Published Book Reviews

The Investment Answer

🤔What I thought it was about

Instructions to invest for the commonfolk and the book delivered on its promise!

📑Book in 3 2 sentences

For best investing results, find yourself a fee-based, independent investment professional, build a portfolio of equities, fixed income, and money market based on your risk tolerance, diversify, use passive (not active), and rebalance
Avoid alternative investments like hedge funds, private equity, or commodity trading because although they’re in the news a lot about how much money they generate, they are higher risk, less liquid, less diversified, more expensive to invest in, and doesn’t even deliver better returns overall compared to traditional asset classes of equities, fixed income, and money marekt

🧑‍🤝‍🧑Who should read it

People who have some background in personal finances and investing, such as knowing the difference between fixed income, mutual funds, private equity, etc. because although the authors explain it clearly and simply, they don’t elaborate on it much

🔃How it changed me

It didn’t, none of this is new to me but it was a good review; granted the breakdown on alternative investments is a good refresher for me and helps better distinguish them from traditional asset classes

📒Annotated Cliff Notes

You just have to make five informed investment decisions to capture the wisdom of Novel Prize winners
Do-It-Yourself — invest on own or find an investment professional
Asset Allocation — % stocks (equities), bonds (fixed income), and cash (money market)
Diversification — which categories and in what proportions
Active vs. Passive — outsmart the market or market-like returns
Rebalancing — when to sell and buy

Ch1: Do-It-Yourself

Authors advise retail brokers or independent fee-only advisors to avoid…
Overconfidence → success in other areas of life lead to over-estimating your own expertise in investing, leading to severe investment losses
Attraction to rising prices → past performance is not indicative of future results yet financial assets are more attractive when their prices rise (buy high, sell low)
Herd Mentality → comfort with being part ofa group
Fear of Regret → such as staying in cash because fear of entering the market at the wrong time; but the best time to invest is when you have money, best time to sell is when you need money
Affinity traps → investing because of mutual ties to organization, friend or celebrities
Retail Brokers work for their firm
commissioned agents compensated by firm or third party for selling you investment products; known today as Financial Advisors or Financial Consultants
Broken into two different types, a “classic” brokerage account” and “investment advisory account”
Brokerage Account >> Your broker acts for their firm, earns income from trades and commission, no fiduciary duty to you the client, don’t have to disclose conflict of interests
Investment Advisory Account >> may offer financial planning and advice for a single fee, has a fiduciary duty and must disclose conflicts of interest and put your interests first
are not independent if they are registered representatives, a technical term
Independent, Fee-Only Advisors work for you
generally free from conflict of interest, constraints, and pressures that brokers have
compensated with a fee based on your assets under management; and compensated by the client and not an investment firm or broker
uses third-party custodians o hold your investments under your name with limited authority to manage your portfolio
What to look for in a Independent, Fee-Only Advisor:
Investment philosophy: they need to communicate their investment beliefs and methods, and be in line with yours
Personal connection and trust: understand your feelings about money, dreams, aspirations
Professional qualifications: Such as Certified Financial Planner (CFP), Chartered Financial Analyst (CFA), and Certified Public Accountant (CPA)
Education: Where they got their formal education
Experience: Where they worked prior to becoming advisors, more weight to those with careers in financial services (like accounting) before being advisors
Business structure: solo practitioners, small partnerships, or large organizations
Services offered: whole suite of services as wealth management
Current clients: you should be their typical client to benefit from advisors’ experience of working with similar clients

Ch2: Asset Allocation

Portfolios of long-term investors are made up of equities (stocks) or fixed income (bonds)
Risks to consider: credit risk, inflation risk, maturity risk, market risk
Risk is measured as standard deviation, where in normal circumstances, two-thirds of the numbers will fall within one standard deviation of the average/mean
Value stocks: companies whose stocks are cheap relative to their underlying accounting measures like book value, sales, and earnings because of bleak prospects, poor growth
Growth stocks: companies whose stocks have high prices relative to underlying accounting measures because they’re highly profitable and growing fast
The primary driver of investment returns is risk, and asset allocation determines the risk in your portfolio
There are three general asset classes: cash, stocks, and bonds
Fixed Income Asset Classes incl. cash equivalents, short-term US gov’t bonds, short-term municipal bonds, high quality short-term corporate bonds, high-quality short-term global bonds
Equity Asset Classes incl. US (large, large value, small, small value), international (large, large value, small, small value) emerging markets (large, small, value), and real estate stocks (domestic, international)
Cash incl. treasury bills, certificate of deposit (CD) aka GIC in Canada
How to choose your asset allocation:
Emotional tolerance for risk: if you can withstand short-term pain then without selling at a loss out of panic, you can tolerate higher risk
Your age: Younger investors have time to withstand the short-term ups and downs of the market

