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In his chapter on debit spreads, Rick Swope uses a baseball analogy to explain their advantage over long calls/long puts. “Debt spreads”, he argues, “give you the opportunity to profit more often, rather than achieve more profit.” The analogy he uses is this. Using long puts/long calls is like swinging to hit a homer. Using debit spreads is like bunting to get a man on base. Everyone would like to hit homers, but they strike out more often than not. Going for singles and doubles is a lot easier. The returns aren’t as high, but they are a lot more assured.

Though he didn’t use the same words, Ben Graham meant the same thing in making his distinction between ‘Defensive Investors’, ‘Enterprising Investors’, and ‘Speculators’. Defensive Investors want things to be easy and safe for themselves, and they are willing to accept very modest returns. (In fact, they have no other choice.) Enterprising Investors want more than modest returns, and they are willing to accept the risk and work of achieving them. Speculators seek even higher returns, which doesn’t mean they have to work very hard, but they do have to accept a huge amount of risk, so much so that most positions go bust on them. Only a few pay off, but when they do, they pay really well.

Going back to the baseball analogy, Defensive Investors are content to hit singles and doubles, and they almost never strike out at the plate. Speculators want homers. They swing for the fences, and they don’t worry about striking out more often than not. Enterprising Investors play the middle ground, hitting an occasional homer, but mostly singles, doubles, and triples and suffer an occasional strike out. OK, keep that thought in mind and consider this. In a Fibonacci series (once it is initiated), each successor is the sum of its two predecessors, thus, 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. If the return possibilities are singles, doubles, triples, and homers, then a table like the following can be constructed for our three investor types:

Defensive Enterprising Speculative
Singles 1% 3% 0%
Doubles 2% 5% 0%
Triples 3% 8% 0%
Homers 5% 13%-21% 34%-144%

Obviously, the likelihood of each payoff would need to be estimated, but generally speaking, the higher the return, the less likely its occurrence. OK, keep that thought in mind and consider another one, namely the one made by Bogle and the advocates of passive indexing. They argue, and the Dalbar studies confirm, that average investors fail to achieve returns that match their relevant benchmark. In fact, they under-perform by a far wider margin than just the expenses incurred by owning a derivative that tracks an index. So, if they can’t beat the market, and since they don’t even come close to matching the market, why don’t they try to own the market by buying one of Bogle’s funds?

In fact, they do buy Vanguard’s funds (or similar), but “…the alpha created by portfolio management is lost to the average investor, who generally abandons investments at inopportune times, often in response to bad news.” (2012 QAIB, p. 5) In other words, they screw up on their market-timing by doing what the Dumb Money always does. They buy high, and they sell low. Predictably, the Dalbar study argues that financial advisers should constrain investors from jumping in and out of markets. But this approach assumes the validity of Buy-and-Hold, which, at best, is merely an optimized betting scheme that fails badly out of sample. An alternative approach is accept the well-known fact that markets can be timed successfully and to learn how to do it for yourself. To that end, some books are listed below that you might want to consider and then apply their ideas (none of which contradict Ben Graham's advice, and all of which complement it) to your bond-investing.

To every thing there is a season, and a time to every purpose under the heaven: A time to be born, and a time to die; a time to plant, and a time to pluck up that which is planted.
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