Most commonly misused/misunderstood investing terms and concepts (on BH forum)

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HEDGEFUNDIE
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by HEDGEFUNDIE » Wed Aug 29, 2018 3:22 am

Dude2 wrote:
Wed Aug 29, 2018 3:04 am
Risk equals volatility

The entire financial industry, academics, BH forum members, and financial advisers all want to dumb down the concept of risk. Apparently it is accepted that risk equals volatility, and you should just know what everybody means when they use the term. On the other hand, every prospectus drones on and on about all the possible risks (risk factors) that a particular fund might be exposed to. Where is the transfer function that takes all of these sub-elements, turns the crank, and arrives at risk equals volatility? If, for some of these sub-elements, the risks showed up, and for others it did not, volatility maybe cancelled out. However, the risks still exist. Lack of volatility does not imply lack of risk. Great degrees of volatility may be associated with particular risk factors and not others. You may have to ride a bucking bronco to get exposure to a risk factor, but all there is to conclude about risk cannot be dumbed down to a single quantity.
Is there a better quantitative measure for risk? Not being facetious, genuinely curious.

Dude2
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Dude2 » Wed Aug 29, 2018 3:32 am

HEDGEFUNDIE wrote:
Wed Aug 29, 2018 3:22 am
Is there a better quantitative measure for risk? Not being facetious, genuinely curious.
I think I have to fall back on a misused term and say that nobody knows nothing. In this context I would say that we have to define what we mean, and not everybody is going to be on the same page. Volatility is a measure of something, but is it really a measure of risk? What risk? Risk of losing money? Are all volatile funds the ones that have the potential for greater reward, i.e. riskier? Perhaps there is no better measure, but it doesn't mean that the measure we are accepting is telling us anything at all.

Let's all search under the light to find our lost quarter. :wink:

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by phantom0308 » Wed Aug 29, 2018 3:44 am

In this thread, list the most common disagreements you have on this forum.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by spectec » Wed Aug 29, 2018 4:15 am

"Principal" vs "principle".

One of my principles is to always use "principal" correctly.
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. - Will Rogers

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Barry Barnitz » Wed Aug 29, 2018 4:24 am

Confusing liquidity and marketability .

regards,
Last edited by Barry Barnitz on Wed Aug 29, 2018 10:53 am, edited 1 time in total.
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by columbia » Wed Aug 29, 2018 4:58 am

I would add one about predicting the future:

With no crystal ball, the rational stance IMO is 50/50 stocks/bonds. Since most accumulators have a much higher stake in stocks, they are - in my estimation - making a bet on knowing the future of those two asset classes.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by dogagility » Wed Aug 29, 2018 5:48 am

Dude2 wrote:
Wed Aug 29, 2018 3:04 am
Risk equals volatility

The entire financial industry, academics, BH forum members, and financial advisers all want to dumb down the concept of risk. Apparently it is accepted that risk equals volatility, and you should just know what everybody means when they use the term. On the other hand, every prospectus drones on and on about all the possible risks (risk factors) that a particular fund might be exposed to. Where is the transfer function that takes all of these sub-elements, turns the crank, and arrives at risk equals volatility? If, for some of these sub-elements, the risks showed up, and for others it did not, volatility maybe cancelled out. However, the risks still exist. Lack of volatility does not imply lack of risk. Great degrees of volatility may be associated with particular risk factors and not others. You may have to ride a bucking bronco to get exposure.

All there is to conclude about risk cannot be dumbed down to a single quantity that is assumed to be used universally. If volatility was a predictor, then somebody should be able to effectively predict something with it.
+infinity! Risk does not equal volatility.
Risk is ill-defined on many BH threads. Operationally, risk is a function of the hazard and exposure to that hazard. Threads referencing risk don't often define the hazard well, so people end up with differing opinions about the "risk" involved.
The hazard can be many things, e.g. losing money this year, next year, within 5 years, over the course of your retirement, etc. Defining the hazard well brings up a productive conversation about one's exposure to that hazard. Typically, the exposure revolves around asset allocation, the poster's expected investment behavior under different market conditions, and the amount of time between the present and withdrawal of the asset.
Taking "risk" since 1995.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by dcabler » Wed Aug 29, 2018 6:38 am

Three-fund portfolio (or whatever) is good enough for you, where "you" is whoever is posting. Pretty sure that whatever is good enough for me is totally up to me.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by kaneohe » Wed Aug 29, 2018 6:51 am

probably not the most common overall........but seems like it recently.................
after-tax TIRA contribution when it is/was to be deducted at tax time...........
there is a bit of sophistication in it, I suppose, since TIRA contributions are supposed to be based on compensation and the compensation in the bank is after-tax but it is confusing .

