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No. of Recommendations: 6
"Like most other Fools, I am convinced that with a modicum of effort, anyone can pick stocks that will outperform the historical 10.2% average annual return of the S&P 500."
http://www.fool.com/news/commentary/2004/commentary040513sj.htm?source=mppromo

With a modicum of effort? I never realized it was so easy to beat the market.
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No. of Recommendations: 4
With a modicum of effort? I never realized it was so easy to beat the market.

Ah, the overconfidence of youth...

T
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No. of Recommendations: 13
Ah, the overconfidence of youth...

Definitely.

I think it's pretty incredible that TMF, as a group, routinely promotes a philosophy that is 180 degrees different from mine on a number of issues.

This article almost has an infomercial feel to it. I'm surprised the headline wasn't:
"Beat the market in only 5 minutes a day!!!"

In my opinion, TMF should be encouraging investors to do *more* work, not less. In fact, for investors who are selecting their own stocks rather than investing in a mutual fund or hiring an investment advisor, they should be doing *much* more work. If you don't want to do the work, then either find someone who *will* do the work (i.e. an investment advisor) or dollar-cost-average into a mutual fund (preferably an index fund) and let it ride.

The article says this:
"Strategic sloth often means doing a bit more work now in order to spare yourself in the future."
I think this message gets lost considering the article promotes the "virtue" of laziness.

Telling an inexperienced investor that they can be lazy, concentrate in a few stocks, and beat the market seems dangerous to me.
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No. of Recommendations: 2

"In my opinion, TMF should be encouraging investors to do *more* work, not less. In fact, for investors who are selecting their own stocks rather than investing in a mutual fund or hiring an investment advisor, they should be doing *much* more work. If you don't want to do the work, then either find someone who *will* do the work (i.e. an investment advisor) or dollar-cost-average into a mutual fund (preferably an index fund) and let it ride."

Good Point.

I went to the Wesco meeting this year and Charlie made the following comment on Investing Overconfidence: "Most people who try it don't do well at all. But the trouble is that if 90% are no good, everyone looks around and says, I'm the 10%."

In fact TMF is implying that 100% of us can be part of that 10%:-)

I think Charlie's emphasis on proper thinking is so important. The first rule is not to fool/Fool yourself.
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No. of Recommendations: 1
Telling an inexperienced investor that they can be lazy, concentrate in a few stocks, and beat the market seems dangerous to me.

This philosophy might have come out of the old Foolish Four strategy, which claimed to beat the market with just 4 stocks. Apparently that strategy didn't do badly in the bear market but the Fool killed it long ago. Don't know how well the Dogs of the Dow strategy has done of late - especially since several dogs were booted out recently.

I agree that there's a minimum time commitment below which it's not a good idea to be investing in individual stocks. However, there's also something to be said for not spending too much time analyzing your portfolio. Average individual investors will never be accounting wizzes, nor should they try to be. Even analysts with extensive accounting experience were blindsided by Enron and Worldcom!

In my experience, picking some solid companies with good management teams and letting them ride through ups and downs, dollar cost averaging along the way, works quite well. Compared to mutual funds, this minimizes taxes and trading costs. You just have to make sure that you pick the right companies and don't overpay.

That's the trick, isn't it.

Best,
Calpinist

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Sheesh, yes it is a dangerous to imply that anyone can do this little and earn that much.

I'm pretty new at this, and just completed what I would consider my first full year of investing results (as of 4/30/04). I did beat the market indexes -- except for roughly equaling the Nasdaq over that period.

But I also estimate that I put about 500 hours of time into that year of studying and working on ideas. The better results (those I wouldn't attribute to being simply lucky) definitely came as the accumulated knowledge started kicking in. I.e. for example this calendar year I'm substantially above the indexes -- but still not very good on an absolute scale.

I think that to continue getting good results I would not be able to feel comfortable with less than a couple hundred hours a year, and probably still more like 500.

-Mike (mklein9)
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No. of Recommendations: 1
Even analysts with extensive accounting experience were blindsided by Enron and Worldcom!

Only because they couldn't understand it but invested anyway.

I looked at both stocks during their heyday and went running in the other direction. And that was before evidence of massive fraud came out.
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No. of Recommendations: 3
Seth's article typifies the concept of "innumeracy."

Assuming that the "average return" in the stock market, going forward, is 10.2%, then by definition, one must OUT PERFORM the market to beat that average. In other words, by definition, to beat the average return, you must be an "above average" investor.

Simple, no?

Therefore, Seth's thesis--that "anyone" can beat the market's average return--is by definition, logically flawed. Only an above-average investor can beat the market average. To significantly beat the market average, one must be significantly better than the average investor.

The whole point of index funds rests with the notion that, net of costs and fees, and allocating a value to the time the investor spends researching stocks, etc. it is extremely difficult for the "typical" investor to "beat the averages" at a given level of risk.

TMF has to put out articles like this because of the stock-picking services it sells.
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No. of Recommendations: 3
"Like most other Fools, I am convinced that with a modicum of effort, anyone can pick stocks that will outperform the historical 10.2% average annual return of the S&P 500."

Bartender, the drinks are on me. Outperformance for everyone!
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No. of Recommendations: 24
Even analysts with extensive accounting experience were blindsided by Enron and Worldcom!

Only because they couldn't understand it but invested anyway.

