:

There is ample evidence that adding a small amount of stocks to a 100% bond portfolio can (not always) reduce volatility and increase returns (especially with periodic rebalancing). We can see this in the chart in the link below:

http://www.mymoneyblog.com/updated-529- ... py-cd.html

Best wishes.
Taylor
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby FabLab » Mon Nov 28, 2011 3:07 pm

Taylor Larimore wrote:Hi Bogleheads:

In clear and concise language, Bogleheads Larry Swedroe and co-author RC Balaban have identified "seventy-seven common mistakes" investors make. I have made many of them myself. Hopefully this book will help you avoid these investing pitfalls the easy way (by reading the book). These are some of the book's valuable quotes that I call "Investment Gems":

"It is important for you to avoid making purchases of a taxable mutual fund just prior to the ex-dividend date. You will be taxed on income you didn’t really earn.“

Best wishes
Taylor


Confession time: I get this (and really always have), but in my own little corner of the world where I'm trying to save/invest every cent possible, to me regularized (weekly) investments trump this dictum. Now, if I were about to make a large, one-off investment right before the ex-dividend date, I would apply it. But, I've found it easiest to consistently, week in/week out, apply the regimen I do and ignore such ex-dividend dates. Then the tax issue doesn't get in the way of my desire to not skip a beat regarding the application of a doable investing schedule. To each his own.
The fundamental things apply as time goes by -- Herman Hupfeld
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Fallible » Mon Nov 28, 2011 3:35 pm

GregLee wrote:
Fallible wrote:One gem gave me pause for thought: "Risk can be defined as the probability of not achieving your financial objective." "Probability" seems a bit strong. There's always a possibility of failing to achieve that objective, but probability seems to say it will likely happen, whereas possibility means it may happen.

You're commenting on an oddity of language. Sometimes an adjective means having what is referred to by the corresponding noun to a high degree. An article is "pricey" not just when it has a price, but only when it has a high price. To say that an event has some probability of occurring is not to say that it is "probable", because that means that it has a high probability of occurring.


I see what you're saying, but here's what I'm saying and why I think it's significant in this case. Probability means likely to happen; possibility means it may happen. If I were told that an investment I was going to make to achieve my financial goals would probably fail, I wouldn’t make it. If I were told it could possibly fail, I would probably (or be more likely to) make it since just about any investment has a possibility of failure. (I also would then ask how possible is possible :) and so on.) Sometimes you do see probable and possible used interchangeably, as if they had basically the same meaning. But when it comes to judging financial risks, the difference is important.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Mon Nov 28, 2011 3:35 pm

Greg
The chart Bob showed clearly shows that in the vast majority of ten year periods (and it should even be longer of course if you are under 80) the low equity allocation improves returns. I just chose 2 of the bad periods and it turns out it was not as bad as depicted. Finally I would add that if you diversify by asset class instead of using just the S&P 500 you would get even better results in most years. That also allows you to own bit less equity too,'
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Re: Adding stocks to reduce bond volatility ?

Postby yobria » Mon Nov 28, 2011 3:41 pm

Taylor Larimore wrote:Bogleheads:

There is ample evidence that adding a small amount of stocks to a 100% bond portfolio can (not always) reduce volatility and increase returns (especially with periodic rebalancing).


Taylor,

Again, the ONLY way this could be true is if you expect stocks and bonds to be negatively correlated going forward - stocks reliably zig when bonds zag.

If stocks and bonds are uncorrelated, risk and return must be linear. Holding more stocks = more expected risk, and return. "A little bit of stocks" can't reduce risk - it can only increase it (ex ante).

Nick
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby yobria » Mon Nov 28, 2011 3:49 pm

larryswedroe wrote:Greg
The chart Bob showed clearly shows that in the vast majority of ten year periods (and it should even be longer of course if you are under 80) the low equity allocation improves returns. I just chose 2 of the bad periods and it turns out it was not as bad as depicted. Finally I would add that if you diversify by asset class instead of using just the S&P 500 you would get even better results in most years. That also allows you to own bit less equity too,'
Best
Larry


Larry,

Do you expect stocks and bonds to be reliably negatively correlated going forward? Or uncorrelated. What's your expectation?

Nick
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Bungo » Mon Nov 28, 2011 4:01 pm

Many if not most of these gems were also quoted in Mr. Swedroe's earlier book, The Only Guide to a Winning Investment Strategy You'll Ever Need: The Way Smart Money Invests Today. I wonder how much overlap there is between these two books: is the new one simply an updated version of the old one, or does it have enough new material to justify reading if one has already read the previous book?
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Taylor Larimore » Mon Nov 28, 2011 4:05 pm

Fundhunter wrote:Taylor, how long did it take to copy all those quotes?? Preaching to the choir here!

Do I need to buy the book now?

I particularly like the one about how worthless CNBC is!!


Hi Fundhunter:

I will try to answer your two questions:

Taylor, how long did it take to copy all those quotes??