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by carolinaman » Wed Aug 29, 2018 7:01 am

Investing the Boglehead way is simple. I totally agree that it is simple but the authors promoting this investing style, including John Bogle, write scores of books about this style of investing, and each book is several hundred pages. If it is so simple, why do we need all of those books?

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by AlohaJoe » Wed Aug 29, 2018 7:29 am

HEDGEFUNDIE wrote:
Wed Aug 29, 2018 3:22 am
Is there a better quantitative measure for risk? Not being facetious, genuinely curious.
"Better" is in the eye of the beholder. But here are some alternative quantitative measures for risk that don't care about volatility:
  • the Ulcer Index (measures the depth & length of drawdowns): http://www.tangotools.com/ui/ui.htm
  • Roy's "Safety First" utility (is the return greater than a pre-determined level or not)
  • Manski-Rostek quantile utility (what's the worst outcome for a given probability)
  • Kahneman-Tversky Prospect theory (use decision weights instead of probability theory)
  • Gul's "disappointment aversion" (which is somewhat different from Kahneman & Tversky's "loss aversion"), extended by Routledge & Zin (2010)
  • Habit utility (Sundaresan (1989), Constaminides (1990), Campbell & Cochrane (1999))
  • Keeping-up-with-the-Jones' utility (Abel (1990), Gali (1994), Heffetz & Frank (2011), Goetzmann & Oster (2012))
  • Uncertainty aversion (Guidolin & Rinaldi (2010))

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by bgf » Wed Aug 29, 2018 7:46 am

the two that drive me crazy have already been mentioned - diversification and volatility.

1) "diversification is great! (but only until the point that I have subjectively determined it is no longer great and then it immediately reverses and starts to suck)"

2) as other posters have already explained, volatility is NOT risk. it was a convenient expediency for those who desired to make financial markets pliable to mathematical and statistical analysis.

the problem is that often discussions veer off into the mathematical weeds of variance, correlation, optimization, sharpe ratios, etc etc. pages upon pages of threads are wasted pouring over historical data and analyses... and no one ever gives EQUAL consideration to the fact that equity distributions present a substantial difficulty to that kind of analysis.

then there are maybe one or two platitudes about the deficiencies of all "models" and everyone just digs right back in.

financial markets are intractable.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by deltaneutral83 » Wed Aug 29, 2018 7:48 am

dcabler wrote:
Wed Aug 29, 2018 6:38 am
Three-fund portfolio (or whatever) is good enough for you, where "you" is whoever is posting. Pretty sure that whatever is good enough for me is totally up to me.
What is good for an individual and what is "up to" an individual are two totally different things. That brings me to the next misunderstanding. BH usually don't adapt well to the concept that finance is more emotional than mathematical with regards to blanket advice (such as the 3F). Bogle and all the founders of this site give investing advice to the masses that will suit the largest population. If you take 10,000 DIY'ers at age 22 and have them in the 3F and take 10,000 more and they tilt to their heart's content, which side comes out better?

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by bgf » Wed Aug 29, 2018 7:56 am

deltaneutral83 wrote:
Wed Aug 29, 2018 7:48 am
dcabler wrote:
Wed Aug 29, 2018 6:38 am
Three-fund portfolio (or whatever) is good enough for you, where "you" is whoever is posting. Pretty sure that whatever is good enough for me is totally up to me.
What is good for an individual and what is "up to" an individual are two totally different things. That brings me to the next misunderstanding. BH usually don't adapt well to the concept that finance is more emotional than mathematical with regards to blanket advice (such as the 3F). Bogle and all the founders of this site give investing advice to the masses that will suit the largest population. If you take 10,000 DIY'ers at age 22 and have them in the 3F and take 10,000 more and they tilt to their heart's content, which side comes out better?
this is a great point. there are a few fundamental principles - lower cost is better than higher cost. diversification is preferred to concentration.

