“Jackass Investing: Don’t do it. Profit from it”., has been a Kindle best seller since its release in mid-2011. Written by 30 year hedge fund veteran Mike Dever, the book has been called both ground-breaking and controversial as it introduces several innovative concepts – proven over decades of trading by Mr. Dever – including the replacement of “asset classes” with “return drivers” and a risk-based portfolio allocation method to replace conventional portfolio diversification.
The book stomps on conventional investment wisdom. Mr. Dever exposes 20 common investment myths; showing that much of what is commonly accepted as investment fact is actually myth. He does this through careful analysis, including extensive research and dozens of studies.
Here over a series of posts, Mr. Dever will briefly describe each myth, which is explained in a chapter of the book, and reveal key findings and innovations to disprove the myth.
In the Introduction to Jackass Investing, I first introduce the concept of “Return Drivers” and explain how a return driver is “the primary underlying condition that drives the price of a market.” This is a key fundamental concept that permeates the entire book. Once developed, a return driver can be combined with relevant markets to create “trading strategies,” and finally, trading strategies can be combined to create truly diversified portfolios. My investment experience, dating back to the 1970’s, has taught me that the conventionally-accepted investment paradigm is flawed beyond repair. Rather than tweaking it in an evolutionary fashion, I construct an entirely new, rational investment paradigm that properly addresses what I have observed and learned over the years.
Myth #1: Stocks Provide an Intrinsic Return
The conventional explanations for equity returns, such as the “equity risk premium,” are a statistical landfill into which academics toss stuff they can’t explain. Find out over which time frames the true “Return Drivers” of stock market returns (which, spoiler alert, are earnings growth and investor sentiment), dominate. The answer will go a long way in explaining why so many stock-selection models fail. The most important takeaways proven in the busting of this myth are:
- Every market’s price is driven by one or more return drivers
- Every return driver has a time period over which it is dominant
Myth #2: Buy and Hold Works Well for Long-term Investors
Stock market returns are extremely “lumpy,” with years of underperformance punctuated by seemingly out-of-the-blue stock market rallies. The large risks inherent in this approach prove that buy-and-hold is not a strategy at all, but merely a way to justify losses. While the large losses, all by themselves, may be reason to avoid the buy-and-hold approach, the data over the past century of global investing is even more alarming. I present results of research that show that more than half of the stock markets that existed in 1900 suffered at least one major hiatus in trading, with the outcome being that many people were wiped out. You don’t hear about studies touting buy-and-hold in those markets; only the ones that, in hindsight, performed well. That doesn’t mean the same performance is destined to occur over the next 100 years. In fact, as I show in the busting of this myth, the odds are against it.
Myth #3: You Can’t Time the Market
This chapter uses a popular Seinfeld episode (“The Opposite”), to impart financial wisdom by presenting data showing how badly people mistime their trading. It explains precisely why YOU CAN correctly time the U.S. stock market (that’s right, by doing “The Opposite”). I present a specific trading strategy that my firm, Brandywine Asset Management, uses in its own trading of client accounts. The strategy is real and effective, one of dozens of trading strategies used by Brandywine. The greatest revelation in this chapter is the assertion that “everyone is a market timer.” It’s just a matter of over what period you’re buying and selling (even if you sell only upon your death). So you might as well do it according to a well-backed plan.
Myth #4: “Passive” Investing Beats “Active” Investing
This chapter begins with the statement, “Passive index investing is active investing.” I then show how the most popular equity indexes (the Dow Industrials, S&P 500 and NASDAQ 100) are calculated – which ranges from mystifying to arbitrary. This leads to the question “why would a person subrogate their investment process to (the index providers) rather than manage their portfolios themselves pursuant to some clearly defined, objective, profit-motivated, systematic, and repeatable set of rules?” In other words, if you’re going to follow a system (in this case someone else’s index), follow one that has been developed to produce profits, rather than merely be “representative,” as is the stated purpose for most of the indexes.
Myth #5: Stay Invested So You Don’t Miss the Best Days.
The first summary point at the end of this chapter says it all: “Investing is the process of taking the best trades and avoiding the disasters. Gambling is being afraid to cut losses for fear of missing out on profits.” Nuff said!