This link has been bookmarked by 3 people . It was first bookmarked on 17 Jan 2008, by someone privately.
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12 Feb 08
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17 Jan 08
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On Sound Fundamental Principles of (Passive) Investment
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Most traders lose money.
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active investing, which is an attempt to beat the market, is speculation. To my way of thinking, investment is passive investment.
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Speculation is an attempt to profit, that is, earn an above-average rate of return, by forecasting the future price movements of specific securities
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Investment aims for average returns without forecasting specific price movements. It relies on general price movements
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Speculation is a business and a very difficult business. The number of people who make a profit by starting and running businesses is relatively small, especially in lines of business that are highly competitive. Speculation is a highly competitive business. There are very few highly successful people in any field of endeavor. The average person who attempts to speculate is very likely to fail at it. Studies of brokerage and commodity trading accounts show that upwards of 80 percent of traders who speculate lose money.
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most amateur speculators do not follow sound fundamental principles of speculation
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What then is involved in investment? Various states-of-the-world can happen in the future, in fact, an infinite number of possibilities. The investor makes no effort to discern what these will be and which ones are more likely to occur.
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The investor swears off trying to forecast the future. This means he pays no attention to the investment markets, to changing prices, to the news, to economic data, to political events, etc. He does not let any of those things influence his investment policies.
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second sound fundamental principle of investment is to buy and hold a value-weighted, highly diversified or market portfolio
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low turnover will be a hallmark of a portfolio
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Diversifying properly means really diversifying. This goes well beyond merely buying the major stock index of one’s country.
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If there is one thing that the finance literature shows definitively, it is that diversification pays. The gains of a portfolio rise relative to the losses as one diversifies into more and more different kinds of securities. This means that the average return rises compared to the possible loss or risk, or the ratio of return to risk rises. There is absolutely no question that diversification pays.
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With a few of the Vanguard portfolios, for example, one can in a few minutes time own a portfolio that has thousands of domestic stocks, thousands of foreign stocks, thousands of bonds, gold and precious metals stocks, and participation in hundreds of real estate investment trusts. One can then fine-tune the process if one wants to hold gold as bullion or break down the asset classes into finer sub-divisions
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The market will sometimes be valuing various securities too richly and others too poorly, but you don’t know which is which and neither does the market. But it is doing the best that it can, and its valuations are reflecting huge amounts of information that you have no access to or knowledge of.
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Harry Browne in his little book Fail-Safe Investing explains and justifies a similar passive investment approach. If it will make you feel more comfortable, read his book. I
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I cannot too strongly stress that a highly diversified portfolio of this kind has far lower risk than investing in any single asset class and far, far lower risk than investing in a handful of securities as speculators do.
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