once you start moving away from the fundamental principles, the behavioral aspect takes over. fortunately, some of the principles have a beneficial impact on the behavioral aspect, but not enough.

for example, i invest internationally. but if someone posted "i know for a fact that if there were a global financial collapse, i would be unable to stay the course if i owned international equities/bonds. i just don't trust them. i'd panic sell them at the worst time. it might be right or it might be wrong, but, regardless, that's how it is."

i would say right there is a wise person. a person who understands his/her own limits and practices accordingly. that, in my opinion, is a better reason for someone to not invest in international markets than any of the plethora of reasons purportedly based on "the data" in that other monster thread we having going.

it is also the best reason to invest in bonds. we all have a breaking point, emotionally.

i guess, another way to put this is that at a certain point theory and practice collide. when they do, practice needs to win over.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Patrick584 » Wed Aug 29, 2018 8:15 am

mhalley wrote:
Tue Aug 28, 2018 6:34 pm
Another one might be “horrible” 401k plans. People often write about their horrible 401k plan expenses, but then it turns out to be 0.5 or so. It ain’t no admiral share er, but it ain’t horrible either.
Interesting post. I happened to post a couple of days ago saying that a 0.46 ER on an S and P 500 index fund was the best of a set of bad funds. It seems like your post could be referring to my post, and I think your post is incorrect. First, bad is different than horrible. Horrible implies that I might as well not invest. Bad implies that this is an investment choice that is costly relative to offerings at other employers. A principle of BH investing is avoiding high fees. 0.46 is definitely higher than the 0.04 offered by Vanguard. If you think this is a trivial difference, you are wrong. Contributing the max with a match over 10+ years is equivalent to ~$1000 per year salary reduction. I would not call this trivial.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by bottlecap » Wed Aug 29, 2018 8:41 am

The forum rules about not posting about the stupidity - real or perceived - of others.

JT

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by acegolfer » Wed Aug 29, 2018 9:00 am

bgf wrote:
Wed Aug 29, 2018 7:46 am
2) as other posters have already explained, volatility is NOT risk.
My professor taught that standard deviation is "a" way to "measure" the risk of an investment. Is he wrong?
Last edited by acegolfer on Wed Aug 29, 2018 10:35 am, edited 1 time in total.

HEDGEFUNDIE
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by HEDGEFUNDIE » Wed Aug 29, 2018 9:05 am

acegolfer wrote:
Wed Aug 29, 2018 9:00 am
bgf wrote:
Wed Aug 29, 2018 7:46 am
2) as other posters have already explained, volatility is NOT risk.
My professor taught that standard deviation is "a" way to "measure" the risk of an investment. Did I waste my money?
I always thought downside volatility made more intuitive sense as a general measure of risk everyone can get behind. Not general volatility.

Would anyone call a stock that only went up in random spurts risky?

Curious why Sortino ratio isn’t used more often in the academic literature.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Shallowpockets » Wed Aug 29, 2018 9:07 am

"50% drop" in the markets.
A what if that is a very big outlier to actually happen.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by aristotelian » Wed Aug 29, 2018 9:18 am

Diversification versus factor/sector concentration.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by obafgkm » Wed Aug 29, 2018 9:21 am

"I invested my IRA contribution on January 1."

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Jiu Jitsu Fighter » Wed Aug 29, 2018 9:26 am

Total Stock Market Fund "contains all of the factors".

