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The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri
asset allocation, backtesting, Bernie Madoff, capital asset pricing model, cognitive dissonance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, Long Term Capital Management, passive investing, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, too big to fail, transaction costs, Vanguard fund, yield curve
—Jim Wiandt, President and CEO, IndexUniverse “Few people understand indexing better than Rick Ferri. In The Power of Passive Investing, Rick clearly explains the sophistication of passive investing and how it will enhance account performance. If you haven’t yet incorporated passive investing into your portfolio, this book will convince you.” —Taylor Larimore, co-author of The Bogleheads’ Guide to Investing and The Bogleheads’ Guide to Retirement Planning “Rick Ferri has brilliantly assembled hordes of unbiased, highly technical investment research so that the average investor can understand and benefit from what the smart money has known for decades. If you care about how much you’ll retire with, you’ll read The Power of Passive Investing.” —Mitch Tuchman, CEO, MarketRiders, Inc. “Rick Ferri has gathered a wealth of research. A passive investment strategy is a great approach because it allows a person to focus on more important things in life.”
The numerous studies he reviews provide powerful support for passive investing and guide trustees and other fiduciaries toward this ideal solution.” —W. Scott Simon, principal, Prudent Investor Advisors, LLC “Passive investments deserve a place in almost all investors’ portfolios, but the range of choices has never been so complex or treacherous. There are now every bit as many flawed, gimmicky, or overpriced index funds as there are those from active managers. If you want to navigate this new terrain successfully, you’ll find Rick Ferri’s The Power of Passive Investing an essential text.” —Don Phillips, Managing Director, Morningstar, Inc. “Powerful! The extensive research behind this book makes a compelling case for a passive investing strategy. Ignore the information in this book at your own peril.”
These facts are well documented in the studies covered throughout this book. So why doesn’t every investor embrace passive investment strategies? The purpose of this chapter is to offer a few general thoughts about why more people don’t go passive when the evidence is so clearly in favor of this way to invest. Three Non-Indexers Non-index investors can be divided into three categories: the uninformed, the naysayers, and the procrastinators. More specifically: 1. The Uniformed: investors who don’t know about passive investing or don’t understand it. 2. The Naysayers: investors who know about passive investing but think they know better. 3. The Procrastinators: investors who understand and accept passive investing but don’t implement the strategy. Not everyone takes the path or knows it exists. There are those who are never enlightened, those who refuse to be enlightened, and those who believe in the strategy but never finish the job.
The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi
asset allocation, backtesting, Bernie Madoff, Black Swan, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index fund, interest rate swap, invisible hand, market microstructure, merger arbitrage, moral hazard, passive investing, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, statistical model, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve
As indicated in the previous chapter, increasing the number of potential asset classes increases both the potential for greater risk management as well as increased return for a predetermined level of risk. As shown in Exhibit 6.2, while the underlying strategic asset allocation may be based on noninvestable benchmarks, an investor’s core portfolio should contain investable passive investments which capture the underlying returns of the noninvestable benchmarks. If an investor desires to increase their potential return without dramatically changing one’s asset class exposure, then, as shown in Exhibit 6.2, adding additional manager based investments (Satellite I and Satellite II) which track the passive investable assets but also may contain potential manager alpha should be considered. 114 THE NEW SCIENCE OF ASSET ALLOCATION Satellite II: Less Liquid Alpha Alternative to Satellite I Investments (Private Equity, Long-Term Lock Up) Satellite I: Investable Alternatives to Core Investables (Mutual Funds, Manager Based Alternatives) Core Investables (ETFs, Replication Products) Strategic Asset Allocation Benchmark Determined EXHIBIT 6.2 Strategic Benchmark, Core, and Satellite Groupings In Exhibit 6.3, the core investment classes have been broken down into equity, fixed income, traditional alternatives, and modern alternatives.
Moreover, global and domestic regulatory forces as well as market forces have created a new list of investable products (exchange traded and over the counter). These products include more liquid and readily available forms of traditional stock and bond investment (e.g., ETFs, OTC forward and options contracts) as well as more liquid and readily investable alternative investment forms (e.g., passive investable benchmark products). The addition of new investment forms has permitted individuals to more readily access previously illiquid or less transparent asset classes (e.g., private equity or real estate) and has increased the number of assets that provide the potential for risk diversification in various states of the world. In fact, risk itself has become a more tradable asset. While options had always provided a means for individuals to directly manage risk, previous attempts to directly trade risk had not met with success.
To the extent that returns to those risk factors can be predicted, then that knowledge can be used to determine asset weighting between various asset classes.2 Unfortunately, academic research has generally concluded that it is not possible to obtain accurate estimates of future returns to macroeconomic factors such that, as a result, future expected returns are often based on subjective estimates related to long term historical returns to risk factors. In the investment area one of the primary, if not the essential, questions is the value of active management relative to manager based or security/ market factor passive investable indices. Most investors are aware of the number of articles as well as books that attempt to address the value of active versus passive management. For years, this discussion was primarily limited to the traditional stock and bond area as informational and trading costs limited its use in the traditional alternative investments (commodities and private equity) area as well as in the area of modern alternatives (hedge funds and CTAs).
asset allocation, corporate governance, diversification, diversified portfolio, index fund, market fundamentalism, passive investing, prediction markets, random walk, risk tolerance, risk-adjusted returns, risk/return, transaction costs, Vanguard fund
Those of us who advise clients on how to invest for market returns find ourselves burdened with names that have negative connotations. The current terminology is a snore; it makes our readers' and our clients' eyes glaze over. 18 8eaJme a Smart Investor The current terminology fo r investi ng for market returns is "passive investing." What could be more boring? Do you want to be an active investor or a passive investor? No one wantS to be passive; it implies you have no abi li ty to have any influence on an outcome. Anomer term historically used for market~return investment is "index-based investing"-anomer less-than-scintiUating bit of verbiage. Over the years. index-based or passive investing has come to be equated with being "average." And no one wants ( 0 be average. We al1 want to believe in the utopian Shangri-La described in James Hi lton's novel Lost Horizon, where everything is perfec t and no one is average.
Ifyour advisor says anything other than "You would, » he or she either does not understand the data or is not being candid with you. u.s. Then walk our the door, dose your account and become a Smart Investor. Chapter40 Where Are the Pension Plans for Smart Investors? [A}ctive investment management is a source ofpension fund losses, not profits. Individual fonds can have profitable strategies, but aggregate profits are negative because of manager foes and transactions costs. The recent growth in passive investment products and increased interest in performance-linked fees are evidence that Canada's pension community recognizes how difficult it is to earn above-market returns. -John I1kiw, "Pension Fund Financing: A Plan Sponsor's Guide to Fiduciary D uty.'" Reponed at: http://www.benefits canada.com/conrcnt/lcgacy/Content/1997103-97/fl. html For many Canadian investors, their registered pension plans (RPPs) and their Registered Reti rement Savi ngs Plans (RRSPs) represent an important part of thei r retirement plann ing.
If you find that there are no (or few) ETFs or index fund investments in your pension plan, complain to the person responsible for selecting the investment managers of the plan. If there are enough complaints, you will start to see investment options for these plans that will permit the beneficiaries to become Smarr Investors. Chapter 41 Have the Inmates Taken Over the Asylum? Of course. I favour passive investing for most investors, buause markets are amazingly sucussful devices for incorporating information into stock prices. I beliroe. along with Friedrich Hayek fa Nobel laureate, and a contemporary ofJohn Maynard KeymsJ and others, that information is not some big thing that's locked in a iafo somewhere. It exists in bits and pieces scattered all over the world. -Merton Miller, Nobel laureate in economics.
Albert Einstein, asset allocation, asset-backed security, Brownian motion, business process, capital asset pricing model, clean water, collateralized debt obligation, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, fixed income, implied volatility, index fund, interest rate swap, inventory management, London Interbank Offered Rate, margin call, market fundamentalism, mortgage debt, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond
This winning bid typically is awarded by means of a random drawing. Related Terms: • Bond • Market Maker • Stock Market • Broker-Dealer • Par Value The Investopedia Guide to Wall Speak 221 Passive Investing What Does Passive Investing Mean? An investment strategy that does not include active buying and selling of securities. Passive investors purchase investments with the intention of long-term appreciation and thus have limited portfolio turnover. Index fund investing, in which shares in the fund simply mirror an index, is a form of passive investing. Investopedia explains Passive Investing Also known as a buy-and-hold or couch potato strategy, passive investing requires good initial research, patience, and a well-diversified portfolio. Unlike active investors, passive investors buy a security and typically do not actively attempt to profit from short-term price fluctuations.
Investopedia explains Index Fund Indexing is a passive form of fund management that some argue outperforms most actively managed mutual funds. The most popular index funds track the S&P 500, but a number of other indexes, including the Russell 2000 (small companies), the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australasia, and the Far East), and the Lehman Aggregate Bond Index (total bond market), are followed widely by investors. Investing in an index fund is a form of passive investing. The primary advantage is the lower management expense ratio. Many actively managed mutual funds fail to beat broad market indexes because their returns are reduced by higher expense ratios. The Investopedia Guide to Wall Speak 137 Related Terms: • Benchmark • Expense Ratio • MSCI—Emerging Markets Index • Mutual Fund • Standard & Poor’s 500 Index—S&P 500 Index Futures What Does Index Futures Mean?
Investopedia explains Spiders (SPDR) Spiders are listed on the American Stock Exchange (AMEX) under the ticker symbol SPY. SPDRs trade like stocks, are liquid, can be sold short and bought on margin, and are a good source for dividend income. As with a stock, investors pay a brokerage commission when trading SPDRs. Investors buy SPDRs to replicate the performance of the overall stock market. SPDRs are not actively managed and are thus passive investments (index investing). Related Terms: • American Stock Exchange—AMEX • Benchmark • Diversification • Exchange-Traded Fund—ETF • Standard & Poor’s 500 Index—S&P 500 Spinoff What Does Spinoff Mean? The creation of an independent company through the sale or distribution of new shares of an existing business or a division of a parent company. A spinoff is a type of divestiture. Investopedia explains Spinoff Businesses that want to “streamline” their operations often sell less productive or unrelated subsidiary businesses as spinoffs.
Portfolio Design: A Modern Approach to Asset Allocation by R. Marston
asset allocation, Bretton Woods, capital asset pricing model, capital controls, carried interest, commodity trading advisor, correlation coefficient, diversification, diversified portfolio, equity premium, Eugene Fama: efficient market hypothesis, family office, financial innovation, fixed income, German hyperinflation, high net worth, hiring and firing, housing crisis, income per capita, index fund, inventory management, Long Term Capital Management, mortgage debt, passive investing, purchasing power parity, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, Silicon Valley, superstar cities, transaction costs, Vanguard fund
Consider a study by Gorton and Rouwenhorst (2006) of the stocks of commodity firms over the period from 1962 to 2003. Gorton and Rouwenhorst compared passive investment in commodity future contracts with the stocks of commodity firms producing the same commodities. They found that the correlation between the two investments was only 0.40. At the same time, the correlation between the stocks of these firms and the S&P 500 was 0.57. So the stocks of the commodity producers were more highly correlated with stocks than the commodities that they produced. Commodity futures provide a pure play on commodity investment. But passive investment is very different from active investment. Passive investment involves buying a futures contract at the beginning of the period, then closing the position automatically at the end of the period.
