Around The Fire

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Investing - Part I	5/14/2009
I have been doing this blog for over two years now. I have been setting the stage trying to lead up to a time when I could introduce my philosophy on investing. There is a reason why I have been in no rush. I wanted to cover all the subjects I needed to before I could talk about investing with a straight face. You see, it isn't until we can meet our normal daily cash needs, we have our high-interest debt paid off, we have our Emergency Fund set up and our Insurance needs are being adequately met that we can begin to accumulate enough money to invest. There are many of us who simply cannot afford to invest because we do not QUALIFY to invest. I will therefore assume that anyone interested in investing has read my previous blogs, has their BASIC finances in control and is now beginning to accumulate enough to invest. What is investing? Investing is trusting other people to do enough of the right things to make us money. Therefore, putting money into a savings account, CD or money market account is not really investing. These are, however, all good, safe places to stick our Emergency Fund dollars. Investing is trusting other people to take our money and grow an enterprise so that it can pay us dividends and/or grow in value (equity securities) or it is trusting other people to pay us back money we have loaned them with interest (bond securities). Investing can also be trusting other people to pay more for something later than we paid for it (raw land and commodities). As we all know, trusting in other people's actions produces life's greatest risks but also life's greatest rewards. There is a multitude of investment opportunities with which we are constantly bombarded. The financial services industry is to a large extent, in my opinion, the most unneccessary and over-used group of individuals in our economy. What makes me say this??? Its simple. Most people in the financial services industry are "active" investors. I am a "passive" investor. I believe in "passive" investment management (sounds like an oxymoron, doesn't it?). Let me explain. Passive investment management makes no attempt to distinguish attractive from unattractive securities, or forecast securities prices, or time markets and market sectors. Passive managers invest in broad sectors of the market, called asset classes or indexes, and, like "active" investors, want to make a profit, but accept the average returns various asset classes systemically produce. Passive investors make little or no use of the information active investors seek out. Instead, they allocate assets based upon empirical research delineating probable asset class risks and returns, diversify widely within and across asset classes, and maintain allocations long-term through periodic rebalancing of asset classes. I am a big advocate of "index investing". Index investing is a form of passive investing in which portfolios are based upon securities which sample various market sectors. The Dow Jones Industrial is, in fact, such an index. Indexes are available for most domestic and international markets, and rise and fall as individual securities within the index rise and fall. Why do I have such faith in investing in indexes? First, I view the playing field as being as big as the ocean. I want to diversify my investments as much as possible so that when the ocean's tide rises, I don't miss anything. Indexes encompass all possible forms of investment, so they are inclusive. Index funds include stocks, bonds, real estate, metals and other commodities. Therefore the diversification I am seeking is possible with index funds. Second, again in the interest of diversification, I want to hold a little bit of MANY offerings within my investment groups rather than a lot of a FEW offerings. Index funds might include dozens or even hundreds of offerings within each Asset Class in which they have holdings. Third, we have at our disposal data going back to year 1900 which shows that, despite such small distractions as the Great Depression and other slumps, the U.S. economy is, in fact, a "rising tide". Please look at index data by going to http://www.stockcharts.com/charts/historical/. These charts show that, by betting on the wide indexes of US securities, I am betting on a proven winner. Furthermore, investing in indexes is an INEXPENSIVE and LAZY way to make money...I can acquire them without paying commissions and let them do the work for me. Statistics show that because of increased costs (like commissions) and risks, about 75% of active managers, as a group, underperform passive portfolios during any given year and, over time, this percentage increases until only a few outperform market averages. The really scary thing is that all active managers fancy themselves in this group of a few. Will these index investments ALWAYS pan out? Although life holds few guarantees, I would say that success is likely, if we can just let these investments rise like a cake baking in the oven for AT LEAST five years. More on investing next time. Cheerio! back