Index Based Investing
Selwyn Gerber writes: Probably the simplest, and certainly the wisest approach to this quandary is the “Core & Satellite” model of investing. The investor should identify what portion of his portfolio he can afford to lose and what portion is necessary for his long term financial survival. The “core” portion should be invested in long-term conservative strategies and the “Satellite” portion can be used for a group of more aggressive, shorter term and opportunistic investing, especially if the satellite elements are independent from and unrelated to the core and to each other.
It goes without saying that the larger an investor’s core, the smaller the impact of the satellite portion of the portfolio. Divorced from the powerful allure of getting rich quick, any rational investor should be willing to embrace smaller investments in risky gambles in exchange for the peace of mind that a conservatively invested core safety net provides.
RVW Principle 6: Invest right. Then sleep tight ™
“There are two times when a man shouldn’t speculate: when he can’t afford it, and when he can.”
- Mark Twain, Following the Equator, Pudd’nhead Wilson’s New Calendar
The final, and perhaps most essential, principle of Rip Van Winkle investing is to go to sleep. Although it sounds like the simplest, it is likely the most difficult principle to apply. In fact, it is completely counterintuitive and contradictory to everything we know about life and human nature. The key element is learning to overcome to impulse to react. You will likely be facing regular bouts of either greed or fear – and your task is to ignore them both. It takes discipline and serious belief in the voracity of the conclusions of countless objective studies.
Any successful person knows that professional success depends, in most cases, on hard work. Scientists sift through data to prove their convictions. Many entrepreneurs rely on highly refined instincts and inspiration to make bold business moves. Soldiers are well trained to react and respond to danger immediately. Even animals in the jungle instinctively respond to threats with either fight or flight.
These deeply ingrained attitudes and behaviors are actually counterproductive when investing. For example, investors tend to sell stocks after a big drop, when the pain is no longer bearable. Generally speaking they are destined to sell at the worst times, right before an upward price reversal. On the other hand, investors will often buy once they see a stock shoot up, not wanting to miss out on the upside, only do catch the ensuing downward correction. Analysts will pour over mountains of data and make a determination that is outdated by changing circumstances as quickly it is publicized. Simply put, the cards are stacked against us and we are hard wired to do the wrong things at the wrong time.
RVW investing is scientific and disciplined. RVW investing is a highly disciplined and there is no room for reacting to gut feelings or intuition Rip Van Winkle investors, transcend the feebleness of all-to-human investing behavior. They know from the outset that their investment will go up and down over time. They understand clearly that the stock market is like a man walking up stairs while playing with a yoyo. Over the long term, it is completely irrelevant if the yoyo goes up and down, because his feet are always climbing and the key is to watch the feet and not the yoyo. The RVW approach is so simple, so straight forward and so validated by the empirical evidence that all a rational investor ever need to do is invest right, then sleep tight.
The Underpinnings Of The RVW Approach: Why It Works
In 1900, a Frenchman named Louis Bachelier, completed a thesis called “Theory of Speculation,” in which he concluded that stock market prices follow a “random walk” in which historic price trends have no predictable influence on future price movement.. Six decades later, the efficient-markets hypothesis finally began to gain widespread acceptance in academic circles. Paul A. Samuelson, the famous neoclassical economist drew attention to the seminal work of Bachelier’s paper, and Eugene F. Fama tested the theory against actual U.S. market data. Fama’s findings supported the thesis of Bachelier: An investor can learn no useful information about likely future stock market prices by examining past performance. Fundamental analysis, technical analysis, industry insight and other esoteric Wall Street techniques for predicting stock-price movements are demonstrably worthless.
This theory was advanced significantly and began to gain widespread acceptance when Burton G. Malkiel published his classic work “A Random Walk Down Wall Street” in which he further evolved the “efficient market hypothesis” showing how prices of publicly traded assets reflect all available information. Predicting stock price movements is therefore a futile attempt to forecast randomness. “The true news is random,” says Malkiel, a Wall Street banker turned Princeton professor. “That’s what people had trouble grasping. It’s not that stock prices are capricious. It’s that the news is capricious.” This hypothesis is at the heart of the RVW approach and is our academic gospel. It is the reason over $1 trillion of assets has moved out of stock picking, mutual funds and active management - and into passive index-based funds.