Ch3: Diversification

First decide on how to allocate portfolio between the general asset classes, then decide how to diversify within each asset class
Per Nobel Laureate economist Harry Markowitz, the blended portfolio of A and B has a lower volatility (lower standard deviation) than either portfolio A or portfolio B
Author’s recommendations are:
invest in S&P 500 Index because the 500 companies account for 70% of US market cap
invest in US small cap and value to diversify and increase portfolio expected return
invest in real estate to further diversify against traditional equity asset classes
US makes up <50% of world’s equity market value so diversify with emerging market securities (companies’ stocks in developing countries)
invest in high quality domestic and international bonds with <5 year maturity to reduce overall volatility, more liquid

Ch4: Active vs Passive

Active managers use stock picking and market timing to attempt to “beat the market” relative to their benchmarks, they can’t because….
can’t reliably predict the future,
misses large gains/losses concentrated in a few trading days
keeps cash on hand to be able to jump on the next great investment opportunity which loses out on time in the market
style drift where a large value cap manager may start pursuing large growth stock because they’re predicting large growth stocks will “take off”, you lose control of diversification
they costs more to pay for trading transaction costs, research, and tax exposure (more turnover means more capital gains)
Passive managers invests in broad asset classes to deliver market-like returns, often via indexing (buying all the securities within the benchmark index)
Efficient Markets Hypothesis asserts that no investor will consistently beat the market over long periods of time except by chance, and studies show most mutual funds fail to beat their benchmarks; prices can be wrong but it’s random and unpredictable

Ch5: Rebalancing Decision

Rebalancing is required when over time your portfolio has drifted away from its original or targeted asset class percentages
For example, if equities increase in value then your 60/40 portfolio could drift to 70/30 and expose you to a higher risk level so you need to sell equities and/or buy more fixed income
Rebalancing allows us to buy low and sell high, without emotions getting in the way
Rebalancing methods:
Rebalance on a fixed frequency, such a quarterly, annually
Place rebalancing trades only in tax-deferred accounts

Ch6: Compared to What?

What people refer to as “the market” is the S&P 500 index, aka domestic large company stocks
Compare your portfolio against a benchmark with similar risk and target asset class, e.g. compare your bonds to those of similar average maturity and credit quality

Ch7: Alternatives?

How are exclusive hedge funds, private equity funds, commodities, and non-traditional investments different from the traditional (equity, fixed income, cash) asset classes?
Alternative investments are worse than traditional investments because…
don’t necessarily have higher returns
increased risk due to using a lot of borrowed money
making concentrated bets
trading excessively
relying on subjective forecasts
lower liquidity so you cannot withdraw your money
Hedge Funds:
invests in distressed debt, currency movements, commodities, corporate mergers, and uses strategies such as short-selling
three common characteristics are
high manager’s compensation, typically 1.5% of assets and 20% of profits
leverage to magnify returns
low liquidity, restrictions on withdrawing your investment
In 2009, 784 new hedge funds were started while 1023 closed, with 60% of them disappearing in <3 years (like a restaurant!)
Private Equity (incl. Venture Capital):
invests in private companies or take public companies private using large amounts of debt (leveraged buyout) or venture capital
adds value by becoming directly involved in management to drive efficiency and growth
aim is to sell the company for more than its initial investment, through IPO, acquisition, or recapitalization (company strong enough to borrow and repay owners)
locks in your investment because takes 5-6 years to realize successful outcomes
high management and profit sharing to compensate private equity managers
more riskier because invests on margin in start-up or early development companies
Commodities (gold, oil, gas, etc.):
can be invested via mutual funds, futures contracts (betting on future price of a commodity), exchange traded funds, or directly owning them if you have storage
categories include agricultural products (grain, food, fiber), livestock and meat, precious and industrial metals (gold, silver), and energy (oil and gas)
the idea is to serve as an inflation hedge; but commodities are very volatile in short-term (more than inflation)
does not produce earnings, if you make money, someone else is losing money
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