I looked at both stocks during their heyday and went running in the other direction. And that was before evidence of massive fraud came out.


I looked at Enron. It was my type of company. I like companies that feed off of the commerce of others. I don't mean feed in a derogatory way. I mean companies that earn on override on economic activity, such as those selling advertising, or providing back office services to businesses. It is the old tollbooth theory, take a little off the top from everyone. I would rather sell insurance to car manufacturers than manufacture cars. I don't care which manufacturer is successful, they all need insurance.

Fortunately, I was also chased away from Enron because I couldn't understand just exactly how they made their money. And, I think what really worried me is that they were reporting huge profits in a type of enterprise that didn't even exist, at least to that extent, until just recently. Well, as it turned out, that industry really didn't exist.

To me, this is one of the biggest warning signs of investing. I ran into this again with Cendant. I don't remember the names of the companies involved that merged to become what we now know as Cendant, but one of them was cooking the books, just like Enron. I also couldn't figure out how that company was making as much money as it was reporting for what it was doing.

When you see a company that is reporting huge profits in some economic activity that is completely foreign to you, not because you are an uninformed person, but simply because such activity doesn't seem to fill an economic need of such magnitude, be very cautious.

This will keep you out of trouble much more often than it will cause you to miss some golden opportunity. Back during the tech.bomb mania, companies that were going to sell groceries over the internet had multi billion dollar market caps. That was just so wrong.

If the books are too good to be true, they aren't.
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No. of Recommendations: 1
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> Only because they couldn't understand it but invested anyway.
>

Thanks, MadCap, for saying what I was about to say. Buffett says that if you can't easily read and understand a company's financials, they're doing that on purpose, to hide something.

Why would anyone want to throw money at someone who wasn't giving them the full scoop? I dunno, but an awful lot of folks did, to their regret now, all these years later.
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No. of Recommendations: 4
Fortunately, I was also chased away from Enron because I couldn't understand just exactly how they made their money. And, I think what really worried me is that they were reporting huge profits in a type of enterprise that didn't even exist, at least to that extent, until just recently. Well, as it turned out, that industry really didn't exist.

fwiw, Enron's annuals and eps releases are still available online:


http://www.enron.com/corp/investors/

This is good one:

http://www.enron.com/corp/pressroom/releases/2001/ene/68-3QEarningsLtr.html

Non-recurring charges totaling $1.01 billion after-tax, or $(1.11) loss per diluted share, were recognized for the third quarter of 2001. The total net loss for the quarter, including non-recurring items, was $(618) million, or $(0.84) per diluted share.

“After a thorough review of our businesses, we have decided to take these charges to clear away issues that have clouded the performance and earnings potential of our core energy businesses,” said Lay.

some issues...

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No. of Recommendations: 2
"Like most other Fools, I am convinced that with a modicum of effort, anyone can pick stocks that will outperform the historical 10.2% average annual return of the S&P 500."

The above statement does sounds somewhat like the claims about losing weight with no exercise. Can it be done? I suppose so. Is it likely? No.

I should note that my mother inherited a basket of stock that has trounced the market over the last twenty years. I have no idea how she has done in some shorter term increments but the last 20? Unbelievable. And she has not sold a one or bought any either. Solid blue chips and she hasn't reinvested any dividends but used them to live.

Sandor
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No. of Recommendations: 2
>
> Only because they couldn't understand it but invested anyway.
>

Thanks, MadCap, for saying what I was about to say. Buffett says that if you can't easily read and understand a company's financials, they're doing that on purpose, to hide something.

Why would anyone want to throw money at someone who wasn't giving them the full scoop? I dunno, but an awful lot of folks did, to their regret now, all these years later.
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And after over 35 years as a tax accountant, They will do it over and over and the closer they get to retirement the greater the risk they will take as they are behind in their compounding (but it is never their fault).
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as WEB said in one article I read, "You either get it in about 10 minutes or you never get it."
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Most people will trust their "barber" or "taxi driver" but never look at an annual report.
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Education doesn't equal "common sense"
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JMHO
Chuck
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No. of Recommendations: 3
I should note that my mother inherited a basket of stock that has trounced the market over the last twenty years.

She actually computed the compound annual rate of return and compared it to a market benchmark?

If she did, that's great, but it is so rare for someone to actually compute their rate of return (and rarer still for them to do it correctly), and I feel that this leads to overconfidence.
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She actually computed the compound annual rate of return and compared it to a market benchmark?

Well as amazing as it may seem, I helped her do it. Not sure if I did it EXACTLY to your specs but here are the numbers.

S and P 500 was at 160.91 the day the account was turned over to her. Now it is 1087.12 (May 10th). That is a return of 9.97% annualized. The account was just under 100K and now is just over 1.8 million. Return on original investment is 15.57%. I wasn't about to go all the way back and figure the TOTAL return. Besides, she has NEVER reinvested dividends. What a shame but she is a widow and needs the income.

In addition, she has never added money to this account. The only challenge is that one stock represents almost 40% of the total dollar amount. And approximately the same amount of income.

Does this make her account more volatile? Of course, but with the capital gains she would owe and the income that would require replacing she is standing pat.

Sandor
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No. of Recommendations: 1
These new stocks that are destined to beat the market will (I am sure) find the same death that all the other Motley Fool Rule Breaker, Rule Maker, Account Breaker, etc ideas have found, a quiet burial under some rock, never tbe be autopsied under teh light of dat by TMF, and never to be learned from.

I am still waiting for all the great perfromance figures from inception to conclusion for all those other sure fire portfolios....
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Hey, let's face it. We all think that it is easy to beat the market.

That's why we've invested in BRK!

AW
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"I'm pretty new at this, and just completed what I would consider my first full year of investing results (as of 4/30/04). I did beat the market indexes -- except for roughly equaling the Nasdaq over that period."

If you can match the glamour index during a bull market, then you've done well, so long as you beat the tar out of it during bear markets.

"But I also estimate that I put about 500 hours of time into that year of studying and working on ideas. The better results (those I wouldn't attribute to being simply lucky) definitely came as the accumulated knowledge started kicking in."

It sounds like you're on the right track. I've found that I need to put less and less time into it as the years go by. I find that the same good businesses keep popping up as good investments.

"for example this calendar year I'm substantially above the indexes -- but still not very good on an absolute scale."

Here's one way to look at it: If you lose 5% while the overall market loses 20%, then you're going to find a lot of very good investments in the overall market after it has declined. And since you haven't lost much money during that time, you are then able to invest in the really good investments. In my book, relative performance to the overall market counts as a big plus.

DeliLama
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She actually computed the compound annual rate of return and compared it to a market benchmark?

Well as amazing as it may seem, I helped her do it. Not sure if I did it EXACTLY to your specs but here are the numbers.

S and P 500 was at 160.91 the day the account was turned over to her. Now it is 1087.12 (May 10th). That is a return of 9.97% annualized. The account was just under 100K and now is just over 1.8 million. Return on original investment is 15.57%. I wasn't about to go all the way back and figure the TOTAL return. Besides, she has NEVER reinvested dividends. What a shame but she is a widow and needs the income.


I don't know if I agree with your return calculation since I don't know the starting date. Also, dividends are obviously an important part of the return, so without knowing the dividend component, you can't state that she beat the S&P 500.

I have an Excel spreadsheet that can be used for return calculation that I talked about here:
http://boards.fool.com/Message.asp?mid=20157964

It won't work in your case though since you don't know the dividends (which would have to be treated as a cash outflow in my spreadsheet since she doesn't maintain the dividends in her account).
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I don't know if I agree with your return calculation since I don't know the starting date. Also, dividends are obviously an important part of the return, so without knowing the dividend component, you can't state that she beat the S&P 500.

I think I can state that without it being a leap. Her port. would be at 668,724.32 assuming the same return as the s and p.(9.97%) There is no way I can imagine that the s and p income would have been 1.1 million dollars. Plus that doesn't take into account the income she got either.

I was only trying to make a point. Make sense?

Thanks for the speadsheet.

Sandor
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No. of Recommendations: 1
She actually computed the compound annual rate of return and compared it to a market benchmark?

Well as amazing as it may seem, I helped her do it. Not sure if I did it EXACTLY to your specs but here are the numbers.

S and P 500 was at 160.91 the day the account was turned over to her. Now it is 1087.12 (May 10th). That is a return of 9.97% annualized. The account was just under 100K and now is just over 1.8 million. Return on original investment is 15.57%. I wasn't about to go all the way back and figure the TOTAL return. Besides, she has NEVER reinvested dividends. What a shame but she is a widow and needs the income.

I don't know if I agree with your return calculation since I don't know the starting date. Also, dividends are obviously an important part of the return, so without knowing the dividend component, you can't state that she beat the S&P 500.

I have an Excel spreadsheet that can be used for return calculation that I talked about here:
http://boards.fool.com/Message.asp?mid=20157964

It won't work in your case though since you don't know the dividends (which would have to be treated as a cash outflow in my spreadsheet since she doesn't maintain the dividends in her account).


***************

There's another extremely important factor in comparing the return of OP's mother's portfolio to the "market."

OP stated that fully 40% of the portfolio was invested in one stock. Since OP's portfolio is overweighted in that stock compared with the S&P 500, the outperformance of OP's portfolio may be almost entirely due to the overweighting in that particular stock. Indeed, the performance of the other 60% of OP's portfolio may have trailed the broad market.

Claiming to have "beaten the market" but without accounting for the difference in weighting of the various stocks is misleading, as the OP's portfolio may have, and in fact almost certainly does, assumed a greater risk or volatility than the broad market, due to the 40% weighting of a single stock.

Given that OP's relative simply inherited the portfolio, and did nothing other than spend the dividends, one must say that the one thing she can be credited with is doing nothing, which saved unnecessary commissions, taxes, etc. Now that's a smart strategy, albeit possibly unintentional in this case.

However, one can't take credit for "beating the market" simply because the portfolio one inherits happens to "beat the market."

Studies show that 90% of the average investor's return is determined by asset allocation (e.g. stocks/bonds/cash/) rather than "stock picking." Over the life of this portfolio, approximately twenty years IIRC, the stock market has had a historically heady boom.




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<< Even analysts with extensive accounting experience were blindsided by Enron and Worldcom! >>

I never understood the appeal of Worldcom. They made countless acquisitions with inflated stock, but never reported any profits.

Their earnings reports talked mainly about EBITDA since net income was always negative. More than likely, their cash flow was negative also, but I was not a cash flow analyst at that time.

The story was that eventually they would reach an economy of scale and become profitable.



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It won't work in your case though since you don't know the dividends (which would have to be treated as a cash outflow in my spreadsheet since she doesn't maintain the dividends in her account).
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Actually the dividends would increase her yield as she payments from the annuity.
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It won't work in your case though since you don't know the dividends (which would have to be treated as a cash outflow in my spreadsheet since she doesn't maintain the dividends in her account).
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Actually the dividends would increase her yield as she payments from the annuity.


Huh?
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No. of Recommendations: 8
"OP stated that fully 40% of the portfolio was invested in one stock. Since OP's portfolio is overweighted in that stock compared with the S&P 500, the outperformance of OP's portfolio may be almost entirely due to the overweighting in that particular stock. Indeed, the performance of the other 60% of OP's portfolio may have trailed the broad market."

This is ridiculous. Assuming the numbers presented are true, she DID trounce the market. If she did it with one stock, that's fine. How many Berkshire millionaires trounced the market with that one stock? Do you think you're automatically more sophisticated than them because you owned more? And anyway, as far as you know, it could have been the other 60% that outperformed, and that one may have been a loser. You seem to have a bias against an extremely concentrated portfolio, which is actually the most critical element in lasting outperformance. And as to risk, it is also quite wrong to assume that her concentration lead to more risk. Buffett has taken a concentrated approach, and his win:loss ratio is 100:1.


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The real question is, can you beat the market without taking undue risk.
I was a energy trader at enron, and I was very good at looking at the fundamentals of the market, converting that into a worldview, and building a trading strategy around that. I had a ROE that quite easily beat the market, however I was also riding a WHOLE lot of risk. And most of that risk/ROE came from the large amounts of leverage futures contacts offer. I always tried to manage that risk by working my tail off to know more than the other traders.
It is EASY to get a return great than the S&P 500, but your going to have to hold the bag on a lot of risk. It is pretty hard to beat the market without loading up on risk.
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No. of Recommendations: 1
"OP stated that fully 40% of the portfolio was invested in one stock. Since OP's portfolio is overweighted in that stock compared with the S&P 500, the outperformance of OP's portfolio may be almost entirely due to the overweighting in that particular stock. Indeed, the performance of the other 60% of OP's portfolio may have trailed the broad market."

This is ridiculous. Assuming the numbers presented are true, she DID trounce the market. If she did it with one stock, that's fine. How many Berkshire millionaires trounced the market with that one stock? Do you think you're automatically more sophisticated than them because you owned more? And anyway, as far as you know, it could have been the other 60% that outperformed, and that one may have been a loser. You seem to have a bias against an extremely concentrated portfolio, which is actually the most critical element in lasting outperformance. And as to risk, it is also quite wrong to assume that her concentration lead to more risk. Buffett has taken a concentrated approach, and his win:loss ratio is 100:1.

*************************

I think I didn't make my points clearly enough; permit me to try again.

1. OP's mother didn't "beat" anything. She inherited a pre-existing portfolio. Her smartest move was actually doing "nothing", thus saving taxes, transaction costs, and avoiding chasing returns of hot sectors/stocks. (You can't succumb to internet fever if you're not trading, right?) The average investor, in for the long term, with a basket of large caps for a portfolio, at least during the past twenty years, probably had the best returns by simply "sitting pat,"
allowing a rising tide to lift all boats.

2. The main point, however, is that "performance" should be measured by risk-adjusted return, not simply by raw "return." If, in order to achieve an above-average return, your portfolio must assume greater risk, then your excess returns--or at least a large part of those excess returns--may simply be a function of having a portfolio with a higher risk or volatility than that of the broad market. Thus, your superior results may not be really due to superior stock picking, but rather, due to the overweighting of your portfolio in a particular stock which happened to outperform the market during the period in question.

Think of it another way: OP's mother's portfolio could have shown TWICE the return if all the stocks had been bought on a 50% margin (disregarding margin interest costs, tax effects, etc.) However, the bigger return would have purely been a function of assuming a riskier (i.e. leveraged) portfolio. She would have a superior return, but this would have nothing to do with "stock picking." Conversely, if the market had declined during the relevant period, she would have lost twice as much money.

The same type of logic applies when comparing a portfolio so heavily overweighted in one stock (e.g. 40% of the portfolio!). Depending on a more specific analysis, the excess performance of the portfolio could be entirely attributable to that one stock, which may have been a "lucky hit." Conversely, had that one stock been an "unlucky hit", OP's mother's portfolio might have badly underperformed the market.

The comparison to WEB is inapposite. Remember, OP's mother exercised no decision-making in terms of individual stock selection, other than simply retaining what she inherited. Was that a good decision? Does that show she's a good "stock picker"?

On the contrary--if her strategy was to concentrate the portfolio, and she anticipated that one particular stock would outperform the rest, she should have sold off the other 60% of the portfolio and invested all in the one stock--now, had she done this, you could possibly compare it to a Buffet/Munger strategy.

I have absolutely no "bias" against a concentrated portfolio. However, this thread was started to examine the notion of whether "anyone" could "beat the market." If you are inheriting a portfolio, decide not to make any changes, what proof is there that you have consciously made an investment allocation decision by which you could be said to have "beaten the market"?






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The real question is, can you beat the market without taking undue risk.

The answer to that is ABSOLUTELY. Buffett has proved it time and time again.