In a sense, managed futures are a form of hedge fund. You are investing in the manager’s expertise. That expertise will guide the manager on when to be long or short in the commodity, whether to overweight one commodity relative to another, or whether to take positions more aggressively in currencies rather than commodities. Passive investments in commodity futures represent a much purer play on the commodities themselves. For this reason, most of the chapter will be devoted to passive investment. SOURCES OF RETURN ON COMMODITY FUTURES Before considering actual returns on commodity contracts, it’s important to understand the sources of return on commodity futures. There are two main sources of return, risk premiums and forecast errors. John Maynard Keynes wrote extensively about futures contracts in his Treatise on Money (1930).
P1: a/b c12 P2: c/d QC: e/f JWBT412-Marston T1: g December 10, 2010 15:49 Printer: Courier Westford 249 Real Assets—Commodities Thus in the recent period, in particular, there is only a weak case for diversifying a portfolio with a passive investment in commodities. Despite having a very low beta, it’s not a miracle drug for the portfolio. DOES GOLD BELONG IN THE PORTFOLIO? For millennia, gold has been considered the ultimate store of value. So does it deserve a place in a modern portfolio? To answer that question, consider the return on the GSCI Gold index, a sub-component of the Goldman Sachs commodity futures index. Like the overall GSCI index, the return on the GSCI Gold index is derived from passive investment in futures contracts, in this case the futures contract tied to the London gold price (which is quoted in dollars).10 This gold index is available beginning in 1979.
Rigged Money: Beating Wall Street at Its Own Game by Lee Munson
affirmative action, asset allocation, backtesting, barriers to entry, Bernie Madoff, Bretton Woods, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fiat currency, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, High speed trading, housing crisis, index fund, joint-stock company, moral hazard, passive investing, Ponzi scheme, price discovery process, random walk, risk tolerance, risk-adjusted returns, risk/return, too big to fail, trade route, Vanguard fund, walking around money
While most active investors fail in beating the market, it is human nature to try and defeat most other people. Notable winners include Warren Buffet and Peter Lynch. Losers include most active mutual fund managers. passive investing An investing strategy that buys and holds low-cost index funds to closely match the market returns. By admitting you don’t want to go for the gold, a passive investor wins by choosing to be mediocre. Most American passive investors fail, though, by not being able to stick with the strategy during exceptionally good or bad periods in market performance due to the inherent manifest destiny gene. Notable winners include active investors that write books on the virtues of passive investing. What are the assumptions? 1. That asset classes will not move in tandem with each other. 2. That each class has a unique thing called expected return, and somehow smart people know what this number is and it is expected to happen. 3.
None of this was wrong, but up until that time everyday people didn’t own ETFs, nor understand them in general. What was about to happen was a resurgence in indexing, or passive investing. ETFs were supposed to allow long-term investors a cheap and easy way to grow their money with less expense than mutual funds and more diversification than buying a few stocks. The plan worked too well, and then the baskets kept increasing. You see, Wall Street will lure people in with ideas of a better mousetrap, which ETFs were to a large extent. Once in the system, you will be fed more and more options until you slowly forget what your plan was in the first place. Let’s look at the most basic example of how things got out of hand quickly. We are told by those that sell ETFs that passive investing is cheaper, better performing, and tax-efficient. This only occurs if you buy and hold an index ETF forever.
Simple: Stock exchanges wanted to compete for speculators who traded indexes all day. That’s right, the sole purpose was to capture business from the futures exchange. Now they are quickly becoming a staple in many portfolios because they are cheap, tax-efficient, and tradable during market hours. However, just because something is an ETF doesn’t mean it will have those attributes. Now they are sold to the public as a cure-all, ranging from the ultimate in long-term passive investing to high-octane leveraged bets on specific commodities like gold and oil, creating access to markets not previously open to most individual investors. Breaking down boundaries can have unintended consequences. You can expand your mind to the point of losing it. There has been an explosion of ETFs that short the market with double or triple leverage. Listen to me now: Professional traders don’t use these tools.
The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer
asset allocation, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, passive investing, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, transaction costs, Vanguard fund, yield curve
In fact, most of them build substantial wealth at their clients' expense. More than one broker has been heard to remark, "We make millionaires-out of multimillionaires." What's that? You say your money guy is making you a fortune? We sincerely hope that's the case. However, with a very simple, no-brainer investment strategy called passive investing you have, at the very least, a 70 percent chance of outperforming any given financial pro over an extended period of time. And over some 20-year periods, passive investing outperforms as many as 90 percent of actively managed funds. The reason is because this system allows you to keep more of your money working for you, which means less money for the brokers, investment houses, mutual fund managers, money managers, and the government. It may sound too good to be true, but this time it really is true, and it's backed up with a preponderance of empirical evidence.
Style Drift and Tracking Errors Not a Problem With active funds, there is always a possibility of some of the stocks in a fund moving from one classification to another. Inasmuch as index funds are designed to replicate a particular segment of the market, such as largecap growth, or small-cap value, there is no possibility of the funds drifting into another category. READ WHAT OTHERS SAY Most of the world's leading investment researchers, scholars, authors, and almost anyone who isn't trying to sell you their investment products, agree that low-cost, passive investing is an excellent strategy for most or all of your portfolio. Following are what many of them have to say on the subject of passive vs. active investing: Frank Armstrong, author of The Informed Investor: "Do the right thing: In every asset class where they are available, index!-Four of five funds will fail to meet or beat an appropriate index." Gregory A. Baer and Gary Gensler, authors of The Great Mutual Fund Trap: "With returns corrected for survivorship bias, the average actively managed funds trail the market by about 3 percentage points a year."
And in the past 25 years, a portfolio of Vanguard's actively managed funds outperformed the Wilshire 5000 (the total U.S. stock market index) by an average of 0.9 percent per year. This portfolio's excellent performance has been largely due to a combination of good management coupled with low costs. Vanguard's actively managed funds, like all Vanguard funds, carry no sales charge and have an average annual expense ratio of just 0.47 percent. Does this mean one should abandon passive investing and opt for low-cost, actively managed funds? Not at all! At the same time Vanguard Health Care was doing phenomenally well, Vanguard U.S. Growth was a disaster, turning in a shameful performance during the great bull market of the 1990s. It's also important to keep in mind that investing in a health care fund is placing a sector bet. What if the government enacts new regulations or some unforeseen event happens, depressing the market for health care stocks?
Take the money and run: sovereign wealth funds and the demise of American prosperity by Eric Curt Anderson
asset allocation, banking crisis, Bretton Woods, business continuity plan, business intelligence, business process, collective bargaining, corporate governance, credit crunch, currency manipulation / currency intervention, currency peg, diversified portfolio, floating exchange rates, housing crisis, index fund, Kenneth Rogoff, open economy, passive investing, profit maximization, profit motive, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, sovereign wealth fund, the market place, The Wealth of Nations by Adam Smith, too big to fail, Vanguard fund
The Democratic Senator from Indiana offered the following two proposals in mid-February 2008: 1. At a minimum the U.S. ought to require passive investment by sovereign wealth funds 2. CFIUS reviews are only triggered when an investment exceeds 10% of total ownership . . . a more realistic standard is required115 Allow me to comment on these proposals in reverse order. As we have seen above, proposed regulations for implementing FINSA 2007 do indeed end the perceived 10% ownership “rule.” It increasingly appears as though CFIUS is going to be tasked with conducting a review and/or investigation any time a sovereign wealth fund invests in the United States. As for the argument concerning passive investment, the Norwegian Government Pension Fund-Global, for one, has made it quite clear such rules will drive their investments elsewhere.
Now, back to our previous discussion of the CIC’s intended purpose. Western observers were aware of a debate over the China Investment Corporation’s mandate before the institution even opened its doors for business. In an article published in September 2007, The Wall Street Journal reported, the “fund’s mandate has been the subject of contention among Chinese ofﬁcials.” According to the Journal, “many involved in the [CIC] planning favor passive investments, by turning money over to professional money managers, with the single goal of improving returns on China’s $1.53 trillion foreign exchange reserves . . . Other ofﬁcials are viewing [the CIC] as a more strategic vehicle, such as to back Chinese state-owned companies as they invest overseas.”49 At the moment, the truth seems to lie somewhere between these two extremes. CIC ofﬁcials used the ﬁrst tranche of $67 billion to acquire Central Huijin and thereby win control of the Chinese government’s holdings in the largest three recapitalized, publicly listed commercial banks: the Industrial and Commercial Bank of China, the Construction Bank of China, and the Bank of China.
“Therefore,” he continued, “we must have a certain level of income from our investments and [they] must have a certain liquidity.”96 How to accomplish this objective? Lou contended his fund would seek to primarily invest in ﬁnancial instruments like indexed listings. Lou, however, seems to have slipped on the “benign intent” message, as he told the assembled ﬁnancial analysts that CIC hoped to help improve corporate governance at ﬁrms receiving Chinese funding.97 So much for the promise of passive investment. In the meantime, U.S. and international demands for Chinese investment transparency had come under attack. In a publication issued by the Jamestown Foundation—a nonpartisan think tank with the self-declared mission of informing and educating policy makers—Wenran Jiang, acting director of the China Institute at the University of Alberta, wrote: If Washington is comfortable having Beijing buy up $400 billion of its treasury bonds to subsidize President Bush’s deﬁcit spending economic policy, it needs to answer the question of why it should be so alarmed about Chinese investments in the form of sovereign wealth funds—both are in the nature to seek returns for the money.98 A comparable message was issued by the Heritage Foundation.
asset allocation, backtesting, Black-Scholes formula, Bretton Woods, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, new economy, oil shock, passive investing, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund
Every extra percentage point of annual costs requires investors aged 25 to retire two years later than they would have in the absence of such costs. 11 Charles D. Ellis, “The Loser’s Game,” Financial Analysts Journal, July/August 1975, p. 19. CHAPTER 20 Fund Performance, Indexing, and Beating the Market 351 THE INCREASED POPULARITY OF PASSIVE INVESTING Many investors have realized that the poor performance of actively managed funds relative to benchmark indexes strongly implies that they would do very well to just equal the market return of one of the broadbased indexes. Thus, the 1990s witnessed an enormous increase in passive investing, the placement of funds whose sole purpose was to match the performance of an index. The oldest and most popular of the index funds is the Vanguard 500 Index Fund.12 The fund, started by visionary John Bogle, raised only $11.4 million when it debuted in 1976, and few thought the concept would survive.
