I just wanted to share this New York Times article which I recently stumbled across. It was interesting in that it did a good job of summarizing my overall approach to investments over the past 20 years. The point of the article is that trying to beat the market mostly results in drastically worse performance in the end. But with a rational investment strategy of buying and holding low overhead index mutual funds, your investments will normally perform much better with less work and less risk.

My own take on it goes like this:
Imagine for a moment that you know with complete certainty that health care companies are going to outperform other kinds of stocks. So you sell your diversified mutual fund and buy a health care specific mutual fund. Good idea?

No, not at all. This is true even if you are totally 100% certain that health care companies will outperform other companies. Because the performance of a stock or a fund has very little to do with how well the underlying assets (i.e. companies) will do. It has to do with how much better or worse the underlying assets will do compared to what other people think. So if you know that health care companies will grow more, or make more money than other companies but a number of other people already know it and placed trades based on that knowledge, then you are too late to the party. They’ve already driven up the price of buying the fund to the point that it is no longer a better deal than the diversified fund you already own. (If it was underpriced, why wouldn’t they have kept buying until it wasn’t underpriced anymore?) And since so many people buy based on “momentum”, the value may have already overshot the correct value and you are buying an overpriced asset. In which case, in addition to the costs associated with trading, the extra taxes you may be paying by selling your old fund, and the opportunity cost of keeping money uninvested while looking for an opportunity like this one, you’ve probably also paid more than this “promising fund” is worth.

So ask yourself, “do I have some specific knowledge about the future performance of an investment that other professional investors who spend millions of dollars searching out these kinds of opportunities don’t also know?” If the answer is “no”, then they will have already “bought low” and you are the sucker that they will “sell high” to.

Now ask yourself, “what am I good at?” Because the strategy that I’ve been using for the past 20 years and has done me very well is this:
Focus as much of your time and energy in something you enjoy doing and are good at in order to make as much money as you can (by working!). Then take the money you earned at what you are actually really good at and invest it in the absolutely most diversified funds you can find. Funds like this one from Vanguard. With an expense ratio of 0.25% and a diversification that spans stock markets around the world, it won’t beat the market, but it won’t do more than about 0.25% worse on average either.

(Side note: if you are actually considering buying a fund like that one, you should probably look into some diversified bond funds, also. But I’m not really trying to recommend funds. Just strategies. 😉

In the end, I’ve found that the return on investment of the stock market as a whole has been quite good. And looking back, my ability to make more money by focusing on my strengths has almost certainly resulted in increasing the value of my portfolio by more than “playing the markets” would have. And with much lower statistical risks associated with it.

And I enjoy my work. 🙂

(At least on most days.)

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