Where is the other half?
Posted by richwillis in Investing Wisdom on August 7, 2011
The stock market fell over 5% this past week, and the financial media reported half of the story. The headline article in Friday’s Wall St. Journal provides a classic example. Here is a sample quote: “Volume on stock exchanges has spiked in recent days, a sign that more investors are piling into selling.” The thrust of the article is that “everyone” is selling, “no one” is buying, and that is what is driving the market down. Most readers do not question statements like this. They should, because such statements are misleading at best and flat out wrong at worst. Read the rest of this entry »
Why buying five star mutual funds is hazardous to your wealth
Posted by richwillis in Investing Wisdom on July 26, 2011
Many mutual fund investors believe that buying the highest rated funds is a good way to invest. It actually is a very poor idea, and it is likely to lead to, at best, mediocre performance. Why? Because investors who buy such funds are buying at the wrong time. Read the rest of this entry »
Six important questions
Posted by richwillis in Investing Wisdom on July 22, 2011
When managing an investment portfolio, it is necessary to answer six straightforward questions. The questions are what to buy, when to buy, how much to buy, what to sell, when to sell, and how much to sell. All one needs to do is to have an adequate plan for answering these questions and the job is complete. When the task of investment management is framed in this manner, some of the drawbacks of the more common approaches are exposed. For example, if you read the financial press or check out the personal finance section of your local bookstore you will find a disproportionate amount of attention focuses on the first question, what to buy, and not nearly as much on any of the others. What to buy is important, but it is not really the most important driver of investment performance. The next two questions actually have more of an impact on overall performance. The “how much” questions are much more significant than the others, but get relatively little attention. Frequently, the answer to “how much” is the amount of “spare” cash lying around in an account. This is a rather shortsighted way to manage a portfolio and can result in being poorly positioned when market trends change and can also lead to over- or under- allocations to important asset classes. Investors who have not given ample consideration and attention to the “how much” question frequently are exposed to unnecessary amounts of risk due to their misallocated portfolios. Read the rest of this entry »
Are you a crystal ball investor?
Posted by richwillis in Investing Wisdom on June 22, 2011
Is your investment success dependent on the unfolding of a specific set of future events, such as the direction of interest rates, inflation, or the global economy? Are you relying on particular companies to outperform their competitors for as long as you own their stock? If so, you may have a problem.
Have you ever critically examined the accuracy of those who claim to be able to divine the future direction of any market? You will find that the accuracy of such predictions is about the same as if you took a random guess. How many forecasters foresaw the depth and breadth of the recent financial crisis? The Federal Reserve did not see it coming. The manager of the largest mutual fund, Bill Gross, said two months before Lehman collapsed that “there was close to 100% probability that Lehman would avoid failure.” What makes this situation even worse is that the biggest forecasting errors occur when you need the information the most—right before a major turning point. Read the rest of this entry »
The critical distinction between a good investment and a good investment decision
Posted by richwillis in Investing Wisdom on May 15, 2011
Two and half years ago, Apple stock was selling for around 90 dollars per share. Now it is above 300. If an investor put 75% of his wealth into Apple stock, would that have been a good investment decision? Many people would say so. Just look at the results. More than tripling your investment can’t be bad. The choice of individual investment does not matter for this example. I could have chosen Ford stock, junk bonds, gold bars, or Chinese ceramics. Many different assets appreciated at abnormally high rates over the last several years.