318 Chapter 19 Behavioral Finance and the Psychology of Investing 319 The Technology Bubble, 1999 to 2001 320 Behavioral Finance 322 Fads, Social Dynamics, and Stock Bubbles 323 Excessive Trading, Overconfidence, and the Representative Bias 325 Prospect Theory, Loss Aversion, and Holding On to Losing Trades 328 Rules for Avoiding Behavioral Traps 331 Myopic Loss Aversion, Portfolio Monitoring, and the Equity Risk Premium 332 Contrarian Investing and Investor Sentiment: Strategies to Enhance Portfolio Returns 333 Out-of-Favor Stocks and the Dow 10 Strategy 335 PART 5 BUILDING WEALTH THROUGH STOCKS Chapter 20 Fund Performance, Indexing, and Beating the Market 341 The Performance of Equity Mutual Funds 342 Finding Skilled Money Managers 346 xiv Persistence of Superior Returns 348 Reasons for Underperformance of Managed Money 348 A Little Learning Is a Dangerous Thing 349 Profiting from Informed Trading 349 How Costs Affect Returns 350 The Increased Popularity of Passive Investing 351 The Pitfalls of Capitalization-Weighted Indexing 351 Fundamentally Weighted versus Capitalization-Weighted Indexation 353 The History of Fundamentally Weighted Indexation 356 Conclusion 357 Chapter 21 Structuring a Portfolio for Long-Term Growth 359 Practical Aspects of Investing 360 Guides to Successful Investing 360 Implementing the Plan and the Role of an Investment Advisor 363 Concluding Comment 364 Index 367 CONTENTS F O R E W O R D Some people find the process of assembling data to be a deadly bore.
Because of proprietary trading techniques and interest income from loaning securities, Vanguard S&P 500 Index funds for individual investors have fallen only 9 basis points behind the index over the last 10 years, and its institutional index funds have actually outperformed the index.15 THE PITFALLS OF CAPITALIZATION-WEIGHTED INDEXING Despite their past success, the popularity of indexing, especially those funds linked to the S&P 500 Index, may cause problems for index 12 Five years before the Vanguard 500 Index Fund, Wells Fargo created an equally weighted index fund called “Samsonite,” but its assets remained relatively small. 13 Heather Bell, “Vanguard 500 Turns 25, Legacy in Passive Investing,” Journal of Index Issues, Fourth Quarter 2001, pp. 8–10. 14 Vanguard’s number includes assets of its 500 Index Fund open to both individuals and institutions. 15 The Vanguard Institutional Index Fund Plus shares, with a minimum investment of $200 million, have outperformed the S&P 500 Index by 7 basis points in the 10 years following the fund’s inception on July 7, 1997. 352 PART 5 Building Wealth through Stocks investors in the future.
What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson
Admiral Zheng, banking crisis, Basel III, Bernie Madoff, Black Swan, centralized clearinghouse, clean water, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial innovation, financial intermediation, Flash crash, income inequality, index fund, invisible hand, London Whale, Long Term Capital Management, moral hazard, Northern Rock, passive investing, performance metric, Ponzi scheme, principal–agent problem, rent-seeking, Ronald Coase, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks
Yet many more people, probably including you and definitely including the authors of this book, don’t invest like Buffett. Instead, they invest through index funds—pools of money that buy shares of many companies listed in an index. The S&P 500 or the FTSE 100 are two such indices, comprising, respectively, the 500 largest companies listed in the United States and the 100 largest in the United Kingdom. Because the investments match an index, this is sometimes called “passive” investing, since it involves no “active” stock picking. But few people stop to think how the indices themselves are determined: how much of stock A is included and how much of stock B. The most common method is to use the market capitalization of the stocks being considered, that is, how much the market values each stock. The amount of each stock within that index will vary with its market capitalization.
There are issues created by the widespread adoption of cheap beta strategies. As we’ve seen, mass adoption of diversification can allow risks to build up in the system, even while decreasing the risk to an investor of something going wrong with any one investment. Thankfully, thought leaders like the Royal Society of the Arts are trying to mitigate those risks and accentuate the positives. We discuss how in chapter 5. 58. “Passive Investing Has Room to Grow,” Financial Times, September 23, 2012. 59. “Investors Shift to Low-Cost ‘Tracker’ Funds,” The Telegraph, February 12, 2013. 60. www.unpri.org, accessed September 21, 2014. 61. “Public Funds Take Control of Assets, Dodging Wall Street,” New York Times, August 19, 2013. 62. Ibid. 63. US Department of Labor, “Fact Sheet: Final Rule to Improve Transparency of Fees and Expenses to Workers in 401(k)–Type Retirement Plans” (US Department of Labor, February 2012). 64.
See National Employment Savings Trust (NEST) Nestor, Stilpon, 43 Netherlands, 90, 111, 113 collective pension system in, 60, 197, 199, 209, 264n6 fund governance regulation in, 108–9 pension beneficiaries and investment returns, 265n20 New York Stock Exchange: average holding period of traded stock, 63 financial services as percent of, 16 high-frequency trading and, 88 New York Times (newspaper), 77, 88 Nippon, 18 Normal curve, 161–63, 260n18, 261n38 real world phenomena and, 172–73 Northern Rock, 245n31 Nusseibeh, Saker, 140 One-way market for financial assets, 240n31 Ontario Teachers’ Pension Plan, 59, 111 Opportunities, fiduciary duty and, 140 Organisation for Economic Co-operation and Development, 109 Outcomes, measuring success using, 132 Oversight: regulation and, 150–51 trust in government and, 141 Owner, use of term, 235n25 Ownership: agency capitalism and, 74–80 capitalism and, 62, 83–93, 243n2 changing conception of, 62–63 corporate governance and, 22 derivatives and, 80–83, 93 economic attention deficit hyperactivity disorder and loss of, 63–68 election of directors and, 78–79 exercised by financial agents, 230 for long-term investors, 87 individual investor’s use of technology and, 90–92 institutional investors and, 3–4, 249n3 portfolio management function and, 246n36 promoting culture of, in investment, 222–24 tax policy and, 92 Oxford University, 122 Passive investing, 45 Pax World, 77 Pay for performance, institutional investors and, 112–13 Payments system, banks and, 16–17, 20, 22, 211–12 Pension funds: collective, 197, 199, 209, 263n1, 264n3, 264n6, 266n28 commonsense, 194–96, 199–202 fees, 97–98, 195–96, 233n5 governance of, 100–101, 104–6, 107–9 investment strategy, 195, 196 People’s Pension, 202–11 portability of, 196 purpose of, 194 regulation of, 107–9, 251n22 shift from defined benefit to defined contribution plans, 99–100, 104–5 time frame and, 207 Webster and Wallace’s, 14, 199–202, 209.
Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber
AI winter, algorithmic trading, asset allocation, banking crisis, barriers to entry, Big bang: deregulation of the City of London, butterfly effect, buttonwood tree, buy low sell high, capital asset pricing model, citizen journalism, collateralized debt obligation, corporate governance, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, en.wikipedia.org, experimental economics, financial innovation, Gordon Gekko, implied volatility, index arbitrage, index fund, information retrieval, Internet Archive, John Nash: game theory, Khan Academy, load shedding, Long Term Capital Management, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, moral hazard, mutually assured destruction, natural language processing, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, quantitative hedge fund, quantitative trading / quantitative ﬁnance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Renaissance Technologies, Richard Stallman, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, semantic web, Sharpe ratio, short selling, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, too big to fail, transaction costs, Turing machine, Upton Sinclair, value at risk, Vernor Vinge, yield curve, Yogi Berra
Part Two Alpha as Life 90 Nerds on Wall Str eet I ndex funds are passive investments; their goal is to deliver a return that matches a benchmark index. The Old Testament of indexing is Burton Malkiel’s classic A Random Walk Down Wall Street, first published in 1973 by W.W. Norton and now in its ninth edition. For typical individual investors, without special access to information, it offers what is likely the best financial advice they will ever get: It is hard to consistently beat the market, especially after fees. A passive strategy will do better in the long run. Of course, no one thinks of oneself as a typical individual investor. That might be your brother-in-law or the guy across the hall. And index funds are just not as much fun as picking stocks. It’s called passive investing for a reason. Alpha, outperforming a passive benchmark, is the goal of active investing.
Looking at stocks just by price and ignoring dividends tends to favor stocks that don’t pay dividends. Simply listing acquisition price and current price ignores the aspect of time, and not comparing it to any well-defined benchmark (like the S&P 500 index) leaves the meaning of even a well-studied report unclear. A.G. Becker was the first firm to compare the total return of a stock portfolio to an index. Since an S&P 500 index fund is just a passive investment consisting of a capitalization-weighted portfolio of the 500 stocks in the index, it will do no better than the index—and if managed effectively, no worse. An index fund can’t just be started up and left alone to run itself forever. The stocks in the index change; dividends need to be reinvested, and most significantly, there are cash flows in and out of the portfolio from new funding or payment requirements.
This increases effective housing demand, which would help absorb the nation’s excess housing supply, thereby stabilizing prices at a higher equilibrium price than would otherwise be possible. Structural Ideas for the Economic Rescue 309 A Capital Market for Home Equity Fractional Interest Securities The HEFI security represents a passive investor interest in a home— just as a share of stock represents a passive investment in a company. Institutional investors such as pension and endowment funds would be interested in HEFIs to achieve diversification beyond stocks and bonds. The single-family, owner-occupied (SFOO) equity asset class is as large as the entire U.S. stock market, around $10 trillion. To be properly diversified, institutional investors should hold about as much in the SFOO equity asset class as they do in stocks.
Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, London Whale, Long Term Capital Management, loose coupling, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, moral hazard, mortgage debt, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative ﬁnance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, Richard Feynman, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War
The strength and ethical integrity of a chain are as strong as its weakest link. The rise of passive investment management has been a response to excessive costs and conflicting objectives in this investment chain. Vanguard – the largest asset management firm after Black-Rock and Allianz – was established in 1975 by Jack Bogle, an evangelical promoter of passive investment.7 Bogle’s thesis was that, since the chances of out-performing a stock market index on a sustained basis were slight, replicating that index was a simple and inexpensive investment strategy. Passive investment has steadily grown in scale, and much of the activity of BlackRock, Vanguard and State Street is in the management of indexed funds, an activity that can now be entrusted to a computer. There are significant economies of scale in passive investment, and these large incumbents derive competitive advantage from their size.
Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen
algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, mortgage debt, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative ﬁnance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond
Ainslie III of Maverick Capital 108 Chapter 8 Dedicated Short Bias 115 Interview with James Chanos of Kynikos Associates 127 Chapter 9 Quantitative Equity Investing 133 Interview with Cliff Asness of AQR Capital Management 158 Part III Asset Allocation and Macro Strategies 165 Chapter 10 Introduction to Asset Allocation: The Returns to the Major Asset Classes 167 Chapter 11 Global Macro Investing 184 Interview with George Soros of Soros Fund Management 204 Chapter 12 Managed Futures: Trend-Following Investing 208 Interview with David Harding of Winton Capital Management 225 Part IV Arbitrage Strategies 231 Chapter 13 Introduction to Arbitrage Pricing and Trading 233 Chapter 14 Fixed-Income Arbitrage 241 Interview with Nobel Laureate Myron Scholes 262 Chapter 15 Convertible Bond Arbitrage 269 Interview with Ken Griffin of Citadel 286 Chapter 16 Event-Driven Investments 291 Interview with John A. Paulson of Paulson & Co. 313 References 323 Index 331 The Main Themes in Three Simple Tables OVERVIEW TABLE I. EFFICIENTLY INEFFICIENT MARKETS Market Efficiency Investment Implications Efficient Market Hypothesis: Passive investing: The idea that all prices reflect all relevant information at all times. If prices reflect all information, efforts to beat the market are in vain. Investors paying fees for active management can expect to underperform by the amount of the fee. However, if no one tried to beat the market, who would make the market efficient? Inefficient Market: Active investing: The idea that market prices are significantly influenced by investor irrationality and behavioral biases.
The alpha is the intercept from a regression on the MCSI World stock index, Barclays Bond Index, and the GSCI commodities index. The t-statistic of the alpha is shown in parentheses. Source: Hurst, Ooi, and Pedersen (2013). In addition to reporting the expected return, volatility, and Sharpe ratio, table 12.1 also shows the alpha from the following regression: We regress the TSMOM strategies on the returns of a passive investment in the MSCI World stock market index, the Barclays U.S. aggregate government bond index, and the S&P GSCI commodity index. The alpha measures the excess return, controlling for the risk premiums associated with simply being long in these traditional asset classes. The alphas are almost as large as the excess returns since the TSMOM strategies are long–short and therefore have small average loadings on these passive factors.
Such struggling firms are sometimes defined as those with a credit spread over comparable-duration Treasuries of more than 1,000 basis points (bps). This credit spread means that the price of the firm’s debt is so low that its yield to maturity is more than 10 percentage points higher than the yield on Treasuries. While this credit spread is large, so is the risk of not getting paid. In fact, a passive investment to distressed debt has historically not been well compensated according to some indices, surprisingly. Hence, distressed managers must be active to add value. Indeed, companies in distress often present significant opportunities and risks as the underlying business is in flux and the various stakeholders may attempt to extract the remaining value. An event manager can approach a distressed investment in many different ways.
accounting loophole / creative accounting, airline deregulation, Andrei Shleifer, asset allocation, Bretton Woods, buy low sell high, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, fixed income, frictionless, high net worth, index fund, inflation targeting, invisible hand, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, merger arbitrage, new economy, passive investing, price mechanism, purchasing power parity, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, statistical arbitrage, the market place, transaction costs, Y2K, yield curve
Some time ago, Rex Sinquefield made the case that the efficient market theory—which, in brief, states consistently “beating the market” is improbable because existing stock prices are the result of all current information—is simply an application of Adam Smith’s invisible-hand theory to financial markets. I share this efficient market world view. More, although it is true market inefficiency is a sufficient condition for justifying active management, it is not a necessary condition. In this sense, I again part ways with Sinquefield’s passive-investing-only mandate. A broad market can be defined as a majority of stocks outperforming a benchmark index. This is a good way for an active manager to envision market breadth. To illustrate why, let’s borrow an analogy from the efficient market theory: Assume a number of people are throwing darts at a blackboard containing the names of all the stocks in the S&P 500. The chance of one dart thrower picking a winning stock is equal to the number of stocks outperforming the benchmark index at any point in time.
Our Midwest hedge fund from Chapter 8, “The Cyclical Asset Allocation Strategy’s Versatility,” came to understand this. The long–short hedge-fund strategy captures the value-added the CAA produces. Chapter 12 Keeping the Wheels on the Hedge-Fund ATV 239 This page intentionally left blank 13 MARKET TIMING OR VALUE TIMING? 241 O ne of the central themes of this book is the size effect and the relative performance between active and passive investing are directly related. As stated, these are two sides of the same coin. The interaction between the indices’ weighting schemes and the size effect tells active investors and managers when to build index-like portfolios and when to pursue an active strategy. The newer, equal-weighted S&P 500 index is tailor-made for empirically testing the desirability of a pure-passive strategy, a pure-active strategy, and a strategic asset allocation (SAA) and tactical asset allocation (TAA) to passive and active strategies.
They are also exempt from many of the rules and regulations governing other mutual funds. high-yield bonds A debt instrument issued for a period of more than one year with high rates of return because there is a higher default risk. hurdle rate-of-return The required rate of return in a discounted cash flow analysis, above which an investment makes sense and below which it does not. index In economics and finance, an index (for example, a price or stockmarket index) is a benchmark of activity, performance, or evolution in general. Consumer price indexes (an inflation measurement), or a country’s gross domestic product (GDP) index (an economic growth measurement) can be used to adjust salaries, Treasury bond (T-bond) interest rates, and tax thresholds. Index funds manage their portfolio so their evolution always mirrors a stock-market index’s evolution. A passive investment strategy in which the portfolio is designed to mirror a stock-market index’s performance. 304 UNDERSTANDING ASSET ALLOCATION inflation hedging An investment designed to protect against inflation risk. Such an investment’s value typically increases with inflation. information ratio The expected return-to-risk ratio as measured by standard deviation. This statistical technique is usually used to measure a manager’s performance against a benchmark. interest rate parity Relationship that must hold between the spot rate currencies’ interest rate if there are to be no arbitrage opportunities. interest rate spread The difference in yield between two distinct securities, such as corporate bonds and government securities. investor’s horizon The time length a sum of money is expected to be invested. law of one price The economic rule that states that, in an efficient market and absent transaction or transportation costs, a security and/or a commodity must have a single price, no matter how that security is created. leverage buyouts (LBOs) A transaction used to privatize a public corporation financed through debt, such as bank loans and Treasury bonds (T-bonds).
How to Form Your Own California Corporation by Anthony Mancuso
How business profits are taxed General Partnership Ease of conversion to another business form Sole Proprietorship generally not, if all members are active in the business owners who want limited liability, a less formal legal structure, and automatic passthrough of profit individual tax rates of members, unless LLC files IRS Form 8832 and elects corporate taxation; $800 minimum tax each year plus additional fees if gross income is $250,000 or more same as C corporation owners who want limited liability, the built-in formality of the corporate form with the pass-through of corporate profits to individual owners individual tax rates of shareholders; $800 minimum tax for second and subsequent tax years issuance or transfer of stock subject to state and federal securities laws owners who want limited liability, the built-in formality and capital incentives of the corporate form, and the ability to split business income to lower overall taxes split up and taxed at corporate rates and individual tax rates of shareholders; $800 minimum state tax for second and subsequent tax years joint owners who partnership tax treatment and some nonmanaging investors; general partners must be willing to assume personal liability for business debts individual tax rates of general and limited partners, unless partners file IRS Form 8832 to elect corporate tax treatment may change to corporation or LLC; legal paperwork involved issuance or transfer of limited partnership interests is subject to state and federal laws LLC may change to general or limited partnership or corporation; legal paper involved S Corporation generally same as C corporation—may terminate S tax status to become C corporation but cannot reelect S status for five years after C Corporation may change to S corporation by filing simple tax election; change to LLC can involve tax cost and legal complexity Limited Partnership Business Entity Comparison Tables—Legal, Financial, and Tax Characteristics (cont’d.) chapter 1 | choosing the right legal structure for your business | 27 yes partners may use losses to deduct other income on individual tax returns if at risk for loss or debt yes Automatic tax status Tax level when business is sold personal tax level of owner income on individual tax returns (subject to active-passive investment loss rules that apply to all businesses) personal tax level of individual general partners general partners and other employees may set up IRA or Keogh plans; can make corporate tax election to obtain corporate benefits sole proprietor may set up IRA or Keogh retirement plan Tax-deductible fringe benefits available to owners who work in business Deductibility of owner may use losses business losses to deduct other General Partnership Sole Proprietorship follows sole proprietor ship, partnership, or corporate tax rules depending on tax status of LLC follows sole proprietor ship, partnership or corporate tax rules depending on tax status of LLC shareholders may deduct share of corporate losses on individual tax returns, but must comply with special limitations normally taxed at personal tax levels of individual shareholders, but corporate level tax sometimes due if S corporation was formerly a C corporation corporation may deduct business losses (shareholders may not deduct losses) two levels: shareholders and corporation are subject to tax on liquidation same as general partnership, but limited partners may only deduct nonrecourse debts (for which general partners are not specifically liable) personal tax level of individual general and limited partners yes, one-owner LLC treated as sole proprietorship; coowned LLC treated as partnership; one-owner and co-owned LLCs can elect corporate tax treatment no; must meet require ments and file tax election form with IRS; revoked or terminated tax status cannot be re-elected for five years same as general partnership yes, upon filing certificate of limited partnership with state filing office can get benefits associated with sole proprietorship, partnership, or corporation, depending on tax treatment of LLC LLC yes, upon filing certificate of limited partnership with state filing office S Corporation employee-shareholders owning 2% or more of stock are restricted to partnership rules C Corporation employee-shareholders eligible for medical reimbursement, term life insurance, and equity-sharing plans Limited Partnership Business Entity Comparison Tables—Legal, Financial, and Tax Characteristics (cont’d.) 28 | how to form your own california corporation ● 2 C H A P T E R How California Corporations Work Types of California Corporations .................................................................................................... 30 The Privately Held California Profit Corporation ............................................................. 30 Nonprofit Corporations ................................................................................................................. 31 Professional Corporations ............................................................................................................. 31 The Close Corporation...................................................................................................................... 32 Corporate Powers .................................................................................................................................... 34 Corporate People ..................................................................................................................................... 35 Incorporators......................................................................................................................................... 35 Directors................................................................................................................................................... 36 Officers...................................................................................................................................................... 40 Shareholders........................................................................................................................................... 41 How Many People May Organize the Corporation?..............................................................
A bank that makes a loan to a new business will often demand that the personal assets of the incorporators be pledged as security for the loan. A standard note, however, unlike a stock certificate, doesn’t carry with it the attractive possibility of providing the lender with a percentage of the profits or the liquidation assets of a successful enterprise. The situation is altered somewhat for a closely held corporation. The shareholders of the corporation are not normally passively investing in an enterprise but are simply incorporating their own business, which will pay them a salary in return for their efforts and provide them with favorable corporate tax advantages. Nonetheless, if the incorporators lend money to the corporation, they, too, will be able to look to the specific terms of a promissory note in seeking a guaranteed rate of return on their investment, rather than relying solely on the profits of the corporation to pay them money by way of salary.
An accredited investor includes persons who come within, or whom the corporation reasonably believes come within, any of chapter 3 | issuing and selling stock | 59 the following categories at the time of the sale of shares to the person (we don’t list categories unlikely to apply to small corporations or those already included in another suitability category under the California limited offering exemption): • a person whose individual net worth, or joint net worth with the person’s spouse, exceeds $1,000,000 at the time of the purchase of shares, or • a person who had an individual income in excess of $200,000 in each of the two most recent years, or joint income with the person’s spouse in excess of $300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year We won’t dwell on these requirements here. In the unusual event that you do need to use one of these major shareholder tests, it will usually be to qualify an outside shareholder (one who is passively investing in your corporation). Because these shareholders are outsiders and should have financial resources, your best bet is to ask them to check with their lawyer to make sure they meet the technical requirements of this suitability category. Or you can ask them to designate a professional advisor who will protect their interests in connection with their purchase of shares in your corporation (as explained in Category 5, just below).
Optimization Methods in Finance by Gerard Cornuejols, Reha Tutuncu
asset allocation, call centre, constrained optimization, correlation coefficient, diversification, finite state, fixed income, frictionless, frictionless market, index fund, linear programming, Long Term Capital Management, passive investing, Sharpe ratio, transaction costs, value at risk, Y2K
(5.8) In this equation, wit quantities represent the sensitivities of Rt to each one of the n fach iT tors, and t represents the non-factor return. We use the notation wt = w1t , . . . , wnt h i and Ft = F1t , . . . , Fnt . The linear factor model (5.8) has the following convenient interpretation when the factor returns Fit correspond to the returns of passive investments, such as those in an index fund for an asset class: One can form a benchmark portfolio of the passive investments (with weights wit ) and the difference between the fund return Rt and the return of the benchmark portfolio Ft wt is the non-factor return contributed by the fund manager using stock selection, market timing, etc. In other words, t represents the additional return resulting from active management of the fund. Of course, this additional return can be negative.
Early Retirement Guide: 40 is the new 65 by Manish Thakur
There's no hard and fast answer for this since some individuals are very entrepreneurial and want to actively manage where their dollars are put to work, and some individuals are already booked solid and want a more passive approach. The key to this is to simply get started. This section will give you 90% of the knowledge and resources to get started investing today. Invest in an adequately diversified portfolio of low cost passive investments and hold for the long term. That sentence holds all the secrets and techniques needed to invest and thrive. Don't spend a dime on finance gurus and conferences that will teach you "the 5 key techniques to earning millions on stocks" or "the secret to how I made $65,000 in a month." When first starting out in investing, it's understandable to look for a secret to consistently making money with investments.
Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Wesley R. Gray, Tobias E. Carlisle
Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, Black Swan, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, systematic trading, The Myth of the Rational Market, time value of money, transaction costs
Analysis Legend Word/Symbol Description Quantitative Value or QV The quantitative value strategy described in the book. MF The Magic Formula strategy. S&P 500 TR Standard & Poor's 500 Total Return Index, the free-float, market capitalization–weighted index including the effects of dividend reinvestment. MW Index A total-return, market capitalization–weighted index that we construct from the universe of stocks included in the analysis. The MW Index's returns represent a passive investment in the universe of all stocks we analyze. CAGR Compound annual growth rate. Standard Deviation Sample standard deviation (annualized by square root of 12). Downside Deviation Sample standard deviation of all negative observations (annualized by square root of 12). Sharpe Ratio Monthly return minus risk-free rate divided by standard deviation (annualized by square root of 12). Sortino Ratio (MAR = 5%) Monthly return minus minimum acceptable return (MAR/12) divided by downside deviation (annualized by square root of 12).
Word/Symbol Description QV Our quantitative value strategy. MF The Magic Formula strategy. S&P 500 TR Standard & Poor's 500 Total Return Index, the free-float, market capitalization–weighted index including the effects of dividend reinvestment. MW Index A total-return, market capitalization–weighted index that we construct from the universe of stocks included in our analysis. The index's returns represent a passive investment in the universe of all stocks we analyze. CAGR Compound annual growth rate. Standard Deviation Sample standard deviation (annualized by square root of 12). Downside Deviation Sample standard deviation of all negative observations (annualized by square root of 12). Sharpe Ratio Monthly return minus risk free rate divided by standard deviation (annualized by square root of 12). Sortino Ratio (MAR=5%) Monthly return minus minimum acceptable return (MAR/12) divided by downside deviation (annualized by square root of 12).
How Asia Works by Joe Studwell
affirmative action, anti-communist, Asian financial crisis, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collective bargaining, crony capitalism, cross-subsidies, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Deng Xiaoping, failed state, financial deregulation, financial repression, Gini coefficient, glass ceiling, income inequality, income per capita, industrial robot, Joseph Schumpeter, land reform, land tenure, large denomination, market fragmentation, non-tariff barriers, offshore financial centre, oil shock, open economy, passive investing, purchasing power parity, rent control, rent-seeking, Ronald Coase, South China Sea, The Wealth of Nations by Adam Smith, urban sprawl, Washington Consensus, working-age population
Syed Mokhtar became Mahathir’s pet entrepreneur in the wake of the financial crisis. In the final years of his premiership, before he resigned in 2003, Mahathir lavished Syed Mokhtar with electricity generation deals and state financing to build a new container port at Tanjung Pelepas. But once again it was without any export or manufacturing quid pro quo. In time-honoured fashion, the grateful billionaire took the cash flow and poured it into relatively passive investments in mining, plantations, hotels and real estate – a small part of which I am looking at now from my car window.168 A little further north, on the west side of the Jalan P. Ramlee intersection, is Menara Hap Seng, formerly MUI Plaza, which for decades was the headquarters of fallen billionaire Khoo Kay Peng. Khoo got on the wrong side of Mahathir in the 1980s, and stopped receiving state concessions.
Infant industry policy required that funds be directed to industrial projects that were less immediately profitable than either other potential manufacturing investments or consumer lending. Banks were therefore kept under close control. International inflows and outflows of capital were also strictly limited so that domestic capital remained under state control and unregulated flows of foreign funds did not disrupt developmental planning. And the returns that citizens could earn on bank deposits and other passive investments were frequently crimped, increasing the surplus left at the financial system’s disposal, which could then be used to pay for development policy and infrastructure. This amounted to a hidden taxation, which was tolerated by people in these societies because they could see the economic transformation taking place all around them. South Koreans, for instance, put up with negative real interest rates on bank deposits because they saw their economy overtake first North Korea, then the south-east Asian states, then even Taiwan in only three decades.
Mahathir began discussions with Daihatsu on another trip to Japan in 1991. The trading house Mitsui, then managed in Malaysia by Mahathir’s long-time confidant Kazumasa Suzuki, handles much of Daihatsu’s international trading activity. 200. In 1982, long after the original MMC technology transfer deal had been agreed, Hyundai did sell a 10 per cent stake to the Japanese to raise cash; this subsequently rose to 12.6 per cent, but remained a purely passive investment. 201. Written response to questions put to Mahathir, 7 March 2011. 202. For Mahathir’s personal forays into businesses in real estate, taxis and trading, and his home workshop where – among other things – he invented a new Islamic toilet, see Wain, Malaysian Maverick, pp. 15–16 and p. 55 respectively. 203. For a more detailed discussion, see K. S. Jomo, ‘The Proton Saga: Malaysian Car, Mitsubishi Gain’ and Kit G.
Stock Market Wizards: Interviews With America's Top Stock Traders by Jack D. Schwager
Asian financial crisis, banking crisis, barriers to entry, Black-Scholes formula, commodity trading advisor, computer vision, East Village, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John von Neumann, locking in a profit, Long Term Capital Management, margin call, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K
Only about 25 mutual fund institutions control almost one-third of total equity assets in this country, and every one of those guys knows what the others are doing. It may become quite uncivil if they all run for the exits at the same time. So you're saying that many individual investors who believe they have placed their money into the most conservative stock funds are unwittingly holding high-risk investments. Absolutely. What started out as a conservative, passive investment strategy has metamorphosed into a "greater fool" investment pyramid. When this situation begins to unravel, the losses will be horrific. People talk in terms of a bear market being a 20 percent or 30 percent decline. I can make a case why a stock such as Microsoft—which is by far the largest component of the S&P 500, and not surprisingly the biggest holding in Magellan (and most other mutual funds)—could decline by as much as 80 or 90 percent.
The point is that a short-selling approach is normally not intended as a stand-alone investment; rather, it is intended to be combined with long investments (to which it is inversely correlated) to yield a total portfolio with a better return/risk performance. Most, if not all, of Galante's investors use her fund to balance their long stock investments. Apparently, enough investors have recognized the value of Galante's relative performance so that her fund, Miramar Asset Management, is closed to new investment. Most people don't realize that a short-selling strategy that earns more than borrowing costs can be combined with a passive investment, such as an index fund or long index futures, to create a net investment that has both a higher return than the index and much lower risk. This is true even if the returns of the short-selling strategy are much lower than the returns of the index alone. For example, an investor who balanced a Nasdaq index-based investment with an equal commitment in Galante's fund (borrowing the extra money required tor the dual investment) would have both beaten the index return (after deducting borrowing costs) and cut risk dramatically.
3D printing, accounting loophole / creative accounting, additive manufacturing, Airbnb, algorithmic trading, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, interest rate derivative, interest rate swap, Internet of things, invisible hand, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, knowledge economy, labor-force participation, labour mobility, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative ﬁnance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund
By the end of this period, around a third of the largest firms in the United States had ceased to exist as independent companies.38 Yet even as their laws were helping to create a climate ripe for financialization, Reagan and his advisers had begun to worry about the results, which included the eroding market share of US manufacturing firms vis-à-vis their Asian and European competitors. One report released by Reagan’s Commission on Industrial Competitiveness in 1985 sounds, amazingly enough, like something that could have been written by President Obama’s Council on Jobs and Competitiveness today: “In the 1960s, the real rates of return earned by manufacturing assets were substantially above those available on financial assets. Today, the situation is reversed. Passive investment in financial assets has pretax returns higher than the rates of return on manufacturing assets….As a result, the relative attractiveness of investing in our vital manufacturing core has been compromised.” 39 A little-known and truly stupefying fact is that Reagan was so worried about the financialization of the US economy and its impact on competitiveness that he actually launched a secret project to develop a US industrial policy—a term that is still so strongly associated in the public consciousness with Soviet Russia that it has become (wrongly) a third-rail topic even among most American liberals, not to mention conservatives.
He published an article about his idea in the Harvard Business Review and began raising it within his firm. Not surprisingly, the notion met with a chilly reception amongst Scudder principals, who could see the handwriting on the wall—index funds, and passively managed products in general, might eventually put them out of business. Sedgwick didn’t get rich, never made partner, and died a rather frustrated man, upholding his ideas about passive investing to the end.16 His article about how the “20 largest” had beaten all actively managed funds between 1948 and 1972, published in the Financial Analysts Journal in 1973, three years before his death, had the plaintive title “The Record of Conventional Investment Management: Is There Not a Better Way?”17 The answer, of course, was yes. But that way wouldn’t enrich the financial industry. By the 1970s, the die was basically cast.
The End of Jobs: Money, Meaning and Freedom Without the 9-To-5 by Taylor Pearson
Airbnb, barriers to entry, Black Swan, call centre, cloud computing, Elon Musk, en.wikipedia.org, Frederick Winslow Taylor, future of work, Google Hangouts, Kevin Kelly, Kickstarter, knowledge economy, knowledge worker, loss aversion, low skilled workers, Lyft, Mark Zuckerberg, market fragmentation, means of production, Oculus Rift, passive income, passive investing, Peter Thiel, remote working, Ronald Reagan: Tear down this wall, sharing economy, side project, Silicon Valley, Skype, software as a service, software is eating the world, Startup school, Steve Jobs, Steve Wozniak, Stewart Brand, telemarketer, Thomas Malthus, Uber and Lyft, unpaid internship, Watson beat the top human players on Jeopardy!, web application, Whole Earth Catalog
We lose control to react to market forces outside the scope of the job. Entrepreneurship: The Fast Lane The alternative to jobs, entrepreneurship, is based on Fast Lane math. At its core is a focus on rapidly building assets that grow without perpetually requiring direct intervention. According to research and marketing firm The Harrison Group (HarrisonGroupInc.com), only 10% of penta-millionaires (net worth $5 million) report that their wealth came from passive investments.49 They accumulated their wealth actively through building businesses, assets that grew without them. I spoke with a business owner who had a similar experience to MJ. He’d always loved cars and spent time at the race track growing up. He had a moment of realization when he saw that the only way he could ever race consistently was if he became an entrepreneur. In order to race cars, you need lots of money and lots of time.
A Mathematician Plays the Stock Market by John Allen Paulos
Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Nash equilibrium, Network effects, passive investing, Paul Erdős, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, transaction costs, ultimatum game, Vanguard fund, Yogi Berra
It was probably this last, rather ludicrous version of the hypothesis that prompted the joke about the two efficient market theorists walking down the street: They spot a hundred dollar bill on the sidewalk and pass by it, reasoning that if it were real, it would have been picked up already. And of course there is the obligatory light-bulb joke. Question: How many efficient market theorists does it take to change a light bulb? Answer: None. If the light bulb needed changing the market would have already done it. Efficient market theorists tend to believe in passive investments such as broad-gauged index funds, which attempt to track a given market index such as the S&P 500. John Bogle, the crusading founder of Vanguard and presumably a believer in efficient markets, was the first to offer such a fund to the general investing public. His Vanguard 500 fund is unmanaged, offers broad diversification and very low fees, and generally beats the more expensive, managed funds.
Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, cleantech, compound rate of return, credit crunch, diversification, diversified portfolio, equity premium, estate planning, fixed income, high net worth, implied volatility, index fund, invisible hand, Kenneth Rogoff, market bubble, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, Robert Shiller, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond
In general the taxes I will refer to are: income tax, including taxes on dividends and coupons; capital gains tax (CGT): this covers a broad range and depending on jurisdiction will be greatly affected by the holding period and type of asset; transaction taxes, such as stamp duty in the UK; other taxes such as inheritance tax, corporation tax, taxes on gifts, etc. Owing to its simple construction with a strong bias towards minimum turnover and very long-term holding periods, the rational portfolio is very tax-efficient for most people. Below are some of the most obvious tax benefits most people would realise from holding a rational portfolio: Low turnover = less capital gains and transaction tax A passive investment product will have fewer trades than an active fund. This will typically lead to lower capital gains (including short-term ones often taxed at higher rates), but also fewer payments of transaction taxes such as stamp duty. In addition to tax, there are other obvious advantages such as trading costs associated with the low turnover. Fewer fund changes = defer tax on gains into the future Related to the low turnover of securities in the fund, investors in index trackers also change funds far less frequently than investors in active funds.
asset allocation, backtesting, capital asset pricing model, computer age, correlation coefficient, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, fixed income, index arbitrage, index fund, Long Term Capital Management, p-value, passive investing, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, South Sea Bubble, the scientific method, time value of money, transaction costs, Vanguard fund, Yogi Berra, zero-coupon bond
High-yield (“junk”) bond: A debt instrument with a Standard & Poor’s rating of BB or less. By definition, such bonds have yields higher than less risky investment grade bonds. Index fund: A mutual fund designed to mimic the returns of a given stock market index, such as the S&P 500. Indexing: The strategy of exactly matching the performance of a given stock index, such as the S&P 500. See also passive investing strategy. Initial public offering (IPO): The initial, or primary, public security sale of a corporation. After the IPO, the security thus issued trades in the secondary market. Institutional investors: Large investment organizations, including insurance companies, depositary institutions, pension funds, and philanthropies. Ladder: A bond portfolio with equal amounts invested in evenly spaced maturities.
Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen
Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, New Journalism, oil shock, p-value, passive investing, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative ﬁnance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond
Active management is a zero-sum game even before costs; after trading costs and fees it is a negative-sum game (this observation is mathematically true regardless of whether the market is efficient). Empirical analyses unequivocally confirm that most managers underperform passive indices after fees and leave open the possibility that winners have just been lucky. People’s innate optimism and the financial industry’s marketing machines have been able to muddle these messages, thereby slowing the lure of passive investing. In its early years, the EMH was often equated with the random walk hypothesis (RWH). The ideas are closely linked. According to the RWH, aggressive competition among market participants to exploit any predictable patterns makes price changes fully random and unpredictable. All news is instantly incorporated into market prices. However, the EMH allows time variation in rational risk premia whereas the RWH assumes the special case of constant expected returns.
A common view is that skill is best applied in illiquid asset classes and in market segments where mispricings are harder to arbitrage and thus they survive longer. A counterview is that it is easier to identify skill vs. luck in liquid assets with frequent performance measurement. With illiquid assets, effective sample sizes will be tiny. Moreover, if you reassess a manager’s skill over time, there will be times (say in 2008) when you may want to get out but you have no flexibility to do so. 28.1.4 Cost control Passive investing minimizes trading costs. However, some costs are worth paying. Buying an equity index fund costs more than investing in a bank deposit, but the equity premium should make the extra cost worthwhile in the long run. Value-oriented non-market-cap weighting involves higher turnover and fees than market cap indices, but proponents of fundamental indexation argue that long-run net returns will be better.
The Misbehavior of Markets by Benoit Mandelbrot
Albert Einstein, asset allocation, Augustin-Louis Cauchy, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black-Scholes formula, British Empire, Brownian motion, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, Elliott wave, equity premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, new economy, paper trading, passive investing, Paul Lévy, Plutocrats, plutocrats, price mechanism, quantitative trading / quantitative ﬁnance, Ralph Nelson Elliott, RAND corporation, random walk, risk tolerance, Robert Shiller, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, volatility smile
But Wall Street’s customers were even more grumpy and difficult. So the financial industry became a convert to the new, “modern” finance. Merrill Lynch turned CAPM into an industry in its own right, producing a periodical “Beta Book” for its brokers and customers eager to do the math themselves. Across the world, financial firms started constructing efficient portfolios for their clients. After a few false starts, the index fund, the ultimate in passive investing, was born. It now constitutes more than a fourth of U.S. fund investments. Options took off. The industry was transformed. It discovered economies of scale: If there is just one market portfolio and one size fits all, then the same funds and same analysts can serve all customers. Merge and save. Bigger is better. And the academics themselves turned from disparaged outsiders to valued insiders.
What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale
affirmative action, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Bretton Woods, capital controls, Cass Sunstein, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial innovation, floating exchange rates, full employment, Gini coefficient, global reserve currency, global village, high net worth, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, invisible hand, Just-in-time delivery, Kenneth Rogoff, labour market flexibility, labour mobility, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, sovereign wealth fund, special drawing rights, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Washington Consensus, women in the workforce, yield curve
According to LCM Research, adding exchange-traded options and futures contracts to the latter figure represents no less than seven billion barrels of oil. The deleveraging that took place in the second half of 2008 reduced this amount to about 1.7 billion barrels. Over-the-counter crude oil contracts exacerbated this speculative spike, adding a full 120 percent to the peak figure as opposed to a fraction (on the order of 80 percent) before and after the spring 2008 episode. Similarly, passive investment into index funds also rose and fell spectacularly, from about $75 billion in 2006 to $280 billion by mid-summer 2008, and back to the 2006 level six months later.40 The Goldman Sachs–fed allure of $200-per-barrel oil has faded, and it is unlikely that the next couple of years will see an episode of exuberant investing comparable to the year 2008 that is still remembered for oil at $147 per barrel.
The Essays of Warren Buffett: Lessons for Corporate America by Warren E. Buffett, Lawrence A. Cunningham
compound rate of return, corporate governance, Dissolution of the Soviet Union, diversified portfolio, dividend-yielding stocks, fixed income, index fund, invisible hand, large denomination, low cost carrier, oil shock, passive investing, price stability, Ronald Reagan, the market place, transaction costs, Yogi Berra, zero-coupon bond
In doing that, we always mentally 41 [Divided by hash lines: 1995; 1991 (the latter with similar versions beginning in 1982 and continuting thereafter).] 152 CARDOZO LAW REVIEW [Vol. 19:1 compare any move we are contemplating with dozens of other opportunities open to us, including the purchase of small pieces of the best businesses in the world via the stock market. Our practice of making this comparison-acquisitions against passive investments-is a discipline that managers focused simply on expansion seldom use. Talking to Time Magazine a few years back, Peter Drucker got to the heart of things: "I will tell you a secret: Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an enormous amount of grubby detail work ... dealmaking is romantic, sexy. That's why you have deals that make no sense."
The Clash of the Cultures by John C. Bogle
asset allocation, collateralized debt obligation, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, mortgage debt, new economy, Occupy movement, passive investing, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam
We were the only mutual mutual fund complex; and the index fund was a perfect fit. It was a marriage made in heaven, strongly supported by the unequivocal data that I had assembled on fund performance relative to the S&P 500 over the previous three decades. Simple Arithmetic: An Unarguable Conclusion Few commentators have recognized that two distinct intellectual ideas formed the foundation for passive investment strategies. Academics and sophisticated students of the markets—“quants,” as they are known today—rely upon the EMH—the Efficient Market Hypothesis, first articulated by University of Chicago Professor Eugene Fama in the mid-1960s. This theory suggests that by reflecting the informed opinion of the mass of investors, stocks are continuously valued at prices that accurately reflect the totality of investor knowledge, and are thus fairly valued.
Present Shock: When Everything Happens Now by Douglas Rushkoff
algorithmic trading, Andrew Keen, bank run, Benoit Mandelbrot, big-box store, Black Swan, British Empire, Buckminster Fuller, cashless society, citizen journalism, clockwork universe, cognitive dissonance, Credit Default Swap, crowdsourcing, Danny Hillis, disintermediation, Donald Trump, double helix, East Village, Elliott wave, European colonialism, Extropian, facts on the ground, Flash crash, game design, global supply chain, global village, Howard Rheingold, hypertext link, Inbox Zero, invention of agriculture, invention of hypertext, invisible hand, iterative process, John Nash: game theory, Kevin Kelly, laissez-faire capitalism, Law of Accelerating Returns, loss aversion, mandelbrot fractal, Marshall McLuhan, Merlin Mann, Milgram experiment, mutually assured destruction, Network effects, New Urbanism, Nicholas Carr, Norbert Wiener, Occupy movement, passive investing, pattern recognition, peak oil, price mechanism, prisoner's dilemma, Ralph Nelson Elliott, RAND corporation, Ray Kurzweil, recommendation engine, Silicon Valley, Skype, social graph, South Sea Bubble, Steve Jobs, Steve Wozniak, Steven Pinker, Stewart Brand, supply-chain management, the medium is the message, The Wisdom of Crowds, theory of mind, Turing test, upwardly mobile, Whole Earth Catalog, WikiLeaks, Y2K
Members of the various local networks meet on regular market days to purchase goods or negotiate simple service agreements for the coming week. This is a presentist economy, at least in comparison with the storage-based economics of the euro and traditional banking. Nothing is spring-loaded or leveraged, which makes it harder for these markets to endure changing seasonal conditions, support multiyear contracts, or provide opportunities for passive investment. But this style of transaction still does offer some long-term benefits to the communities who use it. Human relationships are strengthened, local businesses enjoy advantages over larger foreign corporations, and investment of time and energy is spent on meeting the needs of the community itself. Greek villagers in the shadow of a failing euro aren’t the only ones abandoning time-compressed investment strategies.
algorithmic trading, asset allocation, asset-backed security, backtesting, banking crisis, Black Swan, Black-Scholes formula, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, discrete time, diversification, fixed income, implied volatility, interest rate derivative, interest rate swap, margin call, market microstructure, martingale, p-value, passive investing, quantitative trading / quantitative ﬁnance, random walk, risk/return, Sharpe ratio, short selling, statistical model, stochastic process, stochastic volatility, time value of money, transaction costs, value at risk, volatility smile, Wiener process, yield curve, zero-coupon bond
Hence, it makes sense to consider that in a risky investment (r, σ) it should be the excess return only, that is, r − rf, that pays for the supported risk. Hence the Sharpe ratio: Practically speaking, for a given period of past data leading to r and σ measures, the rf rate must be of a non-defaultable government bill or bond of maturity coinciding with the same period of time as used for r and σ. The data for r and rf being usually expressed on a p.a. basis, σ must also be computed on a p.a. basis. Example. For a fund passively invested in the S&P 500 in 2009, the computed return and risk were 17.96% p.a. and 27.04% p.a. respectively (based on daily closing prices). The corresponding 12-month T-Bill was 2.004%. The Sharpe ratio is Note that in the fund industry, it is hard to achieve a Sharpe ratio above 1, which may be viewed as a reference level. The Treynor Ratio In the funds industry, the performance objective of a portfolio P is generally referring to a benchmark, typically an equity index.
Throwing Rocks at the Google Bus: How Growth Became the Enemy of Prosperity by Douglas Rushkoff
3D printing, Airbnb, algorithmic trading, Amazon Mechanical Turk, Andrew Keen, bank run, banking crisis, barriers to entry, bitcoin, blockchain, Burning Man, business process, buy low sell high, California gold rush, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, centralized clearinghouse, citizen journalism, clean water, cloud computing, collaborative economy, collective bargaining, colonial exploitation, Community Supported Agriculture, corporate personhood, crowdsourcing, cryptocurrency, disintermediation, diversified portfolio, Elon Musk, Erik Brynjolfsson, ethereum blockchain, fiat currency, Firefox, Flash crash, full employment, future of work, gig economy, Gini coefficient, global supply chain, global village, Google bus, Howard Rheingold, IBM and the Holocaust, impulse control, income inequality, index fund, iterative process, Jaron Lanier, Jeff Bezos, jimmy wales, job automation, Joseph Schumpeter, Kickstarter, loss aversion, Lyft, Mark Zuckerberg, market bubble, market fundamentalism, Marshall McLuhan, means of production, medical bankruptcy, minimum viable product, Naomi Klein, Network effects, new economy, Norbert Wiener, Oculus Rift, passive investing, payday loans, peer-to-peer lending, Peter Thiel, post-industrial society, profit motive, quantitative easing, race to the bottom, recommendation engine, reserve currency, RFID, Richard Stallman, ride hailing / ride sharing, Ronald Reagan, Satoshi Nakamoto, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Snapchat, social graph, software patent, Steve Jobs, TaskRabbit, trade route, transportation-network company, Turing test, Uber and Lyft, Uber for X, unpaid internship, Y Combinator, young professional, Zipcar
“It’s good for a market economy to have income inequality but to extremes, it can actually damage growth long term and make it less sustainable.”19 Bovino showed that it’s not just the extreme of inequality that’s to blame but the decline of labor and business income in the face of rising capital gains. Simply stated, it’s harder to make money by working or creating value when the scales tip too far in favor of investors and shareholders. In a sense, though, the aim of the original corporate program has been achieved: those who create value have been utterly subsumed by those who passively invest. But as Bovino is trying to warn us, corporate shareholders can’t take this much money out of circulation without killing the goose. Those who run real businesses or, worse, work for a living end up like the musicians on the bad end of the long tail. Meanwhile, passive investors who depend on economic growth end up sitting on their bags of money, unable to find new productive investments. That’s why the S&P cut its growth forecasts for U.S. corporations, which are still flummoxed by the whole situation.
affirmative action, Affordable Care Act / Obamacare, Bernie Sanders, Bretton Woods, carried interest, clean water, collateralized debt obligation, collective bargaining, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, desegregation, diversification, diversified portfolio, Donald Trump, financial innovation, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, illegal immigration, interest rate swap, laissez-faire capitalism, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, medical malpractice, moral hazard, mortgage debt, obamacare, passive investing, Ponzi scheme, prediction markets, quantitative easing, reserve currency, Ronald Reagan, Sergey Aleynikov, short selling, sovereign wealth fund, too big to fail, trickle-down economics, Y2K, Yom Kippur War
At least that’s what Goldman Sachs told its institutional investors back in 2005, in a pamphlet entitled Investing and Trading in the Goldman Sachs Commodities Index, given out mainly to pension funds and the like. Commodities like oil and gas, Goldman argued, would provide investors with “equity-like returns” while diversifying portfolios and therefore reducing risk. These investors were encouraged to make a “broadly-diversified, long-only, passive investment” in commodity indices. But there were several major problems with this kind of thinking—i.e., the notion that the prices of oil and gas and wheat and soybeans were something worth investing in for the long term, the same way one might invest in stock. For one thing, the whole concept of taking money from pension funds and dumping it long-term into the commodities market went completely against the spirit of the delicate physical hedger/speculator balance as envisioned by the 1936 law.
Money and Power: How Goldman Sachs Came to Rule the World by William D. Cohan
asset-backed security, Bernie Madoff, buttonwood tree, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, fear of failure, financial innovation, fixed income, Ford paid five dollars a day, Goldman Sachs: Vampire Squid, Gordon Gekko, high net worth, hiring and firing, hive mind, Hyman Minsky, interest rate swap, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, merger arbitrage, moral hazard, mortgage debt, paper trading, passive investing, Ponzi scheme, price stability, profit maximization, risk tolerance, Ronald Reagan, Saturday Night Live, South Sea Bubble, time value of money, too big to fail, traveling salesman, value at risk, yield curve, Yogi Berra
“Fed officials seem to worry that control is a subtle influence and that, despite the nonvoting agreement, Sumitomo might end up exerting some influence over Goldman’s activities and decisions.” The Fed decided to hold a public hearing on October 10. “We want people to discuss not only the specific terms of the Sumitomo-Goldman deal but the broader issues,” a Fed official explained. “Is this the end of Glass-Steagall, or is this indeed just a passive investment?” At a rare public hearing at the Fed, which was attended by more than two hundred people, Michael Bradfield, the general counsel, seemed particularly focused on whether the investment would “lead to Sumitomo influencing the management decisions of Goldman Sachs” and be a violation both of Glass-Steagall and the Bank Holding Company Act of 1956, which limits to 25 percent the nonvoting stock ownership from another entity.
“In our view, with these changes the investment is truly passive,” Bradfield said. In a statement, the Fed said, “The board was concerned that this combination of significant equity investment and maintenance of extensive business relationships would give the investor both the economic incentive and means to exercise a controlling influence over the management policies” of Goldman. Weinberg seemed happy to make the changes. “This was a passive investment from the first word,” he said, “and there was never a desire on Sumitomo’s part to get control.” The Fed’s approval cleared the way for Goldman to get Sumitomo’s money by December 1. “This will give us additional capital to provide clients with a broad range of investment,” Weinberg said. But the bigger question floating around the halls of 85 Broad Street was whether the Sumitomo capital was enough.
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel
accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, mortgage tax deduction, new economy, Own Your Own Home, passive investing, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, The Myth of the Rational Market, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond
A Broader Definition of Indexing The indexing strategy is one that I have recommended since the first edition in 1973—even before index funds existed. It was clearly an idea whose time had come. By far the most popular index used is the Standard & Poor’s 500-Stock Index, an index that well represents the major corporations in the U.S. market. But now, although I still recommend indexing, or so-called passive investing, there are valid criticisms of too narrow a definition of indexing. Many people incorrectly equate indexing with a strategy of simply buying the S&P 500 Index. That is no longer the only game in town. The S&P 500 omits the thousands of small companies that are among the most dynamic in the economy. Thus, I believe that if an investor is to buy only one U.S. index fund, the best general U.S. index to emulate is one of the broader indexes such as the Russell 3000, the Wilshire 5000 Total Market Index, or the MSCI U.S.
Your Money: The Missing Manual by J.D. Roth
Airbnb, asset allocation, bank run, buy low sell high, car-free, Community Supported Agriculture, delayed gratification, diversification, diversified portfolio, estate planning, Firefox, fixed income, full employment, Home mortgage interest deduction, index card, index fund, late fees, mortgage tax deduction, Own Your Own Home, passive investing, Paul Graham, random walk, Richard Bolles, risk tolerance, Robert Shiller, Robert Shiller, speech recognition, traveling salesman, Vanguard fund, web application, Zipcar
But a funny thing happens the longer you hold onto them: They begin to float to the top of the stack. That's because the "hot" funds don't stay hot year after year—they cool down. So while index funds are usually in the middle of the pack in any given one-year period, they shine over the long term. During the recent stock market tumble, some folks shouted, "Look! Buy-and-hold investing is dead!" They took the stock market's decline as evidence that passive investing with index funds doesn't work. Well, it doesn't work if you sell after a fall, but if you hold onto your investments, you're fine—you haven't lost anything but time. In fact, many savvy investors viewed the market crash as a chance to buy—and hold onto—even more shares of their index funds. Investing is a game of years and decades, not months. What your investments did this year is far less important than what they'll do over the next decade (or two, or three).
Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen
asset allocation, asset-backed security, capital controls, cognitive dissonance, corporate governance, diversification, diversified portfolio, fixed income, index fund, law of one price, Long Term Capital Management, market bubble, market clearing, market fundamentalism, passive investing, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Steve Ballmer, technology bubble, the market place, transaction costs, Vanguard fund, yield curve
While the value added by operationally oriented buyout partnerships may, in certain instances, overcome the burden imposed by the typical buyout fund’s generous fee structure, in aggregate, buyout investments fail to match public market alternatives. After adjusting for the higher level of risk and the greater degree of illiquidity in buyout transactions, publicly traded equity securities gain a clear advantage. Active Management and Buyout Funds In the private equity world, active management success goes hand-in-glove with investment success. In asset classes such as domestic equities and fixed income, which contain passive investment alternatives, investors can buy the market. By owning a marketable-security index fund, investors reap market returns in a cost-efficient, reliable manner. In the inefficient private equity world, investors cannot buy the market, as no investable index exists. Even if a leveraged-buyout index existed, based on past performance, index-like results would fail to satisfy investor desires for superior risk-adjusted returns.
