Roger Ibbotson is an emeritus professor of finance at Yale and a respected expert on capital markets and cost of capital. I recently came on a thought he provided.
“Yes. The trend is your friend, but if the trend is over-trending, it is not your friend anymore.”
Trends are real in the sense that stock prices often continue on a path related to previous prices. That is contradictory to the idea that prices are independent variables. The random walk idea. That contradiction may not matter if the time frame is short enough, but I have always mistrusted contradictions in fundamental ideas.
I think “The trend is your friend” idea is much like the Marine Corp idea. “Once you pull the pin, Mr Grenade is no longer your friend.” At least the Marines have an indicator when the relationship has switched. Trend investors are less well informed.
There is a lesson here. You cannot rely on a single indicator for your investment decisions.
The fund managers I know are very curious, interested and alert people. Everything that happens in the real world may influence their investments, so they keep informed. They assess dozens of variables. Not to the point of hyper-vigilance, but they know. They are skilled at looking and they are bright enough to see the handwriting earlier than most others.
The rest of us, cannot stay fully informed and we often pass over important information. We lack the template to compare all the information and so find things too late. Professionals see a fact and they understand its meaning. We may see the fact but fail to grasp its meaning. Usually we do not even see it because our scope of information and interest is too narrow.
To overcome the deficiency we have choices.
Suppose we found some particular industry that we could understand and track. Rare earth mineral mines, or manufacturers of surf boards, or a chain of variety stores. Maybe we could allocate 15% of the portfolio to that specialty. Cut down the scope of the information we must track. Simplify. We might allocate another 25% to a fund manager who specializes in some industry or market that has potential. Could be small cap, or India, or high dividend payers. Maybe companies less than five years old within 10 miles of Stanford. Decide and write out your reasons.
The remaining 60% in this example, could be passively managed through an index fund or an ETF of some sort. Maybe a fund manger who has a good record for earning their fees. There are some of those. Consider tax sensitivity, too.
When you understand a market more deeply, the trend, P/E ratio, the federal discount rate, the weather in Brazil and the government in Taiwan can all be useful variables. Taken together. When you know enough you can know the meaning of what you know.
Investing well is not as easy as people would have you believe. Learn about both yourself and markets.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772