Investment Fact, Investment Speculation

(Last Updated On: August 23, 2013)

twenty dollar bill 200pxInvestment Speculation?  What does a physicist have to say about that?  When the pros get in over their head, why should you listen to an amateur at all?

Never fear, when it comes to what to do, I will point you to the experts.  But “Investment Science” is like any other science — it contains both Fact and Speculation, that is, logic and emotion, and if you recognize that, it will help you sort out the conflicting advice you hear and stay out of trouble.

Background:

Some say your biggest investment is your home.  I say it’s your retirement.

As an example: with 100K income, Zillow says you can afford a 400K mortgage, whose payments of $2750/mo are 1/3 of your pre-tax income.  If you plan to live on 80% of that 100K in retirement (in constant dollars), retire at 65, live till 95, that’s 30 years times 80K = $2.4 million, so your retirement investment is 6 times your house!

I say, avoid the headline books that promise you can get rich with the investment secret that only their author has — chasing “something for nothing” is likely to cost you dearly.  There are many books of varying quality — read the Amazon reviews carefully — but I would start with the best one: Malkiel and Ellis, The Elements of Investing.  From this and similar wise books, you’ll find something like the following:

1.  The most important step is to save as much as you can: use a retirement calculator from someone who’s not trying to sell you something, for example the one at CNN (http://cgi.money.cnn.com/tools/retirementplanner/retirementplanner.jsp).  Make some reasonable assumptions (such as 80% of income in retirement, a “balanced portfolio” of investments) and you may be surprised at how much you need to save: I ran some numbers and found I’d need to save 13% of pay if I start at age 30, but (gulp!) 25% if I wait till age 40.

2.  Next most important is allocating your savings between “safe” money (think bond funds) versus “growth” money (think stock funds).  For two different approaches, look at the “Bogleheads” and Fidelity.

3.  What you’ve just done will determine at least 80% of how your investments will perform.  You can make up the other 20% by allocating your money among a few investment classes, and rebalancing at least once a year to restore the allocation percentages.  Four is generally enough, and those should be stocks, bonds, real estate investment trusts and foreign stocks.

4.  OK, but where do I actually put my money?  Well, that’s where the Fact and Speculation comes in.

Investment Science Fact:

Unless you plan to spend enough time to be an expert at investments, stick with mutual funds or the very similar ETFs (Exchange Traded Funds).  But then you’ll have to choose: index fund or managed fund?

University-based economists have been studying investment funds for many years, and they find that almost all managed mutual funds do worse than the index they are trying to beat.  Moreover, if you identify a few funds that beat the index, say every year for 5 years, statistically that gives you NO assurance that those same funds will beat the index in the coming 5 years.

If you distribute your money among index funds, you’ll sleep well at night, ignore the “chatter” in the newspapers, and come out ahead in the long run.  A good recent guide is Mike Piper’s Investing Made Simple.

Investment Science Speculation:

But you’ll find passionate advocates for “picking” — picking a winning stock, picking a winning mutual fund manager, picking an upcoming industry group, picking when to buy or sell (“market timing”).  This wishful thinking says don’t bother me with the facts, I’ll find a winner and invest with them.  There’s a great book by Hebner and Markowitz that exposes the fallacies of trying to pick a winner, trying to be smarter than everyone else in the market — but some folks just won’t be convinced!

Let’s recognize that for some people, the chance of a big win, the chance to guess right, is worth the price of losing all the wrong picks.  Your friend will tell you quickly enough about the stocks he bought that went up, but he probably honestly doesn’t remember about all the ones that totaled up small losses.

But who among us is immune to the joy of the lottery win?  So one way to straddle the fence is to decide on some portion — say 10% or 15% — of your investments that you will use to speculate, to follow logic or a hunch to buy a particular stock or a particular mutual fund.  Then if you win, you can feel great about it, and if you lose, you won’t lose everything.

Do you follow Investment Fact or Investment Speculation?  Or have you found a happy middle ground?  Tell us!

Comments

Investment Fact, Investment Speculation — 4 Comments

  1. I found the investment part very interesting and already sent its contents to my two sons who are in the beginning of their careers. Fortunately they have taken the advice to put money into IRA and 401 K plans 🙂
    Metin

    The other articles are very interesting too!

  2. Art, love your new site and wish you well with the project !
    As for investments, you and I have touched base on this last year.
    I’m talking 3 Dimensional printing or additive manufacturing. This technology is growing leaps and bounds. Reminds me where desk top computers were in the mid ’80s. Big names (GE) are jumping into the scenario and I believe there is serious money to be made. Remember when Apple could be had @ $35/shr. DDD and SSYS is where it’s happening. Still time to get on board for the ride. Also, the Motley Fool guys is a great source for info.

    • Hi Joe,
      And thanks for weighing in on the investment area! And I absolutely agree, 3 dimensional printing will be big, bigger than we can imagine today. And it’s certainly true that if you’re smarter or luckier than the other guy, you can do better with individual stocks than any combination of stocks.
      However, I’ll tell you a story.
      I read a study of the early days of electrical power distribution, 100 years ago. That was a time you could have invested a day’s pay in GE or Westinghouse and 15 years later, sold it and retired to a mansion with a yacht.
      The study said, what if we bought shares in every company that was offering electrical power distribution? And they found that most of the shares became worthless, but of course the winners did very well. And the upshot? About the same as investing in the total stock market.
      So it’s great to invest in a new technology, as long as you can pick the winners! I say, good luck and happy hunting! – Art

      • Art, thanks for your response. Your support of 3 Dimensional Printing is very positive for this technology. I have been following the subject since May, 2012 and convinced we are on the cusp of revolutionary change in USA manufacturing.