Tuesday, August 30, 2011

Investments of Money: Basic Rules: simplicity and discipline

Investing is simple but not easy (Warren Buffett)

The financial world has elevated the art of transforming ‘the simple’ into ‘the complex’ and this stands particularly true to money investment. Applying the complex structures and applied mathematics to investment is so loved and revered. People like talking mathematical jargons on TV about investment making people like me and your most uncomfortable. The reason for this obsession with an unnecessary complexity is only one: it is easier to apply high fees for something that seems esoteric and understandable. The complexity given to money investment is by our so called ‘experts’ of the markets.

Benjamin Graham wrote: “Generally it is believed that the mathematics produces accurate results and are reliable, but in financial markets, more elaborate and abstruse calculations are more uncertain and speculative are the conclusions we can draw from it.

Each time the algebra or complex formulas are introduced, you have to consider it as a warning that the proposer is replacing the experience and logic theory, especially to give the appearance of a strong speculative investment. I personally believe that the investment which is profitable does not requries complex mathematics to prove its worth.

The basic rules for investment success are simplicity and discipline in the long term. Your productivity in long term will be determined by what you buy and how much you pay. An overly complex and cumbersome formulas (whether in structured bonds, bonus certificates, unit-linked policies, …) only serves the interests of the proponent, but not of the investor.

Although at first glance may seem hard to believe, individual investors have some significant advantages over professionals who daily seek to manage their savings. To take advantage of these benefits, however, should investors avoid some errors.

Error 1: listen to the “background noise” instead of pursuing its objectives

A major problem for investors is through extricate those “background noise” that you hear every day in newspapers and on TV, all that talk of financial experts, analysts and managers that are completely useless to the investment process. For there is an abundance of information, often interspersed with the best intentions, but that can sometimes seriously affect the health of your investments.

Many investors believe it to be fully rational, but are generally subject to random data follow. As amply demonstrated by behavioral finance, most feel more pain and anguish from a loss of pleasure they get from a gain of that amount (“burn more victories and defeats). Therefore, for those investors who focus on the results of their portfolios daily, periods of joy are reduced while those of depression are numerous.

The problem is that the discomfort it creates anxiety, which usually leads to making the wrong choices, in other words, continuously monitor the performance of your portfolio is highly discouraged, although many continue to say otherwise. When an investor focuses on short-term movements, what he observes is the variability of the portfolio, not its performance. This person would be in a situation far better if it was limited to reading only the statements of its portfolio on a quarterly basis (or even better year).

Error 2: Do market timing

Each month, dozens of stocks and funds go up or down by more than 10%, some of which also appear to move in a price band of well-defined. If you could identify which company or fund will move in what direction you could buy on lows and sell at the top, creating a kind of machine for making money.

This really is an excellent strategy, but with a little problem: in the real world does not work. In the short term market movements are largely unpredictable, as investors insist on trying to recognize a pattern in random data: fixed a chart long enough and you’ll see a winning strategy – only to have it vanish when you invest real money.

With this type of strategy sometimes earns. And sometimes you lose. So it works with random events. For your investment you want something that will have some expectations that the best bet on the toss of a coin so try to avoid market timing and focus on price and quality of what you buy.

Error 3: Ignoring the cost

Commissions, transaction costs and taxes are the bane of small investors. The various operators are doing their utmost to convince you to entrust them with your money because they want to retain a portion, and this happens in many forms: boots, expenditure of funds, management fees, account management fees, point spread between prices and money .. . If there’s some profit, the state is happy to step in and take their part in the form of taxation.

Try to be always aware of what they paid, because higher costs are equivalent to a lower return, try to minimize these costs. Buy funds with lower TER (eg passive funds and ETFs). Do not constantly entering and exiting a market. You’d be surprised how often the professional managers do exactly that, resulting only in increased costs (taxes and fees) for you.

Error 4: Buy what is fashionable

We have already seen the Internet bubble and still meet again with China, emerging markets, commodities, hedge funds for all, ….
When you spot a new trend (demographic, political, technological or otherwise), be careful to assume that this will continue indefinitely or that have a positive effect on your portfolio under every scenario. Investing in a market that has the wind in favor is a good starting point, but consider also how they are exploited these advantages: Apple, Microsoft and Intel have prospered, much less their imitators.

Error 5: How to invest in a casino
Markets (especially equity) may seem like Las Vegas. A player may enter the Bellagio, bet on 17 black and win. An investor can, in complete ignorance, buy and earn action. But as the casino, the stock market is not dismissed for incompetence or lack of common sense: when money runs out.

Investing in shares for the thrill or the hope of doubling their money is absolutely wrong, as it is to play blackjack or roulette. But in both cases the players should not be surprised, angry, outraged or even worse if they lose.

If your goal is to invest in order to obtain satisfactory results in the long run, do not treat the bags as casinos. Do not buy on feelings, suggestions or speculation, but rather because you know the company (or country) in detail. Always try to include: 1) its intrinsic value, 2) pursuing the strategy, 3) the quality of managers / administrators, and 4) the possible obstacles you may face on its path.

Simply avoiding these five mistakes increases exponentially the chances of obtaining satisfactory yields, much more than buy another book “How to invest € 1,000 and € 1 million to have in two years.”
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