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by deltaneutral83 » Wed Aug 29, 2018 9:28 am

Patrick584 wrote:
Wed Aug 29, 2018 8:15 am
mhalley wrote:
Tue Aug 28, 2018 6:34 pm
Another one might be “horrible” 401k plans. People often write about their horrible 401k plan expenses, but then it turns out to be 0.5 or so. It ain’t no admiral share er, but it ain’t horrible either.
Interesting post. I happened to post a couple of days ago saying that a 0.46 ER on an S and P 500 index fund was the best of a set of bad funds. It seems like your post could be referring to my post, and I think your post is incorrect. First, bad is different than horrible. Horrible implies that I might as well not invest. Bad implies that this is an investment choice that is costly relative to offerings at other employers. A principle of BH investing is avoiding high fees. 0.46 is definitely higher than the 0.04 offered by Vanguard. If you think this is a trivial difference, you are wrong. Contributing the max with a match over 10+ years is equivalent to ~$1000 per year salary reduction. I would not call this trivial.
mhalley is saying 0.46% is ok relative to other 401ks. At no point did anyone use the word trivial to describe a 0.46% expense ratio. To equate a 0.46% ER in a 401k to a salary reduction over a 0.04% ER assumes that the majority of 401k plans offer 0.04 ER's, which is not the case. There are plenty of 401k plans I've looked at are well over 1.00% ER's for basic S&P indexes. It's more simply a matter of knowing what all is out there in the 401k space.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Texanbybirth » Wed Aug 29, 2018 9:30 am

Tycoon wrote:
Tue Aug 28, 2018 5:54 pm
Middle class, low income, and average.
HA, perfect.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Jiu Jitsu Fighter » Wed Aug 29, 2018 9:35 am

Buy the whole haystack except for any companies domiciled outside of the U.S.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by pqwerty » Wed Aug 29, 2018 9:38 am

I'm debt free except for my mortgage...

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Johnnie » Wed Aug 29, 2018 9:51 am

nps wrote:
Tue Aug 28, 2018 6:18 pm
Fallible wrote:
Tue Aug 28, 2018 6:12 pm
Two often seen on the forum even though they are written up nicely in the wiki, BH books, and blogs:

-Market timing: the predictive component is sometimes misunderstood.

-Rebalancing: the purpose, which is to maintain a preset allocation, is sometimes misunderstood.
And related, the notion of "dry powder" and an assumed rebalancing bonus.
Minor threadjack, but an assertion or insinuation has been made that I think is incomplete:

The "rebalancing bonus" related to equity/fixed income asset allocations has been pretty thoroughly rebutted here (by Nisiprius and others). But I don't think that applies to rebalancing between different equity classes in a slice-'n-dice portfolio. In that in case you really are "selling high and buying low," especially since stocks tend to go up more often than they go down.

IOW, the assertion that rebalancing between equity classes really does generate a bonus has not been falsified here. See viewtopic.php?f=10&t=250313&p=3945152#p3945152
"I know nothing."

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Nate79 » Wed Aug 29, 2018 9:56 am

Lower cost is better than higher cost. Nope. Only when comparing two products of the same composition.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by GoldStar » Wed Aug 29, 2018 10:00 am

I am relatively new but here are the ones I recall seeing (oftentimes corrected):

1) Bogleheads = Vanguard-Only
(first threads I read seemed to imply this; Other threads I've seen folks jumping in and making it clear you can easily invest similar to Bogle while being a customer of Fidelity or Schwab).

2) Net worth is the metric that matters the most when retirement planning

3) Tax advantages of 529 Plans not being worthwhile

4) LTCG rules for ESPP programs

5) If the US Stock market is soaring, mistakenly updating the "Freefall" thread instead of the "Soaring" thread :)

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by mptfan » Wed Aug 29, 2018 10:02 am

One of my biggest pet peeves is people who advocate for owning the entire market as the best way to be fully diversified, unless of course it is the bond market, in which case they advocate for owning only one part of the bond market, treasuries, and ignoring all other bonds. I really don't get that one.

Oh, and another thing...the same people talk about how risky "junk" (high yield corporate) bonds are without realizing that they are way safer than any of the stock funds that they own. I just don't understand that level of cognitive dissonance. Somehow the higher level of risk with stocks is magically different than the lower level of risk with high yield bond funds, and that magical difference makes the lower risk of high yield bonds unacceptable?
Last edited by mptfan on Wed Aug 29, 2018 10:14 am, edited 3 times in total.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Nate79 » Wed Aug 29, 2018 10:04 am

mptfan wrote:
Wed Aug 29, 2018 10:02 am
One of my biggest pet peeves is people who advocate for owning the entire market as the best way to be fully diversified, unless of course it is the bond market, in which case they advocate for owning only one part of the bond market, treasuries, and ignoring all other bonds. I really don't get that one.
To build off this one the common one I see is that people do not understand why they hold bonds in the first place.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by H-Town » Wed Aug 29, 2018 10:09 am

pqwerty wrote:
Wed Aug 29, 2018 9:38 am
I'm debt free except for my mortgage...
For real! If you owe someone some money, in any shape or form, you're in debt. And you're working 15-30 years to pay off such debt. :shock:

