Friday, February 1, 2008

Speculate some, but Diversify more to build Wealth

CNN money has an interesting article on how the experts invest. As you might expect not all of them follow what they preach/teach.

The article presents results from a survey that was conducted of more than 600 finance professors at major U.S. universities to find out how they invest their own money. The survey found that in their classrooms, these professors lecture on complex theories of how markets balance risk and return, while in their portfolios only two-thirds of the professors have diversified the bulk of their assets into index funds.

What about the other one third? They are throwing the theory out the window and chasing stocks based on price growth - not fundamentals.

It seems that a lot of these professors are just like the rest of us. We all know how hard it is to beat the market, but we never stop trying. We are not satisfied with getting anywhere slowly.

The article culminates with some interesting lessons from the survey.

First, whenever anyone tells you that research "proves" a novel method of investing is a market beater, bear in mind that the professor behind the paper is most likely an indexer who has never road-tested his theory in the real world of trading costs, taxes and other expenses.

Second, remember that even many of the people who know best can't resist chasing hot stocks, so you have to control your behavior in advance.

Get rich quick schemes rarely work. Since it is so difficult to control this tendency to chase the latest trend, hot stock, etc, why not strike a compromise? You don’t have to give up completely on trying to beat the market, but you must have a foundation. Just in case you don’t hit it big!

Why not develop a diversified core holding of index funds and then enhance that with a handful of select stocks? This allows for some speculation to feed those "get rich quick" tendencies we all seem to have, while still ensuring that the majority of your funds are working towards "getting rich slowly".

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