To be fair, I must note that a few theorists have offered a plausible case against reversion based on chaos theory, arguing that “off-the-chart” results occur in real life that normal statistics claim are impossible. (For instance, based on the calculated daily volatility of stocks, there is simply no way the U.S. stock market could Read more »
Lesson 10 – The Market Is Not a Pure Coin Flip
In the previous lesson, I promised to provide three reasons to use the median (which improves with diversification) instead of the mean (which does not). I’ll start with my weakest argument, although it is one shared by many academics in the field of finance: Equity returns revert toward long-run averages. The book that first popularized Read more »
Lesson 9 – The Average Meaning of Average
In the last lesson on Modern Portfolio Theory, I used an example involving coin flips that showed the results of a normal outcome of heads and tails for one coin and then for two coins in order to show the surprising benefits of diversification (lower risk combined with higher returns). More than one reader (but Read more »
Lesson 8 – Modern Porfolio Theory
Please read this one slowly (and, hopefully, more than once). Modern Portfolio Theory (MPT) is one of the most important concepts in investing to understand. It isn’t obvious: indeed, Harry Markowitz won a Nobel Prize in economics for coming up with this idea in 1951. (So the idea isn’t really all that modern at this Read more »
Lesson 7 – The Problem of the Short Term
People sometimes get the impression that I think all investors, regardless of their personal circumstances, ought to keep 100% of their investment funds in stocks all of the time. Now I won’t be so disingenuous as to say, “Nothing could be further from the truth.” But I will say that isn’t the truth. As books such Read more »
Lesson 6 – The Real Meaning of Safety
There are some people who believe that a retiree’s portfolio should consist primarily of “safe” investments. In this context, safe generally means low volatility. If, for example, you keep all your money in a federally insured bank account, then it will never have a day when it goes down in value. There are, however, two Read more »
Lesson 5 – What about Inflation?
In the previous lesson, I showed you a quick and dirty method for estimating the lump sum you would need in order to finance a comfortable retirement. The method we used was to determine the purchase price of an immediate fixed annuity that would provide you with the periodic payments you desire. The problem with Read more »
Lesson 4 – How Much Do You Need to Retire?
There are several factors that will determine how much in investable assets you need to be able to live off of them for life. Fancy software exists to help you with these calculations. All you need to know for planning software to work is how much you’re going to earn each year for the rest Read more »
Lesson 3 – How Much Do You Spend?
Determining your spending needs is darn near impossible because all of us “need” very little to survive. For millennia, the average person in the world lived on the equivalent of one dollar a day. Only during the industrial revolution did standards of living start rising significantly above that, and only in some countries. Even today, Read more »
Lesson 2 – Financial Independence
For many people, financial planning is synonymous with retirement planning. In my view, however, retirement itself is not necessarily a worthy goal. First and foremost, you should find work you love and not be engaged in activities that mainly inspire you to daydream about when you won’t have to be doing them. We’ll talk more Read more »