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by mptfan » Wed Aug 29, 2018 10:10 am

carolinaman wrote:
Wed Aug 29, 2018 7:01 am
Investing the Boglehead way is simple. I totally agree that it is simple but the authors promoting this investing style, including John Bogle, write scores of books about this style of investing, and each book is several hundred pages. If it is so simple, why do we need all of those books?
For the same reason that we have lots of diet books...just because something is simple does not mean it is easy. Losing weight is simple, you consume less calories than you burn through exercise. Simple. But not easy.
Last edited by mptfan on Wed Aug 29, 2018 10:13 am, edited 1 time in total.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by dcabler » Wed Aug 29, 2018 10:11 am

deltaneutral83 wrote:
Wed Aug 29, 2018 7:48 am
dcabler wrote:
Wed Aug 29, 2018 6:38 am
Three-fund portfolio (or whatever) is good enough for you, where "you" is whoever is posting. Pretty sure that whatever is good enough for me is totally up to me.
What is good for an individual and what is "up to" an individual are two totally different things. That brings me to the next misunderstanding. BH usually don't adapt well to the concept that finance is more emotional than mathematical with regards to blanket advice (such as the 3F). Bogle and all the founders of this site give investing advice to the masses that will suit the largest population. If you take 10,000 DIY'ers at age 22 and have them in the 3F and take 10,000 more and they tilt to their heart's content, which side comes out better?
Yeah, I hear what you're saying. But at the end of the day, I and my DW are the ones who have to live with our decisions. And I'm pretty sure that nobody here on this board will ever have the full picture of anybody else's situation. So, yeah, ask for advice, get advice, decide if it applies to you. But I'll still hold my pet peeve that I probably know better than anybody else whether something is good enough for me or not.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Jiu Jitsu Fighter » Wed Aug 29, 2018 10:29 am

Gold produces nothing and pays no dividends. I can't eat it. I'm going to assume anyone who owns gold is expecting a zombie apocalypse, so therefore, I would rather own lead and canned beans. It is correlated to neither stocks nor bonds so there is reason to aportion a small allocation to this asset class.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by dcabler » Wed Aug 29, 2018 10:42 am

Whatever choice of assets you choose to create your portfolio with, might be subject to "tracking error" against some benchmark.
We can always find a benchmark that has performed better or worse than what we're doing. :D
Or we can choose not to track against any benchmark, if we're happy with the performance we're getting.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Jiu Jitsu Fighter » Wed Aug 29, 2018 10:47 am

A "good" company is a "good" stock to own. A "bad" company is a "bad" stock to own.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Jiu Jitsu Fighter » Wed Aug 29, 2018 10:49 am

Warren Buffet is God. Owning shares in Berkshire is just a tax-efficient way of owning an index fund.

Larry Swedroe is the devil.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by GoldStar » Wed Aug 29, 2018 10:50 am

Jiu Jitsu Fighter wrote:
Wed Aug 29, 2018 10:47 am
A "good" company is a "good" stock to own. A "bad" company is a "bad" stock to own.
How about simply:
"Buying an individual stock is a good investment"

I can't believe how often people discuss the FAANG stocks, Tesla, GE, etc. on "Bogleheads". Its always fun to see the expected reactions of "I don't invest in individual stocks" but don't people know that before they ask a question related to an individual stock?
Perhaps most of those discussions are folks trolling.

