Monday, April 19, 2010

Three Questions (Part 2)

Ken Fisher's book "The Only Three Questions that Count" he asks the following three questions:

1. What do you believe that is actually false?
2. What can you fathom that others find unfathomable?
3. What the heck is my brain doing to blindside me now?

After learning these three questions, what are Fisher's advice in investing?

He has four rules that count:

Rule 1: Select an appropriate benchmark
Rule 2: Analyze the benchmark's components and assign expected risk and return.
Rule 3: Blend noncorrelated or negatively correlated securities to moderate risk relative to expected returns.
Rule 4: Always remember you can be wrong so don't stray from the first three rules.

Fisher has a very systematic approach to investing. He looks at the past 80 years of S&P returns (Table 8.1)
Return Occurrence Frequency
Greater 20% 31 times 38.75%
0 to 20% 26 times 32.50%
-20% to 0 18 times 22.50%
less -20% 5 times 6.25%

When looking at the past returns, you can have one of four results: big gains, small gains, small loss, large loss. From the past 80 years, positive years outnumber negative years almost 2 to 1. Keep this in mind when you do your investing. On average 2 out of every 3 years are positive. Use this knowledge with your benchmarking. Almost like playing roulettes, your odds in the market are much better than if you stay out of it or selecting single stocks.

By benchmarking, Fisher teaches using something like MSCI, S&P, Russell, etc. something large that you can track and has a large enough pool of stocks so you can compare your portfolio. Fisher advises looking at your relative return to a benchmark instead of an absolute return. That way you limit your risk as well as providing a large enough way to maximize your return. You want to be better than the market.

So he breaks down each benchmark: 70% of what you do should be asset allocation (stocks, bonds, cash); 20% is sub-asset allocation for example international, sector, capitalization (big vs small cap), valuation (value vs. growth); and the last 10% should be actual individual stocks. Figure 9-4 has a good illustration of a portfolio engineering funnel.

And of course you could be always wrong, so also hedge your investments.

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