The founder of one of our favorite blogs, AbnormalReturns.com, has written a book under the same name. In a clear and direct fashion, without excessive detail, he covers all the basics of the field of investing. And, strangely enough, despite its title, the book does not downplay the challenges of successful active investing. Instead, much of the book explains the advantages for most individual investors of a long term, index approach to investing.

Introduction

The book by Tadas Viskanta lists (p. 67) 7 basic do’s and don’ts of successful investing: allocation, diversification, rebalancing, not ignoring performance, avoiding investments you do not  understand, avoiding leverage, and avoid illiquid assets. Useful, straightforward information which sounds non-controversial, but the most interesting sections of the book also identify areas of investing that are counterintuitive, the challenges of active investing, and other helpful advice. Here is a brief overview, but we encourage our readers to buy and read this book and follow the author’s blog of the same name.  

Appearances can be deceiving

Investing and the markets are based on numerous assertions, many of which turn out to be incorrect, questionable or difficult to quantify. Here are examples from the book.

• Every investor has heard his broker say that a particular investment is too risky. But Viskanta explains (p.2-) that finance academics and market professionals actually define risk as a measure of volatility or price fluctuation, up or down, quite different from the individual investor’s understanding of risk as a measure of potential loss.
• Market participants measure fixed income risk in relation to  US treasury bonds which they describe as risk-free, but in fact no security is truly risk free when one considers potential losses when the value of any security can decline when measured in other currencies, or as a result of inflation and/or taxes (p.5,6 ).
• You often hear about the equity risk premium (the fact riskier investments should merit a compensating higher rate of return) as if it were gospel truth , but there is a surprising lack of agreement when one tries to quantify this premium, and it can change significantly over time (p.22-25).
• If one believes in efficient markets one should also probably believe momentum (the phenomena that hot stocks are more likely to rise further than other stocks) does not exist, but studies indicate it is alive and kicking. But it is hard to understand why, and if it ever became so simple that anyone can do it, the returns might disappear over time, so what should investors do (p.28-31). Other examples of observations difficult to reconcile with efficient markets: the  low risk anomaly- lower risk stocks tend to outperform higher-risk stocks (p. 39); and the yield premium phenomena- the sometimes observed historical superior  returns of dividend paying stocks.
• Stocks in countries with strong economic growth do better, right? Actually, economic growth today tells us nothing about future stock market returns, and  there is a negative correlation between equity returns and per capita GDP growth. Paradoxically, slower-growing countries have better returns (p.36-38).
• Investors (Canadians are particularly prone to this) should, where possible at reasonable cost, hedge their foreign investments, right? The book explains you would be better not to hedge your foreign investments because otherwise you no longer get the true international diversification you are looking for (p. 127).
• REIT’s are a useful asset class distinct from equities. Oops!  As REIT’s become mainstream their correlation with equities increases, thereby eliminating their key attraction (p.142).

Active investing is not for the faint of heart

While not coming right out against active, beat the market, investing, the book pulls no punches in identifying the risks and challenges. Here are some examples.

• Historically 25% of stocks accounted for all the markets’ gains. These are tough odds for successful stock pickers (p.44). This probably explains why 90% of investors who try to beat the market fail, and all suffer from opportunity cost (time and effort required) (p. 84-86).
• Market timing, another favorite tool of active investors can be costly. Market timing can cost up to 1% per annum to investors (p.7). Investors tend to view price movements as a safe signal on which to rely, for example viewing as more risky (and therefore not to be purchased)  a security that has declined in price, and vice versa for stocks that have increased in price, whereas just the opposite is just as likely to be true.

His conclusion: trading and active investing should be treated with the same seriousness that you treat any other business (and reminds us that  most businesses are ultimately unsuccessful) (p. 195).