Financial Advice for My Son


Other Investing Tidbits

Traders are losers

Trading, as opposed to long-term investing, incurs transaction costs and tax liabilities. One study on stock returns found that in order to beat the long-term market return, you have to "call the top" and "call the bottom" with an accuracy of more than 80%! Furthermore, the risk/reward ratio is bad. You risk twice as much on the downside as you can gain on the upside.

The transaction costs and tax liabilities can eat up traders. To switch from one stock to another, you pay costs of 3-6%. If you turn over your portfolio several times per year, you must outperform the market by 10% or more just to stay even!

The tax liabilities result because as long as you do not sell your stock, you do not have to pay taxes on any capital gains (the price appreciation of your stock). Thus you are getting income (dividends) and further capital gains on the government's share as long as you don't sell. Once you sell, you have left only 1-b of your investment, which ain't as much as you had before!

Dollar-cost Averaging

One technique that can buy you a percent or two in total return is to use dollar-cost averaging. To dollar-cost average, you purchase your investments on a regular basis using the same dollar amount. For example, you buy $100 worth of a mutual fund every month.

The advantage is that you buy more shares when the cost is low and fewer shares when the cost is high. The result is that your average cost per share is lower than the average cost per share of the investment over the same period. (Mathematicians know that this is just the result of 1/x averaging.) This technique therefore takes advantage of the volatility of any risky investment.

Never commit your money to a risky investment at once

The standard deviation of almost all risky investments has most of its power on short time scales. In particular, the stock market varies significantly over roughly a 4 year period, which magically coincides with the 4 year Presidential Election cycle. This variation has its roots in the roughly 4 year business cycle, of roughly 3 years of expansion and 1 year of recession.

Because of this variation, you should not put your money into any risky investment at once. Instead, Ease in and Ease out. If you have $x and put them into the market at once, you could lose a significant amount of money if the market spends the next year (or day!) going down. Instead, if you invest $x/48 per month over the next 4 years, you almost entirely eliminate the cycle related risk, and because of dollar-cost averaging, you automatically gain a percent or 2. Another benefit is that you no longer need worry at all about fluctuations in the market over time periods shorter than 4 years, because you are taking advantage of them, instead of letting them take advantage of you!

Personal acceptance of risk

If you cannot stand to lose 30% of your money in a year, for example, even though you made 40% last year and 20% the year before, don't invest in stocks. Do realize that the price of your "peace of mind" is that you will be losing money to inflation and taxes every year at a steady rate.


(Add section about how some variable will always correlate with another if enough variables are examined. Mention Superbowl predictor, etc.)

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