Thursday, June 4, 2009

Laziness Does Not Pay

I ran into a few articles on “The Lazy Way to Investment Success” focusing on holding various mutual funds, this “way” will invariably end badly for largely the excessively high fees and credit risk. OK, let us backtrack a moment and remember the actual risks of “buying, holding, and hoping”.

Inflation adjusted

At page 40 of the my SVR Research, we notice that the correlation between GOX (CBOE Gold Index) and the ASX200 stock index stabilizes around 95%. This means that actual stock performance simply adjusts with the real rate of inflation. Buying and holding stock indexes on its own, over time, will end with 0 return. Therefore, when transaction fees become involved, real-losses become inevitable for the long term sucker/investor.

Volatility and Credit risk

I have discussed actual stock return distributions from Katz and McCormick’s Advance Option Pricing Models. The numbers do not lie. The negative skew in actual historical returns not only disagree with conventional assumptions of Monte Carlo price movement, but also points to undesirability of buying & holding. Margin calls and/or bankruptcy related losses remain common with every volatility jump.

Diversification does not work

Imaging going to the casino and instead of blowing all your money on a single game of roulette, you split it up between slot machines, poker, blackjack, etc. Will you expect to win just for playing more games? I think not.

Laziness never ends well

This benefits the diligent trader however. The financial markets were designed deceptively simple to entice the lazy, hell all you have to do is push “buy” or “sell”. Ignore inflation, and you can convince yourself that it is “better” to just sit back and let the good times roll.

The good news

Losses taken by the lazy, uninformed, usually result in profit for the diligent traders. So, if they choose to remain “lazy investors”, so be it.

0 Reflections: