Thursday, January 18, 2007

Go Long and Stay Long

My father-in-law is one of the best investors I have seen. His rate of return on investments is unmatched - stocks, funds and real estate. His strategy - invest for the long-term. He has figured out the true underlying nature of the stock markets - randomness. The objective is not to reduce uncertainty but to develop a strategy to effectively deal with this uncertainty.

Here's a reference to a good book that deals with randomness of the stock market and a review on NY Times about it. If you have been planning to get to the next Google before it takes off - all I have to say to you is that you are being very optimistic about your success in finding the next Google. Robert Merton's portfolio problem under certain assumptions shows that to maximize expected lifetime utility the fraction of income to be invested in a portfolio is independent of the age of the investor. So, get going. It does not really matter when you start. You never missed anything and that's the truth. For an investor in the long term, there are bound to be hits and misses. If an investor has spread his/her own risk reasonably (say 60% stocks and 40% bonds - young ones like me), there will be sufficient avenues to generate good returns.

As the author suggests you are better off gravitating to index funds. Index funds slavishly follow a index such as the S&P for example and given the collective wisdom of the market, in the long run they have been really good at delivering a consistent return, higher than for example funds that are managed actively by "managers". There are hundreds of these index funds and they all have intriguing names - vectors, diamonds, spiders. Apart from the broad based index funds, there are also specialty index funds that follow sectors, industries etc. You might also want to check out ETFs. Fin instruments such as ETFs and index funds give novices like me better ways of managing risk. ETFs trade on the stock market just like stocks and can be traded in real time. They also give investors such as me an option to look out for boutique investments in specialty baskets of firms and sectors. ETFs however are not free of volatility and therefore risk. FXI - China 25 ETF is a good example - it has grown over 30% in the last 3 months. However, it does provide an investor an option to invest in a broad set of Chinese firms instead of just PetroChina od China Mobile.

For a comparison of ETFs, mutual funds and index funds - follow this link here.


Raghuram said...

Good blog. I have always betted my horses on Index funds... and this article sort of vindicates my position.
In the realm of pseudo-financial trading facts, the only truth is the reality of your returns. Amen.

Girish Mallapragada said...

Well said Raghu. There is sufficient information out there for people like us to have a go at investing alone. If we keep our expectations under reign and know the true concept of a "portfolio", we all should be fine.