The problem is that it ain't easy, no matter what TMF would have you believe.
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"The main point, however, is that "performance" should be measured by risk-adjusted return, not simply by raw "return." If, in order to achieve an above-average return, your portfolio must assume greater risk, then your excess returns--or at least a large part of those excess returns--may simply be a function of having a portfolio with a higher risk or volatility than that of the broad market. Thus, your superior results may not be really due to superior stock picking, but rather, due to the overweighting of your portfolio in a particular stock which happened to outperform the market during the period in question."

You're confusing I-need-a-formula-to-go-with-my-theory risk (i.e., beta) with real-life, intuitive risk (i.e., the chance I might permanently lose my money). True risk is determined by the quality of the businesses one owns (i.e., the strength and durability of their moat) and on the price one paid to acquire them. Five truly great stocks obtained a great prices would beat the market, AND
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"The main point, however, is that "performance" should be measured by risk-adjusted return, not simply by raw "return." If, in order to achieve an above-average return, your portfolio must assume greater risk, then your excess returns--or at least a large part of those excess returns--may simply be a function of having a portfolio with a higher risk or volatility than that of the broad market. Thus, your superior results may not be really due to superior stock picking, but rather, due to the overweighting of your portfolio in a particular stock which happened to outperform the market during the period in question."

You're confusing I-need-a-formula-to-go-with-my-theory risk (i.e., beta) with real-life, intuitive risk (i.e., the chance I might permanently lose my money). True risk is determined by the quality of the businesses one owns (i.e., the strength and durability of their moat) and on the price one pays to acquire them. Five truly great stocks obtained a great prices would beat the market, AND be less risky. Now, if you cannot determine with confidence what is truly great or what a great price is, THAT is where the risk comes in, not from the number of stocks you have in your portfolio. What was riskier in April 2000, owning the S/P 500 at 1520 or having all your money in BRK.A at $42,000? If forced to chose, I'd take the latter any day, forget beta.
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Actually the dividends would increase her yield as she payments from the annuity.
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OOps, I meant that the dividends were payments received from her annuity much like the interest payments received from a bond.
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If you have a loan program such as "TValue 5" you can calculate the compound yield fairly easily. Treat the starting balance as a loan, the additional moneys put in as additional loans, all moneys taken out as payments, and the ending balance as the final payment.(whew)
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No. of Recommendations: 5
I have results similar to those of your mother. I have about 11 stocks in my portfolio which for the most part have been there for years. The dividends provide close to half of my retirement income. There is some turnover but not much.
Annually I examine how my stocks are doing versus the S&P 500. The “stock performance graphs” which reporting companies are required by SEC rules to disclose in proxy material make this possible. The comparison is made on a total return basis over the five preceding years. Total return means share price change plus dividends paid with dividends reinvested.
Anyway, during the five year period ended December 2003, the S&P 500 declined from 100 at the start to 97 at the end. In comparison, GE which also started at 100 ended the five year period at 100; Merck ended at 73.75; Johnson & Johnson at 132; Berkshire at 120; American Express at 147; Bank of America at 125; Exxon-Mobil at 126 and Fannie Mae at 104.
The arithmetical average of the foregoing eight is 115.96 which is 19.6% better than 97, the S&P 500 number, or about 4% a year. Because I have no management fees or turnover expense to lower my results, I continue to feel justified in holding individual stocks rather than mutual funds. These results are better than the 80% or more of mutual funds that cannot equal the S&P after fees and expenses. My only mutual fund is Sequoia which charges a flat 1% annual fee, has a 3% turnover the costs of which were borne last year by the management company, not the Fund. The Fund was up 17% in 2003. Other stocks held for long periods include P&G and Automatic Data, both of which are on 6/30 fiscal years. Although I have excluded them from the above because their proxy material will not be distributed until after the close of their fiscal years, PG's excellent recent performance would, I believe, offset ADP's mediocre one.
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Back during the tech.bomb mania, companies that were going to sell groceries over the internet had multi billion dollar market caps. That was just so wrong.

I was a Home Grocer and then later a Webvan customer, when Webvan acquired Home Grocer. I liked the service, it took the "shopping" part out of "grocery shopping."

However, I would never have invested in it, because it was baffling to me how they could be profitable without jacking up prices above supermarket prices, which they did not. Turns out they weren't profitable.

It was nice being a customer while it lasted, though.

- Gus
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This comment might be a product of partial laziness, but I think that although hard work and constant reading can help a lot, the main reason why only 10% of ppl do well is because of the temperament, greedy when others are fearful and vise-versa, not following crown, independence. I think any human with moderate intelligence can eventually derive success if they have those qualities. Even the hard work itself will be a derivate of these..

vg
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You're confusing I-need-a-formula-to-go-with-my-theory risk (i.e., beta) with real-life, intuitive risk (i.e., the chance I might permanently lose my money). True risk is determined by the quality of the businesses one owns (i.e., the strength and durability of their moat) and on the price one pays to acquire them. Five truly great stocks obtained a great prices would beat the market, AND be less risky. Now, if you cannot determine with confidence what is truly great or what a great price is, THAT is where the risk comes in, not from the number of stocks you have in your portfolio. What was riskier in April 2000, owning the S/P 500 at 1520 or having all your money in BRK.A at $42,000? If forced to chose, I'd take the latter any day, forget beta.

owekri

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I'm afraid you misunderstand me. The issue is asset allocation, not "stock picking", since the poster's Mom did not engage in stock picking. The question was how to compare a basket of stocks with the S&P 500 in terms of "performance." When looking at an arbitrary selection of stocks as compared to the S&P 500, in addition to which stocks are in the arbitary selection, one must also determine the percentage that each stock comprises in the portfolio. This is true of evaluating the performance of any capital asset.

