Use Caution with Classical Investment Books

Use Caution with Classical Investment Books - A Tip from The Skilled Investor

Individual investors should exercise caution when applying the tactics of classical investment books to current markets. The more handcrafted, seat-of-the-pants, and individual actor approach to the securities markets in the pre-computer, pre-networking era has given way to different practices. What might have worked then may not work now. Do not to confuse valid investment principles with the tactics that were used to implement them in the past.

Securities markets and the financial services industry have changed dramatically in the past several decades. The markets and the industry have been transformed by:

real-time global trading

huge trading volume,

pervasive computer and networking infrastructure,

increased professionalism and an influx of technocrats,

proliferation of investment vehicles,

extremely rapid information dispersion,

automated market data analysis,

sophisticated computerized risk modeling,

invention of derivative securities, and

numerous other factors.

Many classical investment books from the more distant past have been republished and some have retained a significant following. Classical books, such as “Common Stocks and Uncommon Profits” by Philip A. Fisher and “Securities Analysis: Principles and Techniques” by Benjamin Graham and David L. Dodd, to list just two, remain interesting and instructive. However, these authors were writing in a time when the markets were quite different.

For example, scientific finance studies have verified that the value-based investment focus of Graham and Dodd remains valid in modern times. Well-constructed statistical studies indicate that on average over long periods, the markets do seem to provide better total returns to a value-based approach. The importance of value-based investing has been incorporated into investment theory. For example, the multi-factor market return models of scientific investment studies now incorporate a value-versus-growth factor.

While there is truth behind Graham and Dodd’s value-based approach, it is doubtful whether individual investors on their own can now profitably implement tactics that might have worked in the past. It is doubtful whether an individual who diligently analyzes stocks and self-manages his portfolio will obtain superior returns over the long run, when compared to a passive index fund strategy that has a skew toward value investing. Implementing a value strategy through very low-cost mutual funds and exchange-traded funds or ETFs is just more efficient.

Amateurs tend to do a very poor job of building diversified portfolios, and they incur higher investment costs in the process. Furthermore, portfolio self-assembly requires a very large personal time commitment and the opportunity cost of one’s time adds to costs. Compared to the “olden days,” the current securities market environment strongly favors investments by individual investors that are made through low cost mutual funds and ETFs, rather than through direct investments in individual equities.

For information on how poorly individual investors tend to do at portfolio management, see this article: “What is the cost to individual investors of sub-optimal portfolio diversification?”

For articles that will help you understand the requirements of personal portfolio diversification, see these articles: “Diversify Assets” (12 articles)

For articles on the opportunity cost of your personal time spent on investing activities, see these articles: “Personal Efficiency” (4 articles)

For articles on historical market returns and risk premiums, see these articles: “Returns and Risk Premiums” (10 articles)