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Dude2 » Wed Aug 29, 2018 10:52 am

Jiu Jitsu Fighter wrote:
Wed Aug 29, 2018 10:29 am
Gold produces nothing and pays no dividends. I can't eat it. I'm going to assume anyone who owns gold is expecting a zombie apocalypse, so therefore, I would rather own lead and canned beans. It is correlated to neither stocks nor bonds so there is reason to aportion a small allocation to this asset class.
FYI. Although this may be another red herring like has happened with cold fusion and stem cell breakthroughs that never materialized, scientists may have a breakthrough in room temperature superconductors that use an alloy of gold and silver. Imagine a future where we start construction on railing systems for levitating trains using these superconductors. Industrial use of gold/silver would spike. We better get in on the ground floor. Gold? Back up the truck.

A Superconductor Scandal? Scientists Question a Nobel Prize–Worthy Claim

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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by staythecourse » Wed Aug 29, 2018 10:52 am

HEDGEFUNDIE wrote:
Wed Aug 29, 2018 3:22 am
Is there a better quantitative measure for risk? Not being facetious, genuinely curious.
Yes. The best definition of risk is not having money when you need it. Pure and simple. No one lives and pays money in the world of standard deviations.

For example:
Person A is worth 10 million and liabilities are about 100k per year and is 100% stocks
Person B is worth 1 million and liabilities are 80k per year and is 20/80 allocation

Who is riskier? Who is more volatile? Which one matters most to person A or B?

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

H-Town
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by H-Town » Wed Aug 29, 2018 10:53 am

Jiu Jitsu Fighter wrote:
Wed Aug 29, 2018 10:47 am
A "good" company is a "good" stock to own. A "bad" company is a "bad" stock to own.
This.

"If GE is so bad, why do we include GE in S&P 500 index? Can I buy S&P 500 ETF without GE?" :confused

acegolfer
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by acegolfer » Wed Aug 29, 2018 10:54 am

HEDGEFUNDIE wrote:
Wed Aug 29, 2018 9:05 am
acegolfer wrote:
Wed Aug 29, 2018 9:00 am
bgf wrote:
Wed Aug 29, 2018 7:46 am
2) as other posters have already explained, volatility is NOT risk.
My professor taught that standard deviation is "a" way to "measure" the risk of an investment. Did I waste my money?
I always thought downside volatility made more intuitive sense as a general measure of risk everyone can get behind. Not general volatility.

Would anyone call a stock that only went up in random spurts risky?

Curious why Sortino ratio isn’t used more often in the academic literature.
If you are genuinely asking, here's my opinion from economist's perspective. We always try to explain economic phenomena with the simplest and testable approach. Long time ago, with the help of statisticians, we found stock return distribution is "similar" to a normal distribution. As you know, a normal distribution can be characterized by mean and stdev, which is simpler than other distribution. This opened up the development of new theories. Of course, they were not 100% correct. But it helped us understand the asset pricing better. What many of us have been doing since is to patch up parts that the simpliest theory couldn't explain.
At the same time, some economists also attempted to build new theories from different set of assumptions or risk measurements. They may do well in some parts of areas, but they didn't explain the phenomena in general.

Jiu Jitsu Fighter
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Jiu Jitsu Fighter » Wed Aug 29, 2018 10:59 am

H-Town wrote:
Wed Aug 29, 2018 10:53 am
Jiu Jitsu Fighter wrote:
Wed Aug 29, 2018 10:47 am
A "good" company is a "good" stock to own. A "bad" company is a "bad" stock to own.
This.

"If GE is so bad, why do we include GE in S&P 500 index? Can I buy S&P 500 ETF without GE?" :confused
I'm not saying you should exclude GE, but the past success of a company does not necessarily make it a buy. The same is true in reverse for so called distressed companies. That's why,IN AGGREGATE, so-called value stocks perform better than growth stocks.

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willthrill81
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by willthrill81 » Wed Aug 29, 2018 11:05 am

Man do we need a thumbs-up option in this forum! So many great points have been made here already.

Here's one: 'bonds are for safety'.

