A financial education (my ideas)

When I came to US, I wanted to get an introduction on personal finance. I needed to know what to insure, when, how to buy an house and all this sort of basic things. At the time I read Personal Finance for Dummies. I then discovered that very many US folks don’t know about these things either and I found myself recommending this simple book to plenty of people. You can find it for a few bucks in used book-stores. It might be too basic for you, but again, it might not.

Investment is a subset of personal finance and by far not the most important one (the most important probably being how to save the most – which means paying you first). Nevertheless, understanding how to invest the money that you do save is important. The following represents a very condensed summary of my views on the topic. There are dozens of others very good books that I could have suggested instead.

The first thing I would do is to get a decent understanding of the relationship between risk and reward that is so pervasive in financial markets. Good books on the topic are The Four Pillars of Investing or A Random Walk Down Wall Street. A new book that I haven’t read, but suspect quite good (and short) is The Little Book of Common Sense Investing. This books try to convince you that it is not possible to ‘beat the market’ and the best you can do is to decide on an asset allocation that represents your risk/reward profile. If you believe that, then it is worth getting to the next step by understanding the concept of mean variance optimization. Good medium level books on that are All About Asset Allocation and the Intelligent Asset Allocator. There are advanced books on the topic as well, but I won’t mention them here. An advanced service in this area is IndexInvestor.

With time, analyzing the amount of evidence, I came to believe that it is indeed possible to beat the market. But it is not easy and 99% of the methods out there are bunk. Moreover it does require a lot of work and a certain passion for the investment field. So, if you don’t have time or passion you are probably better off sticking to the strategies described in the aforementioned books. If you have a small amount of time, but you still want to try and beat the market, an avenue open to you is the selection of mutual funds. Even then, you need to have some strong held view of which kind of investment strategy and character traits are more likely to bring about superior investment results so that you can pick the right manager (or most likely set of managers) for your money. I describe below what are my personal views on the matter. They are all very debatable. A good service that gives sane information about mutual funds, how to select them and assemble them in your portfolio is Morningstar. I certainly suggest you subscribe to it, if you invest in mutual funds.

A time honored and generally successful stock picking method is value investing. The father of value investing is Benjamin Graham and two books written by him are everlasting classics of investment. They are The Intelligent Investor and Security Analysis. Aficionados disagree on which releases are the best, the links provided represent my opinion. Please start with the former, as the latter is long and complex. They are both quite dated, but plenty of folks believe that not much has been discovered after their publication. I disagree. Another, maybe better, introductory book is The Little Book of Value Investing. There are wonderful mutual funds out there that invest in the spirit of value investing. Among others, I like Third Avenue, Pinnacle and Royce.

Warren Buffett expanded on Graham by putting more emphasis on the quality of the companies he invests in instead of mostly the price. A good book describing his approach is The Warren Buffett Way. You can obviously go and read Buffett’s letters directly here, but that is better suited as a second step after reading Graham or the aforementioned book. There are plenty of disciples of this method of investing. If you want to have some of them managing your money, my preferred are Longleaf, Fairholme,  Weitz and Clipper among others. A good service that suggest stocks based on this style of investing is the stock section of Morningstar. You also can invest in brk.b directly to buy the services of Buffett himself. I personally believe it is quite undervalued at the current juncture.

In the past 15 years or so, there has been a lot of interesting work done on purely quantitative investing systems. They have several advantages over judgment based ones (essentially the human brain is not wired correctly to fight a complex adaptive system as the stock market). There are two categories of systems I feel I can recommend in this area: fundamental based and momentum based. This is a very complex mathematical topic at the high end, but it is possible to get a profitable understanding of it by reading WWOWS and The Little Book That Beats The Market. These books describe fundamental based systems, for a purely momentum based one the best bet is FundX. The web site is not too informative, but if you go to the library and ask the librarian they have a little book written by the FundX guys that describe their system in a great level of detail. The best quantitative mutual funds I can think of are from Bridgeway (there are also others). Like all the other funds I suggested, they are managed by wonderful people that takes the shareholders interests very seriously.

You can also try to tactically switch between different asset classes (i.e. stocks and cash) based on some indicators. I have mixed feelings about this. It might work, but it is debatable how much do you really gain by doing it, after considering taxes and commissions. It is something I could investigate more. Two good books on the matter are The Only Three Questions That Count and The Research Driven Investor. Good mutual funds that do this (with very different risk profiles) are Hussman and CGM.

A couple of notes to close. Reading these books is an exercise in critical thinking. There are huge amount of contradictory statements on very basic and important concepts. The only way around it is to do your own research and make up your own mind. Even then, you won’t be in a situation of perfect information/clear decision. This cannot be so because the market changes constantly. As soon as something is discovered it gets priced in. This is why it is such an exciting field of study (for some people at least). Also I have my own key rule about investing: I never invest in anything that I don’t understand completely. Every time I’ve done that, I’ve regretted it. If this is the only thing that you remember after reading this, I’ll be very happy.

Comments (5)

  1. Visual Studio Orcas Beta 1 is available for download . Though quite similar to the March CTP in terms

  2. EricGu says:


    If you haven’t read any of Motley Fool stuff (at http://www.fool.com), that’s worth a bit of your time. I’ve been a subscriber to their stock advisor newsletter for a couple of years, and it’s been money well spent.

    For most people, to "beat the market", you have to beat the mutual funds out there, and that’s not that hard, because of the structural limitations that they have.

    And yes, I agree with you – there are tons of really stupid investment ideas out there. I have a friend who in the last year has progressed from selling puts and calls all the way to having most of his money in index funds.

  3. lucabol says:

    Hi Eric,

    I like the newsgroups on fool (i.e. the mechanical investing ones). I’ve never tried the newsletters because I got turned off by the quality of the books they wrote (which I deem very low).

    But Whitney Tilson writes for them, so maybe I’ve been too skeptical …


  4. Jim Savarino says:

    Regarding the practical application of asset allocation models.  Be careful! The theory is perfectly correct but in practice it is difficult to apply.  

    The problem is that most discussions of the subject assume that you know the expected returns, the risk (std deviation) and the pairwise correlations between security returns.  In practice these elements need to be estimated and can contain large estimation error.  If one attempts to apply the usual deterministic quadratic programming algorithm to select the investment weights for a security population, one gets nonsense.  


    First and foremost, the estimation error in the expected return and risk of large mutual funds is much less than that of individual securites do to diversification

    Second, you are selecting from a smaller population of investment objects so the impact of estimation error on the assect allocation algorithm is reduced.

    Sorry, couldn’t resist putting in my 2 words.  Asset allocation was my research expertise in my prior life as an instructor of finance at Pacific Lutheran University.  My current life entails programming simulation models using C# which is how I came here….

    Jim Savarino

    Group Health Cooperative

    Seattle WA


  5. lucabol says:

    I agree with you. I don’t use optimizers because of that. I do think the theory is useful as a framework to understand the importance of diversification.