To answer your question, in April 2000, it was obviously "riskier" to hold BRK.A at $42,000 vs. the S&P 500 at 1520. Since that time, BRK.A has more than doubled; the S&P 500 has declined by about one third. Thus the "bet" on BRK.A was 3x as risky as the bet on the S&P 500.

In fact, it is [almost] ALWAYS riskier to invest your entire portfolio in a single stock than to invest it in a broad index of many different stocks.

The reason you have trouble understanding this is you're choosing the starting and ending points with hindsight, and arbitrarily. Choosing different arbitrary start and end points, with the same type of hindsight, using your logic, one could easily show that BRK.A was "riskier" than the S&P 500 because it dropped relative to the S&P 500 during that arbitarily-chosen time period.

We are not allowed, however, to INVEST with hindsight. Investing all your assets in BRK.A today is clearly riskier than investing in a broad index fund. However, risk works both ways; if one's analysis is correct, the additional risk leads to an additional pay off.
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"To answer your question, in April 2000, it was obviously "riskier" to hold BRK.A at $42,000 vs. the S&P 500 at 1520. Since that time, BRK.A has more than doubled; the S&P 500 has declined by about one third. Thus the "bet" on BRK.A was 3x as risky as the bet on the S&P 500."

This is nonsense, whether retrospectively or prospectively. Prospectively, on the one hand, one faced an *enormously* small chance that a wonderful collection of diverse companies with terrific management and outrageous financial strentgh would suffer severe, permanent economic collapse, bersus, on the other hand, an enormously *high* probability that the S/P 500 would collapse from what was unquestionably a bubble. If FORCED to pick prospectively between putting everything in BRK at $42,000 vs. s/p 500 @ 1520 in 2000, I'd pick the first every time: it would be far less risky.

As far as your *retrospectively* saying BRK was 3X as risky this is unbelievable nonsense.
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"The reason you have trouble understanding this is you're choosing the starting and ending points with hindsight, and arbitrarily. Choosing different arbitrary start and end points, with the same type of hindsight, using your logic, one could easily show that BRK.A was "riskier" than the S&P 500 because it dropped relative to the S&P 500 during that arbitarily-chosen time period.

We are not allowed, however, to INVEST with hindsight."

Actually, I understand it fine. I just think the Efficient Market Theory and Capital Asset Allocation Models are nonsense.
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"To answer your question, in April 2000, it was obviously "riskier" to hold BRK.A at $42,000 vs. the S&P 500 at 1520. Since that time, BRK.A has more than doubled; the S&P 500 has declined by about one third. Thus the "bet" on BRK.A was 3x as risky as the bet on the S&P 500."

This is nonsense, whether retrospectively or prospectively. Prospectively, on the one hand, one faced an *enormously* small chance that a wonderful collection of diverse companies with terrific management and outrageous financial strentgh would suffer severe, permanent economic collapse, bersus, on the other hand, an enormously *high* probability that the S/P 500 would collapse from what was unquestionably a bubble. If FORCED to pick prospectively between putting everything in BRK at $42,000 vs. s/p 500 @ 1520 in 2000, I'd pick the first every time: it would be far less risky.

As far as your *retrospectively* saying BRK was 3X as risky this is unbelievable nonsense.

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I think you misunderstand the concept of asset allocation based on Modern Portfolio Theory to reduce uncompensated non-systemic risk. In theory, given any set of different capital assets, there is an "ideal" mix which will maximize expected return for a given risk level, or alternatively will minimize risk for a given expected rate of return. One of the goals, if not the goal, of all investing is to maximize one's risk-adjusted rate of return.

This holds most strongly when the assets in question are not positively correlated. In the example you gave, the S&P 500 is negatively correlated to the return of BRK.A. Therefore, it should be theoretically possible to select a portfolio containing some non-zero percentage of both the S&P 500 index and BRK.A.

Because non-systemic risk (i.e. company-specific risk) can in theory be diversified away with no loss of total expected return, the market does not compensate the investor for assuming unnecessary amounts of non-systemic, or company specific risk.

When I speak of company-specific risk, i.e. non-systemic risk, think of something like a meteor hitting Kiewit's steak house during the dinner they have there at the annual meeting. This is somewhat of an exageration, however, when your entire portfolio is invested in one stock, no matter how good of a stock it may be, you unnecessarily expose yourself to non-systemic risk--maybe not a meteor strike, but accounting fraud; WEB getting hit by a cab; Gen Re cooking its books; a WTC terrorist attack (e.g. heavy impact on supercat insurers); etc.

BRK.A only "seems" less "risky" to you because the non-systemic risk may have not manifested itself in a clear way. Nevertheless, that risk is still there, it is to a large extent unquantifiable, and simply ignoring it doesn't mean you're not taking a risk.

This logic is precisely why any competent investment advisor would never tell any client to be fully invested in one asset category. No matter how good you think the stock market will do, a sound portfolio will also have other asset classes (e.g. at least some bonds, and perhaps some REITs, perhaps some cash, etc.)