Ask someone who held nominal bonds from 1976-1981 if bonds are safe in real terms (TIPS are another matter).
MJW wrote:
Tue Aug 28, 2018 5:03 pm
Past results do not predict future performance – Alright, but there is also a question of whether anything is to be learned from past performance. Surely there is, or we would have little basis for making decisions one way or another. There would be little point to doing any research on investing.
If we believed that 'past results do not predict future performance', then most financial theory is worthless, and more than half of this forum is pointless.
MJW wrote:
Tue Aug 28, 2018 5:03 pm
It’s a concept that is also used selectively when it suits an agenda, such as touting the benefits of the three-fund portfolio or dismissing potential “rivals” to the 3fund when the situation warrants.
I know exactly what you mean and exactly who you are referring to.
Fallible wrote:
Tue Aug 28, 2018 6:12 pm
-Market timing: the predictive component is sometimes misunderstood.
:thumbsup

Almost everyone here thinks that anyone who practices 'market timing' is trying to predict the future, which is completely false.
triceratop wrote:
Tue Aug 28, 2018 6:31 pm
Diversification -- Honestly not even sure there is a proper definition, but there certainly are a diverse set of definitions out there....of course that doesn't mean that the diversity leads to any greater understanding or improved outcome.
Then there are folks who want to diversify just for the sake of diversification. :oops:
staythecourse wrote:
Tue Aug 28, 2018 7:41 pm
MJW wrote:
Tue Aug 28, 2018 5:03 pm
Past results do not predict future performance
This EASILY the most misunderstood phrase used on this board AND all of the books written by our many esteemed authors. I never understood/ believed what folks thought it meant so I did some investigation into the SEC website to find out what the origins of the phrase came from. It clearly documents that the phrase was a requirement to be placed on mutual fund advertisements during the 2000-2003 down markets. The documentation said it was in response to some active mutual funds claiming that they could deliver excellent returns by using the returns they had in the late '90's where everyone was shooting the lights out and making it seem they could reproduce those same returns during those early 2000 down markets.

So the phrase has NOTHING to do with "Well just because SCV has done well in past it will going forward" for example. It was meant for making sure active funds did not "suggest" that just because they have done well in past that they can repeat that performance going forward. It is more of an indictment that active funds are no gaurantee to repeat going forward just because they did in the past. This, of course, has been known since Jensen's article in the 1930's so nothing new there.

I may be the ONLY person I know who has actually looked into this and have written about it several times on this board yet no one seems to care. In my opinion, this explanation makes a lot more sense then the mantra often repeated on even this forum and by many of the great books we quote on here everyday.

Good luck.
Thanks for doing this research. It's very enlightening. :beer
nps wrote:
Tue Aug 28, 2018 8:30 pm
However, the notion that maintaining "dry powder" provides a rebalancing bonus of presumed significance is often cited here to justify some higher asset allocations to bonds.
This is where I most often see the 'rebalancing bonus' idea being used, and in that regard, it is very easy to demonstrate that it is false.
HEDGEFUNDIE wrote:
Wed Aug 29, 2018 2:19 am
“Nobody knows nuthin’”

Really? Then why are we giving advice of any kind? Might as well pick some sexy individual stocks and be done with it...
:D
Dude2 wrote:
Wed Aug 29, 2018 3:04 am
Risk equals volatility

The entire financial industry, academics, BH forum members, and financial advisers all want to dumb down the concept of risk. Apparently it is accepted that risk equals volatility, and you should just know what everybody means when they use the term. On the other hand, every prospectus drones on and on about all the possible risks (risk factors) that a particular fund might be exposed to. Where is the transfer function that takes all of these sub-elements, turns the crank, and arrives at risk equals volatility? If, for some of these sub-elements, the risks showed up, and for others it did not, volatility maybe cancelled out. However, the risks still exist. Lack of volatility does not imply lack of risk. Great degrees of volatility may be associated with particular risk factors and not others. You may have to ride a bucking bronco to get exposure.

All there is to conclude about risk cannot be dumbed down to a single quantity that is assumed to be used universally. If volatility was a predictor, then somebody should be able to effectively predict something with it.
:thumbsup

If you view risk as the loss of your investment in real dollars, then bonds have been demonstrated to be riskier than stocks over twenty year periods or longer.
HEDGEFUNDIE wrote:
Wed Aug 29, 2018 9:05 am
I always thought downside volatility made more intuitive sense as a general measure of risk everyone can get behind. Not general volatility.