In spite of the success of this investment, I would argue that this was a shortsighted decision that happened to have a fortuitous outcome. Putting 75% of your wealth in a single investment is almost always a poor idea, no matter what happens subsequently. This investor got lucky. In 2011, he might have another great idea and put 75% of his now larger wealth into another investment, and it might not turn out so well. His process for making investment decisions has a fundamental flaw, and sooner or later, the laws of probability are bound to catch up with him and he will likely experience a very bad result. Read the rest of this entry »
The importance of a fixed asset allocation
Posted by richwillis in Uncategorized on April 27, 2011
Most investors do not prioritize asset allocation as the most important aspect of their portfolio decision-making process. For them, asset allocation is what results after a series of security selection decisions. Other investors may prioritize asset allocation a bit higher, but are constantly changing it in an attempt to take advantage of the next trend in security popularity. The cognitive investor’s process starts with a fixed asset allocation that drives security selection and market timing decisions. This is a fundamentally different mental model, and it forces the investor to focus on answering a completely different set of questions from those addressed by the conventional media or the purveyors of most financial products and services. Read the rest of this entry »
The importance of asking the right questions
Posted by richwillis in Investing Wisdom on April 20, 2011
As a long time market observer, one of the questions I am most frequently asked is: what do I think the stock market will do next? This question makes me wince. Why? Almost any answer I give is fruitless. I could give a very accurate answer, which is what J.P. Morgan did when he was repeatedly asked the same question many years ago. He said, “Prices will fluctuate.” I could be a little more specific and say, “On average, if history is any guide, prices will rise 20 out of the next 39 days and fall 19 of those days. The particular sequence is unpredictable and unknowable.” Or I could be ultra-specific and say, “The S&P 500 will rise by 4.2% in the next three months.” But why should anyone believe an answer as precise as that? Such predictions are no more than guesses, and even if you gathered a bunch of them from every market pundit, you would simply be taking a sample of the consensus, which may or may not turn out to be true. We know that such forecasts are about as accurate as rolling dice, so why even ask? Read the rest of this entry »
What is this blog about?
Posted by richwillis in Investing Wisdom on March 25, 2011
The Cognitive Investing Institute was founded with the sole purpose of helping people to make better investment decisions. In this blog, I hope to present an unbiased, non-self-serving, thorough examination of the investment decision-making process. It will focus on education, not promotion. The blog will examine such questions as:
- Why do investors make the mistakes they do?
- What common investor assumptions are incorrect?
- What are the important questions that investors should be asking themselves but aren’t?
- What are the key ingredients to a sound investment decision-making process?
The goal of the Cognitive Investing Institute is to be the premier, independent educational resource for the self-directed investor.
- Premier: The focus is on gaining insights, knowledge, and wisdom regarding the investment decision-making process. Unlike many other investment-related sites, the focus is not on reporting news about the latest market developments, offering opinions about market direction, judging the values of various securities, or promoting particular investment products and services.
- Independent: The Cognitive Investing Institute is not affiliated with any provider of financial products or services and receives no compensation in any form from any financial company. This independent stance is required to maintain complete objectivity and present unbiased analyses.
- Educational: The sole focus of the Cognitive Investing Institute is education. There are few other entities offering a similar type of educational services. Many financial companies provide various levels of education as a byproduct to sell their services. However, they typically provide “just enough” education. Their goal is to give their customers just enough education for them to buy their services. They certainly do not want to provide them with additional education that would allow the client to find more cost-effective ways to accomplish the same goals without using their services. Schools and universities generally do not provide this type of education because their typical student is not an investor, and thus not able to relate to the frequent issues encountered by investors. The financial media focus on the most immediate and dramatic events, which more often distract than educate, if the goal is to make wise, long-term decisions.
- Resource: The posts on this web site and the book, Cognitive Investing, answer many important questions that investors should consider. But no site, book, or class can answer every question. So I encourage you to ask questions, challenge my ideas, and offer suggestions of additional topics to analyze and discuss. Send me an email at email@example.com, or post a comment on any item of this web site.
- Self–directed: This site and the associated book, classes, etc., are designed for investors who primarily make their own decisions. These investors understand that no one else truly has their interests at heart, and no one else will completely understand their personal situation as well as they do. They do not wish to pay a never-ending stream of costs for someone else to make the key decisions that determine their financial future.
- Investor: The site is focused solely on investing issues, rather than everything involved in personal finance, which is a much broader topic and mostly beyond the scope of this blog. Cognitive investors are not gamblers, speculators, or traders. They understand the difference between investing and gambling and are not interested in get-rich quick schemes, the latest hot stock tips, or the latest strategies for timing the market.