For over 20 years I have made a hobby of reading financial books, articles and academic studies. About 10 years ago I began weeding out, what I considered, the best investment books for inclusion in my "gem collection." I'll guess it takes me 2 or 3 days to carefully read the book and mark the quotes that I think are the most valuable to help us become better investors. It then takes me about 4 hours copying the quotes into Word before again copying them into a window for a new Forum Topic.

It ain't easy, but I think it is worth it to help investors enjoy a quick way to get the best ideas from the best authors. It is how I learned to invest.

Do I need to buy the book now?


The quotes are only a small (but important) sample of what is in the "gem" books.

A primary purpose of the gems is to allow the reader to decide if they want to read more--especially the reasoning behind many of the gem quotes. I strongly believe every investor needs to read, and keep for reference, at least one good book about mutual fund investing. Indexing and stay-the-course is so counter-intuitive that we are unlikely to be convinced of its benefits without reading a good book on the subject. Many of the gem books are available public libraries.

Best wishes.
Taylor
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby GregLee » Mon Nov 28, 2011 4:35 pm

larryswedroe wrote:Greg
The chart Bob showed clearly shows that in the vast majority of ten year periods (and it should even be longer of course if you are under 80) the low equity allocation improves returns.

Larry,
Yes, I accept that Bob's chart gives evidence that adding 10% equities will probably improve returns. But, after all, it's no great surprise that equities give better returns than bonds. You seemed, above, to be saying something more interesting -- that it is probable you will get the higher return and lower SD.
Yours,
Greg, retired 8/10.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby bob90245 » Mon Nov 28, 2011 4:45 pm

GregLee wrote:Yes, I accept that Bob's chart gives evidence that adding 10% equities will probably improve returns. But, after all, it's no great surprise that equities give better returns than bonds. You seemed, above, to be saying something more interesting -- that it is probable you will get the higher return and lower SD.

I haven't checked, but it might be more probable as the time frame measured is lengthened. I have this chart to show as an example. (Source: http://www.bobsfinancialwebsite.com/dow ... l#Frontier)
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Mon Nov 28, 2011 4:47 pm

Nick your statement is simply wrong. Just look at the data. You don't need negative correlation or even non correlation for that to hold true. In fact, demonstrating that is what made Harry Markowitz famous and earned him a Nobel Prize
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Mon Nov 28, 2011 4:50 pm

Bungo
There is of course some overlap, but not much. This book to a great degree is about behavioral finance, which is not discussed at all in that first book. And then there are many topics not discussed there about building portfolios and developing plans as well. Check out the TOC on amazon.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Bungo » Mon Nov 28, 2011 5:29 pm

larryswedroe wrote:Bungo
There is of course some overlap, but not much. This book to a great degree is about behavioral finance, which is not discussed at all in that first book. And then there are many topics not discussed there about building portfolios and developing plans as well. Check out the TOC on amazon.
Best wishes
Larry

Thanks - I scrolled through the TOC and checked out a few random pages. It looks good, and I like that it's arranged into 77 bite-sized sections. I just bought the Kindle version. BTW, Amazon says the physical book will take 3-5 weeks to ship, so I guess that means it's not in their warehouses yet.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Mon Nov 28, 2011 6:10 pm

Bungo
I was surprised to learn that they moved the date up. My last information was suppsed to be Dec 13. I just got the copies to ship to those who were kind enough to write blurbs endorsing the book. So I know it is done.
Best wishes
Larry
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby dbr » Mon Nov 28, 2011 6:53 pm

Fallible wrote:I see what you're saying, but here's what I'm saying and why I think it's significant in this case. Probability means likely to happen; possibility means it may happen. If I were told that an investment I was going to make to achieve my financial goals would probably fail, I wouldn’t make it. If I were told it could possibly fail, I would probably (or be more likely to) make it since just about any investment has a possibility of failure. (I also would then ask how possible is possible :) and so on.) Sometimes you do see probable and possible used interchangeably, as if they had basically the same meaning. But when it comes to judging financial risks, the difference is important.


The issue is one of context and linguistic style; many variations are possible. Just about anywhere probable means highly likely and possible means more unlikely than likely but not impossible. However, in many contexts the word probability, distinct from probable, is a synonym for likelihood or chance. More than that, probability is usually used in a fairly precise mathematical sense of being a fraction where the possible range is zero, meaning impossible, to one, meaning certain. Possibility, as expected, means something the probability of which is rather closer to zero than to one, but not too close to zero. It is true that one can find expressions where probability might be used to describe a high likelihood of something, but, as suggested, the context and style of language would be different from that just described. Certainly when discussing investment outcomes it would be conventional for probability to be more often used in the mathematical sense than in a colloquial sense.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Fallible » Mon Nov 28, 2011 9:15 pm

dbr wrote:
Fallible wrote:I see what you're saying, but here's what I'm saying and why I think it's significant in this case. Probability means likely to happen; possibility means it may happen. If I were told that an investment I was going to make to achieve my financial goals would probably fail, I wouldn’t make it. If I were told it could possibly fail, I would probably (or be more likely to) make it since just about any investment has a possibility of failure. (I also would then ask how possible is possible :) and so on.) Sometimes you do see probable and possible used interchangeably, as if they had basically the same meaning. But when it comes to judging financial risks, the difference is important.


