Tuesday, December 11, 2007

How to Invest

There is a great article by Michael Lewis on the efficient market hypothesis - the idea that financial markets are so good that you can't actually beat the market. (I can't find it online anywhere) I'd summarize it, but this blog by Megan McArdle has already done so in a much pithier manner than I am capable of:

"Lewis completely glosses over distinctions between various forms of the efficient markets hypothesis, bizarrely simplifies arguments about the various premia on asset classes (those looking for a solution to this riddle might start with the word "liquidity"), and tells a suspiciously pat morality tale about a stock-jammer-turned-sainted-investment-advisor. But he gets the big thing right. The world would be a better place if we all took home the point of his sermon:

You can't beat the market. YOU can't beat the market. YOU CAN'T BEAT THE MARKET.

It doesn't matter which version of the EMH (efficient market hypothesis) is correct. It doesn't matter if the behavioral finance guys are correct. You--adorable, clever, hardworking little you--are mathematically just as likely to underperform the market as outperform it. You would do better to go to Vegas and sit down at the $25 blackjack table with a firm resolve to walk away as soon as probability has varied a few hundred dollars in your favor."

McArdle concludes with the essential investing advice that any sane economist should give you:

"You can't beat the market, and neither can the jerk on the phone trying to sell you stocks. Put your money in the broadest possible index fund (being young and having no children, I'm all equity with a 70/30 split between domestic and international; your mileage may vary). Then leave it there. Don't even peek. Throw the statements away unopened. Rebalance once a year to keep your money at your target allocation, and otherwise don't think about it. If you want the thrill of gambling, go to Vegas. At least they'll give you free drinks."

No comments: