There is a discernible thrill to picking stocks correctly. Carefully considering risks, weighing possible options, and evaluating every aspect of a company, pulling the trigger, and finally seeing all your hard work pay off is extremely satisfying—and it can be very profitable too. While one must take care to avoid being sucked into the gambler’s paradise of day-trading, there is clearly an important role for the active investor, in value and growth. But there is an obvious catch: consistently successful trading is extremely difficult (read more here).
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The Investor Balancing Act
This week I’ll shift away from the cognitive biases and irrational behavior that affect our decision-making, and instead shift my focus towards one of the most important aspects of investing: portfolio theory. Modern portfolio theory (MPT) focuses on building a portfolio of assets that maximizes the risk-adjusted return—that is, maximizes the expected return of an investment portfolio while minimizing its risk (learn more about how to avoid risk here).
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The Voice Of Reason
Despite being one of the most basic ideas of microeconomics, “sunk costs” are deceptively easy to understand; yet, they lead even the most rational people to make irrational decisions. The basic idea of a sunk cost is quite simple: once a cost has been incurred, it should have no bearing on future decisions (it is “sunk”). The classic example of this phenomenon is the advance purchase of a movie ticket for which one cannot receive a refund.
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Momentum Investing
Technology stocks, once the darlings of Wall Street, are now facing intense investor scrutiny. Over the last three months, key tech stocks, such as Twitter (TWTR), Netflix (NFLX), and Amazon (AMZN), experienced significant declines in their stock prices. Twitter is down more than 44%, Netflix is down nearly 20%, and Amazon is down about 17% (all since March).
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Dividends For Dummies
Entering the world of investing can seem like a daunting endeavor. With so many different stocks, bonds, ETFs, and mutual funds to choose from, how can one ever figure out where to start? For new investors, I believe the answer to this question is large, proven companies that pay dividends.
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The Importance Of Rationality
“Economics,” as I was told early in my undergraduate career, “is really just common sense, codified.” This seems true enough. Economics is fundamentally concerned with scarcity and opportunity costs—the intuitively obvious, yet often overlooked ideas that that there is no such thing as a free lunch, and that if you spend your money on one thing, you can’t spend it on something else. It gives us the tools to understand and measure these concepts in the world around us.
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Make The Right Bets
As I reflect on my three years of investment experience, I realize that I've done many things correctly. However, I also understand I've made my share of mistakes. I'm not at all upset with the errors of my past, as they've provided me invaluable insight into how the game is played, and are part of the learning curve associated with the stock market. Although I encourage people to push their limits when learning a new activity, investing is different.
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