Friday, May 24, 2013

5 things to know about investing

I own one finance textbook, and I occasionally open it to remind myself how little I know about finance. It's packed with formulas on complex option pricing, the Gaussian copula function, and a chapter titled, "Assessment of Confidence Limits of Selected Values of Complex-Valued Models." I have literally no idea what that means.

Should it bother me that there's so much about finance I don't know? I don't think so. As John Reed writes in his book Succeeding:
When you first start to study a field, it seems like you have to memorize a zillion things. You don't. What you need is to identify the core principles -- generally three to twelve of them -- that govern the field. The million things you thought you had to memorize are simply various combinations of the core principles.
Evolution tells you a lot about biology. A handful of cognitive biases explain most of psychology. Likewise, there are a few core principles that explain most of what we need to know about investing.

Here are five that come to mind.

1.  It takes time.
2.  The largest single variable that affect returns is valuations [Peter Lynch might disagree].
3.  Simple is better than smart.
4.  The odds of high volatility is 100%.
5.  The industry is dominated by cranks, charlatans, and salesmen.

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