Would anyone call a stock that only went up in random spurts risky?
:thumbsup
Shallowpockets wrote:
Wed Aug 29, 2018 9:07 am
"50% drop" in the markets.
A what if that is a very big outlier to actually happen.
I believe that that has only happened twice in the U.S., at least in nominal dollars. In real dollars, I believe it's happened four times.
Nate79 wrote:
Wed Aug 29, 2018 10:04 am
To build off this one the common one I see is that people do not understand why they hold bonds in the first place.
:sharebeer

'I want to shift away from stocks, but total bond market yield is terrible right now, so I'll load up on these nice high-yield bonds instead.' :shock:
staythecourse wrote:
Wed Aug 29, 2018 10:52 am
HEDGEFUNDIE wrote:
Wed Aug 29, 2018 3:22 am
Is there a better quantitative measure for risk? Not being facetious, genuinely curious.
Yes. The best definition of risk is not having money when you need it. Pure and simple. No one lives and pays money in the world of standard deviations.

For example:
Person A is worth 10 million and liabilities are about 100k per year and is 100% stocks
Person B is worth 1 million and liabilities are 80k per year and is 20/80 allocation

Who is riskier? Who is more volatile? Which one matters most to person A or B?

Good luck.
Excellent analogy!
Last edited by willthrill81 on Wed Aug 29, 2018 11:07 am, edited 1 time in total.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

acegolfer
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by acegolfer » Wed Aug 29, 2018 11:07 am

HEDGEFUNDIE wrote:
Wed Aug 29, 2018 3:22 am
Is there a better quantitative measure for risk? Not being facetious, genuinely curious.
There may be. But I have not seen any study showing other risk measurements (not loadings) explaining cross-section of expected returns.

The real reason why we teach standard deviation as a measurement of investment risk is it logically leads to an asset pricing theory that can explain expected return of a single stock.

IMHO, without Sharpe (1964), Markowitz would not have won the Nobel prize.

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willthrill81
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by willthrill81 » Wed Aug 29, 2018 11:17 am

acegolfer wrote:
Wed Aug 29, 2018 11:07 am
HEDGEFUNDIE wrote:
Wed Aug 29, 2018 3:22 am
Is there a better quantitative measure for risk? Not being facetious, genuinely curious.
There may be. But I have not seen any study showing other risk measurements (not loadings) explaining cross-section of expected returns.

The real reason why we teach standard deviation as a measurement of investment risk is it logically leads to an asset pricing theory that can explain expected return of a single stock.

IMHO, without Sharpe (1964), Markowitz would not have won the Nobel prize.
From a behavioral perspective, standard deviation is not a good measure of risk. As already noted, an investment that only went up but did so in a 'jerky' manner would not be treated by most as very risky.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

typical.investor
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by typical.investor » Wed Aug 29, 2018 11:28 am

Market.

Buy TSM and own the market. Doesn’t the market include all equities? Not saying US stacks aren’t the best, only that they are not the market.

Beta.

Owning TSM will only give you exposure to beta. Never mind that TSM includes high beta and low beta in the same way it includes both value and growth. You get exposure to beta via TSM but you can’t get exposure to value that way. Obviously value exposure is offset by growth but so is high beta offset by low. Still you have only beta exposure.

Price taker.

Indexers are always defined as price takers. Yet anyone owning anything other than the market is really taking an active position that increases the relative demand for the indexes they hold and decreases it for the ones they don’t. Again, TSM isn’t really the market for equities. It’s roughly half depending on the year/decade.

acegolfer
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by acegolfer » Wed Aug 29, 2018 11:35 am

Small / value stocks have higher expected returns than what CAPM indicates because they are riskier without really understanding what "risk" they are referring to.

Jiu Jitsu Fighter
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Re: Most commonly misused/misunderstood investing terms and concepts (on BH forum)

Post by Jiu Jitsu Fighter » Wed Aug 29, 2018 12:20 pm

acegolfer wrote:
Wed Aug 29, 2018 11:35 am
Small / value stocks have higher expected returns than what CAPM indicates because they are riskier without really understanding what "risk" they are referring to.
Risk of bankruptcy doesn't count? These are distressed companies. How did they fair during the Great Depression?

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