Wednesday, November 17, 2010

Thank You Uncle Sam

How soon we forget.

Just two years after a near total economic collapse, the media is rife with complaints about how government intervention failed us and will always fail us. Right now, the topic of the hour is the Fed's very intelligent efforts to inject liquidity into the economy. Only its not described as intelligent. Rather its attacked through internet cartoons and by the likes of Sarah Palin as reckless.

The mood seems to be that if everything isn't good, then we've failed. This is absurd. Yes, unemployment is high and will be for years to come. But an unemployment rate of 9.6% is not an unemployment rate of 20% and GDP growth of 2% is not a contraction of 5%. Things are so much, much better than they would have been without the heroic interventions of 2008.

So it was with a smile on my face that I read Warren Buffett's thank you note to Uncle Sam this morning. Its worth reading to remember and give thanks for a catastrophe averted and for the brave individuals who rose to the challenge.

Friday, April 23, 2010

How to Pick the Investment Strategy that's Right for You

Your most important investment decision is whether to pursue an active or passive investment approach:

With active investing your odds of succeeding range from 0 to 10%. With passive investing, your odds of winning are about 90% after taxes.

So which is right for you?

You can think of active investing as the classic "Buy Low and Sell High" investing strategy. It sounds right until we realize that we are buying and selling from other people who also think they are making a smart decision. And normally these other people -- the ones we are buying and selling from -- are very smart, capable and hard working. We've entered what economists call a zero sum game. In order for one party to win, the other must lose. Then it gets harder. It's not just a matter of half the players winning and the other half losing. Because buying and selling costs both money and taxes, many more people lose than win. After considering transaction costs, about 30% of the players win. After taking out taxes as well, the number of winners falls to 5% - 10%. The rub, however, is that if you do win with active management, you will make more money.

Passive investing is typically a "Buy and Hold" investment approach. It emphasizes diversification and keeping your investments for the long term -- usually decades. The beauty of this approach is that you don't need a sucker at the other end of the trade. Everyone who invests this way can win because as the stock market grows along with company earnings, everyone's investments go up. Because you are not buying and selling, your costs and taxes remain very low.

No one can tell you which approach to take. The answer depends on your appetite for gambling and whether you believe that the 5-10% who win are there by luck or skill.

Said another way: With a $1 million investment, would you prefer a 10% chance of making $120,000 or a 90% chance of making $100,000?