Finance and the Good Society by Robert J. Shiller
bank run, banking crisis, barriers to entry, Bernie Madoff, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, full employment, fundamental attribution error, George Akerlof, income inequality, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, Zipcar
If statistical evidence proves that no one can outperform a strategy of choosing investments randomly, then their attempts to claim that they do so must be fundamentally dishonest. There is an element of truth to this academic view: many investment managers have succeeded in creating false impressions as to their superiority as investors. Evidence in the academic nance literature shows that actively managed stock market mutual funds have generally been worse investments in recent decades than funds that follow a passive investment strategy and merely invest in all shares in the stock market. For example, Martin Gruber found in 1996 that mutual funds underperformed a diversi ed investment in the stock market by about 1.5% a year.1 This underperformance re ected the regularly scheduled management fees imposed by the mutual funds on their investors, but not the load fees (large one-time-only fees that are collected when money is invested or taken out), so the actual performance of mutual funds was even worse.
algorithmic trading, Berlin Wall, bonus culture, BRICs, business process, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, diversification, Emanuel Derman, financial innovation, fixed income, friendly fire, Goldman Sachs: Vampire Squid, high net worth, housing crisis, London Whale, Long Term Capital Management, merger arbitrage, new economy, passive investing, performance metric, risk tolerance, Ronald Reagan, Saturday Night Live, shareholder value, short selling, sovereign wealth fund, The Nature of the Firm, too big to fail, value at risk
Goldman creates GSCI, a benchmark for investment performance in the commodities markets (T). 1992: Bob Rubin leaves Goldman to become assistant to the president on economic policy (O). The move adds to the Goldman mystique but is unusual in that Rubin’s is one of the shortest tenures as senior partner. A Hawaiian educational trust, the Kamehameha Schools/Bishop Estate, invests $250 million in Goldman and receives a stake of more than 5 percent in the firm. It is a passive investment; the trust has no voting privileges but will participate in Goldman’s profits and losses. In an effort to further link pay to performance, and to create a new source of developmental feedback, Goldman institutes 360-degree performance reviews (meaning that even junior staff reviews senior staff). New offices are opened in Frankfurt, Milan, and Seoul (O, C). 1993: Goldman is one of the most profitable firms in the world with record profits and experiences rapid growth and global expansion.
Your Money or Your Life: 9 Steps to Transforming Your Relationship With Money and Achieving Financial Independence: Revised and Updated for the 21st Century by Vicki Robin, Joe Dominguez, Monique Tilford
asset allocation, Buckminster Fuller, buy low sell high, credit crunch, disintermediation, diversification, diversified portfolio, fiat currency, financial independence, fudge factor, full employment, Gordon Gekko, high net worth, index card, index fund, job satisfaction, Menlo Park, Parkinson's law, passive income, passive investing, profit motive, Ralph Waldo Emerson, Richard Bolles, risk tolerance, Ronald Reagan, Silicon Valley, software patent, strikebreaker, Thorstein Veblen, Vanguard fund, zero-coupon bond
At its core, index fund investing means you are using an approach and strategy that seeks to track the investment returns of a specified stock or bond market benchmark or index. One of the most popular index funds today is the S&P 500 Index Fund, which attempts to replicate the investment results of this specific target index. There is no attempt to use traditional “active” money management or to make “bets” on individual stocks. Indexing is a passive investment approach emphasizing broad diversification and low portfolio trading activity. Low cost is a key advantage of index funds, leaving a larger share of the pie for investors, which is why this choice aligns well for your FI investment plan. Low Fees Are Key Fees, by far, are one of the most overlooked areas in terms of investment decisions. Index funds boast some of the lowest portfolio-management fees in the industry, which is why they are the vehicle of choice for investors looking for value as well as performance.
The Snowball: Warren Buffett and the Business of Life by Alice Schroeder
affirmative action, Albert Einstein, anti-communist, Ayatollah Khomeini, barriers to entry, Bonfire of the Vanities, Brownian motion, capital asset pricing model, card file, centralized clearinghouse, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, Donald Trump, Eugene Fama: efficient market hypothesis, global village, Golden Gate Park, Haight Ashbury, haute cuisine, Honoré de Balzac, If something cannot go on forever, it will stop, In Cold Blood by Truman Capote, index fund, indoor plumbing, interest rate swap, invisible hand, Isaac Newton, Jeff Bezos, joint-stock company, joint-stock limited liability company, Long Term Capital Management, Louis Bachelier, margin call, market bubble, Marshall McLuhan, medical malpractice, merger arbitrage, Mikhail Gorbachev, moral hazard, NetJets, new economy, New Journalism, North Sea oil, paper trading, passive investing, pets.com, Plutocrats, plutocrats, Ponzi scheme, Ralph Nader, random walk, Ronald Reagan, Scientific racism, shareholder value, short selling, side project, Silicon Valley, Steve Ballmer, Steve Jobs, supply-chain management, telemarketer, The Predators' Ball, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, transcontinental railway, Upton Sinclair, War on Poverty, Works Progress Administration, Y2K, zero-coupon bond
He, of course, wanted them to choose the cash, leaving the Berkshire Hathaway and Diversified Retailing stocks for himself. Nevertheless, he was honest with them. In a letter of October 9, 1969, he made a market forecast, which he had previously declined to do. With the market at such heights, “…[f]or the first time in my professional life,” he wrote, “I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds”5—although he did allow as how the very best money managers might be able to squeeze out a few percentage points over the earnings of bonds. Nonetheless, the departing partners shouldn’t have high hopes for what they could do with the cash. Two months later, on December 5, he gave a prediction about how these two stocks would do, along with telling the partners what he was going to do himself.
Book value. Tangible book value was $43. Warren Buffett letter to partners, October 9, 1969. 3. Ibid. 4. The more inquisitive partners may have discovered that Berkshire Hathaway owned Sun Newspapers by reading its 1968 annual report. 5. Letter to partners, October 9, 1969. Buffett explained that he expected stocks to yield about 6½% after tax for the next ten years, roughly the same as a “purely passive investment in tax-free bonds.” Even the best managers, he said, were unlikely to do better than 9½% after tax. Compare this to the 17% return he had projected to partners in the early years of the partnership and the 30% average he had actually achieved. 6. Letter to partners, December 5, 1969. 7. According to Buffett, a couple of them never were able to find anyone they trusted to manage their money, and one ended up working as a fortune-teller in San Diego. 8.
Unreal Estate: Money, Ambition, and the Lust for Land in Los Angeles by Michael Gross
Albert Einstein, Ayatollah Khomeini, bank run, Bernie Madoff, California gold rush, clean water, Donald Trump, estate planning, family office, financial independence, Maui Hawaii, McMansion, mortgage debt, offshore financial centre, oil rush, passive investing, pension reform, Ponzi scheme, Ronald Reagan, Silicon Valley, stem cell, Steve Jobs, Steve Wozniak, The Predators' Ball, transcontinental railway
Stewart had the Midas touch when it came to making it—and after moving to Sunset House, he made lots more, unlike so many who moved to the Triangle only to flame out financially and leave again. Stewart bought their first farmland—2,500 acres of citrus trees and a packing plant in Delano, California—in 1978. Lynda would later claim it was a calculated plan to develop businesses that were “good for people.” Stewart, on the other hand, considered it a passive investment. They were more active in Teleflora (a small, profit-making competitor of the huge nonprofit, florist-owned cooperative FTD), which they bought the next year. It was the first example of the teamwork that would build their empire. “Stewart and I together make one perfect person,” Lynda later said. “We’re like little salt and pepper shakers.” Stewart handles strategy, administration, and finance; Lynda, marketing and image.
The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig
accounting loophole / creative accounting, air freight, Andrei Shleifer, asset allocation, buy low sell high, capital asset pricing model, corporate governance, Daniel Kahneman / Amos Tversky, diversified portfolio, Eugene Fama: efficient market hypothesis, hiring and firing, index fund, Isaac Newton, Long Term Capital Management, market bubble, merger arbitrage, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, the market place, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra
Incidentally, 35 years later I called Tom to ascertain some of the facts involved here and I found him on the beach again. The only difference is that now he owns the beach! In 1968 Tom Knapp and Ed Anderson, also a Graham disciple, along with one or two other fellows of similar persuasion, formed Tweedy, Browne Partners, and their investment results appear in Table 2. Tweedy, Browne built that record with very wide diversification. They occasionally bought control of businesses, but the record of the passive investments is equal to the record of the control investments. Table 3 describes the third member of the group who formed Buffett Partnership in 1957. The best thing he did was to quit in 1969. Since then, in a sense, Berkshire Hathaway has been a continuation of the partnership in some respects. There is no single index I can give you that I would feel would be a fair test of investment management at Berkshire.
Oil: Money, Politics, and Power in the 21st Century by Tom Bower
Ayatollah Khomeini, banking crisis, bonus culture, corporate governance, credit crunch, energy security, Exxon Valdez, falling living standards, fear of failure, forensic accounting, index fund, interest rate swap, kremlinology, LNG terminal, Long Term Capital Management, margin call, Mikhail Gorbachev, millennium bug, new economy, North Sea oil, offshore financial centre, oil shale / tar sands, oil shock, passive investing, peak oil, Piper Alpha, price mechanism, price stability, Ronald Reagan, shareholder value, short selling, Silicon Valley, sovereign wealth fund, transaction costs, transfer pricing, éminence grise
In 1987 Conoco had lost millions of dollars drilling dry holes there. Unable to afford further exploration from rigs floating 3,000 feet above the seabed, the company sold the rights to Shell. Bookout was convinced that the drill should have been placed just 400 yards away. Soon after Shell’s purchase, Jack Golden, BP’s head of exploration in the Gulf, offered to buy a third of Shell’s investment in return for sharing a proportion of the cost. Passive investment, or “farming in,” by competitors was not unusual in big projects. Even the mighty oil corporations needed to mitigate their risks. Golden had regretted BP’s tardiness in bidding for the US government’s first round of 10-year licenses for deep-water exploration in the Gulf, and his irritation was compounded by Shell’s perfunctory rebuff of his offer. Shell’s executives did not want to share their potential profits, especially with BP.
Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann
Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money: store of value / unit of account / medium of exchange, moral hazard, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative ﬁnance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, transatlantic slave trade, tulip mania, wage slave
Venetian citizens could take the economic value saved up from past labor or trade and convert it into future cash flows. In this way, it was possible to economically hedge against the depletion of earnings capacity as the body and mind grow old; it was possible to create a perpetual stream of benefits to endow a charity. It was also a way to pass along an asset that did not have to be managed. Venetian prestiti were attractive particularly because they were passive investment vehicles whose value depended only on the viability and honesty of the state, not on the capabilities of the owner. USURY AND A REVOLUTION IN THOUGHT In institutionalizing government loans, Venice would seem to have directly contradicted the well-known ecclesiastical proscription against usury. The mendicant orders of the Catholic Church were founded in the early thirteenth century: the Franciscans in 1206 and the Dominicans in 1216.