The issue is one of context and linguistic style; many variations are possible. Just about anywhere probable means highly likely and possible means more unlikely than likely but not impossible. However, in many contexts the word probability, distinct from probable, is a synonym for likelihood or chance. More than that, probability is usually used in a fairly precise mathematical sense of being a fraction where the possible range is zero, meaning impossible, to one, meaning certain. Possibility, as expected, means something the probability of which is rather closer to zero than to one, but not too close to zero. It is true that one can find expressions where probability might be used to describe a high likelihood of something, but, as suggested, the context and style of language would be different from that just described. Certainly when discussing investment outcomes it would be conventional for probability to be more often used in the mathematical sense than in a colloquial sense.


I would certainly agree with this use (investment outcomes) of probability in the mathematical sense and thanks for expanding my horizons. :)
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby Beagler » Mon Nov 28, 2011 11:03 pm

Taylor Larimore wrote: I'll guess it takes me 2 or 3 days to carefully read the book and mark the quotes that I think are the most valuable to help us become better investors. It then takes me about 4 hours copying the quotes into Word....

Best wishes.
Taylor


Thank you for your extraordinary efforts, Taylor!
Last edited by Beagler on Mon Nov 28, 2011 11:05 pm, edited 1 time in total.
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby hollowcave2 » Tue Nov 29, 2011 2:05 pm

What a great list. I inherently know that these gems are true, but I still fall into some of the traps. I have gotten better over the years, however.

There's only one quote in which I disagree:

What you paid for a security should have no bearing (except for tax consideration) on whether you should continue to hold it.


I contend that even tax considerations should be secondary to whether the security should be held or not. Would you hold on to a stock you know has deteriorating fundamentals and no longer fits your IPS just to avoid taxes this year? Do you want to turn a gain into a loss? That would save taxes too.

If a security really needs to be sold, sell it and worry about the taxes later.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Tue Nov 29, 2011 2:13 pm

hollowcave
I agree completely that taxes should be secondary consideration, but they should be considered. For example, just to take an extreme example, let's say you held a stock for 364 days and had a big gain, would it not be wise to hold for another day or two to get LT gain treatment? There are considerations like that including when rebalancing that should be taken into account.

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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby hollowcave2 » Tue Nov 29, 2011 2:59 pm

Ok Larry, I can see your point. Thanks for your example above. Also thanks for your contributions to this board.

Steve
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Overlooking taxes can be costly

Postby Taylor Larimore » Tue Nov 29, 2011 3:18 pm

hollowcave2 wrote:Ok Larry, I can see your point. Thanks for your example above. Also thanks for your contributions to this board.

Steve


Hi Steve:

Many elderly investors hold securities with large capital gains that must be paid if sold before death. By waiting until death for these securities to be sold, all capital gain taxes are eliminated -- leaving substantially more for heirs.

Selling to get a tax-loss benefit is dictated almost entirely by tax considerations.

Taxes are usually a bigger cost than mutual fund expense ratios.

We must never forget it is after-tax returns that count.

We cannot forecast returns, but minimizing taxes is something we can do.

Best wishes
Taylor
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby 1210sda » Tue Nov 29, 2011 3:43 pm

Thank you Taylor, et al

1210
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby jginseattle » Thu Dec 15, 2011 10:06 pm

I have the first edition. I was just browsing through the new version the other day and the following really struck me. (And this may seem very obvious to some of you)...

Diversification is even more important in the short-term. The reason is that somebody with a short-term time horizon, and who is not well-diversified, is more vulnerable to underperformance. Investors in this situation should reduce overall exposure to stocks, rather than make a concentrated bet on big, safe growth stocks, for example

This is why I'm trying to get my eighty-four year-old mom to add Total International to her portfolio.
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby AgnosticInvestor » Fri Dec 23, 2011 9:54 pm

"What you paid for a security should have no bearing (except for tax consideration) on whether you should continue to hold it."

This is one (important) concept that so many of my friends/family members just don't (and never will) get!
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby fundtalker123 » Fri Dec 23, 2011 10:58 pm

larryswedroe wrote:Nick your statement is simply wrong. Just look at the data. You don't need negative correlation or even non correlation for that to hold true. In fact, demonstrating that is what made Harry Markowitz famous and earned him a Nobel Prize
Best
Larry


I guess you just need correlation <1
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Re: "Investment Mistakes Even Smart Investors Make" --A Gem

Postby larryswedroe » Sat Dec 24, 2011 9:56 am

Fundtalker
That is right and that is what won Harry Markowitz the Nobel Prize
I have seen cases for example where including an asset that had negative returns over a period improved the efficiency. Reason was volatility was high enough and correlation negative enough that the rebalancing bonus (diversification return) was very large
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