You will note that WEB himself is very heavy into cash right now. If what you were saying is correct--i.e. BRK.A is "obviously" the best investment going, [apparently at all times], then WEB would be engaging in a BRK.A stock buy-back program. He's not, is he?

I say this as someone with about 25% of my equity investments in BRK.B's, and the rest of my equity investments primarily in index funds.

So don't think my attitude is because I think BRK is a "bad" stock. I think it's great, I think WEB's great. But that doesn't change the analysis.

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"I think you misunderstand the concept of asset allocation based on Modern Portfolio Theory to reduce uncompensated non-systemic risk."

I understand it; I do not agree with it. And I definitely disagree with your definition of risk. Further, this faulty idea of risk leads to all sorts of crazy attempts to eliminate or deal with such risk.

I agree with Buffett's idea of capital allocation: always invest your money in the available investment with the best discernible discount from intrinsic value. If this leads you to an all-stock portfolio, that's fine. If you end up mostly in cash, that's fine. Maybe bonds, maybe real estate...but NOT because of some formulaic division between these assett classes, but rather because a particular assett was more attractive at that time than other available assetts.

"any competent investment advisor would never tell any client to be fully invested in one asset category"

Two points: This is why I would never use an investment advisor, "competent" or otherwise. Two, an investment advisor may not, but Buffett would.
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I think you misunderstand the concept of asset allocation based on Modern Portfolio Theory

Do you actually believe that bunk?
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You've hit on my biggest quarrel with the Fool -- half-truth innuendo marketing. Anyone remember The Unemotional Investor? Unforgettable What's-his-name (Sheard) chalked up something like a 41% annualized return for one of his strategies before the book went to press. Good show! But hinting as the dust jacket did, that such returns are typical of a mechanical investing strategy, is crowding a line that I don't want my investment advisors anywhere near.

How about the full page newspaper ad for the Rule Breaker portfolio a few years ago, trumpeting the RB's returns vs. the S&P 500? DaveG's RB returns were impressive by any measure, and every time an MF strategy pays off, the strategist has every right to brag about it, but turning that bragging into a subtle (or not) marketing suggestion that I can set my investment watch by such numbers is unworthy of the great investing minds at TMF.







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"I think you misunderstand the concept of asset allocation based on Modern Portfolio Theory to reduce uncompensated non-systemic risk."
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I understand it; I do not agree with it.

Fair enough. But a lot of people who placed all their eggs in the tech basket in 1999 would have been a lot better off holding some other asset classes as well. Similarly, a lot of people who put most of their retirement funds or 401-K in company stock ended up crying, too.

And I definitely disagree with your definition of risk. Further, this faulty idea of risk leads to all sorts of crazy attempts to eliminate or deal with such risk.

I might not have stated it correctly, I'm no expert. But it's not my definition. I think the idea of not putting all one's eggs in a single basket is a good place to start and intuitively easy to understand. At a more sophisticated level, call it "hedging one's bets."


I agree with Buffett's idea of capital allocation: always invest your money in the available investment with the best discernible discount from intrinsic value.

--I think WEB's investment philosophy covers a lot broader ground than that. This is a guy with investments in a candy company, a shoe company, a furniture company, insurance companies, lots of cash, foreign currencies, equity stakes in publicly traded companies, a mobile home manufacturer, commodities and junk bonds on occasion, time-share jets, etc. etc. BRK is often described as a quasi-"mutual fund" precisely because of the very broad diversity of WEB's investments.

It seems to me that a large part of WEB's philosophy is preserving capital/avoiding excessive risk. E.g. go for the huge margin of safety; don't go outside your circle of competence; only swing at the fat pitches, etc. Or, big self-criticism in the letter to shareholders for failure to adequately underwrite/reserve for things like terrorist attacks. Or, the concept that it's better to shrink market share of an insurance co. than to lessen underwriting standards.

It might be more accurate to say that WEB's philosophy is "Don't invest at all unless you are reasonably assured of a high risk-adjusted rate of return with a big margin of safety."


If this leads you to an all-stock portfolio, that's fine. If you end up mostly in cash, that's fine. Maybe bonds, maybe real estate...but NOT because of some formulaic division between these assett classes, but rather because a particular assett was more attractive at that time than other available assetts.

--The attractiveness of a particular asset must be measured in the context of one's entire investment portfolio. I find it difficult to imagine that WEB makes any investment decision without considering his entire portfolio mix. I.e. WEB bought junk bonds in 2002 apparently because for some reason the yield was 30-40%, which to him was apparently a "slam dunk." But this was still just a small fraction of the BRK portfolio.

In terms of a "formulaic division", I have no doubt that WEB has some method of asset allocation.

"any competent investment advisor would never tell any client to be fully invested in one asset category"

Two points: This is why I would never use an investment advisor, "competent" or otherwise. Two, an investment advisor may not, but Buffett would.

I wouldn't use an investment advisor either, however, the reason I wouldn't has nothing to do with whether or not they are familiar with the concept of not putting all one's eggs in one basket, which I think is fundamentally a very sound concept.

I suppose in theory WEB would put all his eggs in one basket, but obviously it would have to have an extraordinary high rate of return and margin of safety to sufficiently compensate for the assumption of the non-systemic risk.

My take on WEB is that his investment philosophy is one which is fundamentally risk-averse. (This might not be stated in terms of Modern Portfolio Theory in his case. He follows his own path. Nevertheless, anyone looking to buy equities at below intrinsic value, i.e. the classic "value" investor, operates on the principle of trying to obtain a risk-free return.)
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(One clarification: although I disagree strongly with your ideas, I only disagree as they would apply to an intelligent investor, schooled by the masters of value investing. If you're NOT in this group, then buying index funds and dividing your money might make sense.)


"My take on WEB is that his investment philosophy is one which is fundamentally risk-averse."

Now, at least on this we can agree. I, too, have as Rule #1, Never Lose Money. But for him and I, this has absolutely NOTHING to do with beta/volatility. As he has said, a lumpy 15% is much better than a smooth 12%.
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"In terms of a "formulaic division", I have no doubt that WEB has some method of asset allocation."

He and Munger have both recently said classical assett allocation is garbage. Do you have reason to believe he would mislead on this?
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"Fair enough. But a lot of people who placed all their eggs in the tech basket in 1999 would have been a lot better off holding some other asset classes as well."

I would argue this was not primarily a result of too many eggs in one basket, but rather too many eggs in a basket which by its nature should not hold many eggs.
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"I think WEB's investment philosophy covers a lot broader ground than that. This is a guy with investments in a candy company, a shoe company, a furniture company, insurance companies, lots of cash, foreign currencies, equity stakes in publicly traded companies, a mobile home manufacturer, commodities and junk bonds on occasion, time-share jets, etc. etc. BRK is often described as a quasi-"mutual fund" precisely because of the very broad diversity of WEB's investments. "

Berkshire is so diversified because it is so big. Given its current size, there is no way Berkshire could have just a handful of holdings, unless it were willing to overpay. Buffett has never shied away from making enorous bets when the opportunity arose: American Express (the first time around), GEICO (back in his earliest days, then again with Berkshire), Coca-Cola, GenRe.

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(One clarification: although I disagree strongly with your ideas, I only disagree as they would apply to an intelligent investor, schooled by the masters of value investing. If you're NOT in this group, then buying index funds and dividing your money might make sense.)

I think I'm a victim of "thread drift." At some point we were talking about someone's mom who inherited an existing portfolio and basically just sat on it, spending the dividends. She got an above-market return, but it was not through application of any investment wisdom or strategy.

I believe somewhere in the distant past, this thread started in reponse to some silly TMF article which claimed that investing was easy and that "anyone" [read "every one"] can beat the market by being "lazy". In other words any idiot could beat the market by being an idiot.



"My take on WEB is that his investment philosophy is one which is fundamentally risk-averse."

Now, at least on this we can agree. I, too, have as Rule #1, Never Lose Money. But for him and I, this has absolutely NOTHING to do with beta/volatility. As he has said, a lumpy 15% is much better than a smooth 12%.

It all depends on how "lumpy" the "lumpiness" is and how much of a return one anticipates. Even for Mr. Buffett. Mr. Buffett has a higher tolerance for volatility because he demands a higher risk-adjusted return on investment. In the example you gave above, Buffett makes the 15% returning-investment because he's calculated that the extra risk in the higher-yielding investment is more than compensated for by the 3% excess return.
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"In terms of a "formulaic division", I have no doubt that WEB has some method of asset allocation."

He and Munger have both recently said classical assett allocation is garbage. Do you have reason to believe he would mislead on this?

No, I think they are truthful. Look carefully at the statements--I didn't say that "WEB uses classical asset allocation"; I deliberately chose my language to say that "WEB has some method of asset allocation." Like sitting on a huge cash hoard because he feels equities are priced too high right now. That's a method of asset allocation, and a very defensive one. It may or may not be consistent with a "classical asset allocation", although I'm not really sure what WEB and Munger meant by that.
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"Fair enough. But a lot of people who placed all their eggs in the tech basket in 1999 would have been a lot better off holding some other asset classes as well."

I would argue this was not primarily a result of too many eggs in one basket, but rather too many eggs in a basket which by its nature should not hold many eggs.

Well, it's clear that these people underestimated the risk they were exposed to in having such concentrated portfolios.
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"I think WEB's investment philosophy covers a lot broader ground than that. This is a guy with investments in a candy company, a shoe company, a furniture company, insurance companies, lots of cash, foreign currencies, equity stakes in publicly traded companies, a mobile home manufacturer, commodities and junk bonds on occasion, time-share jets, etc. etc. BRK is often described as a quasi-"mutual fund" precisely because of the very broad diversity of WEB's investments. "

Berkshire is so diversified because it is so big. Given its current size, there is no way Berkshire could have just a handful of holdings, unless it were willing to overpay. Buffett has never shied away from making enorous bets when the opportunity arose: American Express (the first time around), GEICO (back in his earliest days, then again with Berkshire), Coca-Cola, GenRe.

I think you underestimate the man if you believe he is not willing to use every available tool in the investment toolbox. To the extent that asset allocation is one of those tools, he will use it.

Just like if WEB ever sees a technology company for the right price, he would buy it. At a low enough discount to intrinsic value it will be a good enough deal that he will "expand his circle of competence" to attempt to fully understand it.

And many will be shocked because "WEB doesn't buy technology." Guess again--the fat pitch in technology simply hasn't come along yet.


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