The Best Investment Advice You'll Never Get (2008)

> I think the biggest problem with any ideal portfolio allocation tool are black swan events (Taleb).

Yes. Black Swans are certainly a problem. It's insane to think that investment returns are anything resembling a Gaussian distribution. In the financial crisis of 2008-2009, people were using phrases such as "a 9 sigma event" to describe the markets.

Wrong! Basically THERE'S NO SUCH THING AS a 9 SIGMA EVENT. Wikipedia gives the probability of a 6 sigma event as 1 in 500 million. So it the epitome of arrogance to think that we're so "special" that we just happened to be alive during a 9 sigma market move.

What it all really means is that the markets do not behave the way lazy eggheads want them to. Everyone understands Gaussian distributions and standard deviation. So they are eager to use that math where they shouldn't.

I'm sure you know all this. But for those people who aren't familiar with Taleb and want to read more, he wrote three pop books about it:

2001 Fooled by Randomness http://en.wikipedia.org/wiki/Fooled_by_Randomness

2007 The Black Swan http://en.wikipedia.org/wiki/The_Black_Swan_%28Taleb_book%29

2012 Antifragile http://en.wikipedia.org/wiki/Antifragile

I'm in the middle of reading Antifragile, and I am thoroughly enjoying it so far.

I feel like I get this advice all the time. "Invest in Indexes" is ridiculously popular advice. I've also been exposed to portfolio theory in lots of academic literature.

It's not obscure within finance or without.

It's really hard to do MPT on your own. I got really into finding a collection of 10-12 mutual funds that are in a collection of sectors. I also mixed it with a strategy of selling each fund when it went below its 12-month moving average, and buying back in when it went above. I backtested it a bit and read some studies and it seemed reasonable. Sacrifice a little upside to protect against more downside. It sure would have saved me had I followed those strategies during the last two mega crashes; the dotcom bomb and the finsys crash.

Of course, since doing that, the S&P has been on a sustained climb that I've only partially benefitted from since I've had some bond funds, etc. The selling/buying has worked ok - it's whipsawed me in some cases and saved me in others, but given that I'm not spending more than a day a month on it, and that I only have a surface level understanding of sector-balancing, and that while it seems my funds are cheap, who really knows for sure... I'm regularly tempted to just dump the whole thing and get back into one fund, just in time for the next crash the other part of my brain says.

Also, it's worth pointing out that a lot of the "beat the market" talk is rubbish for entirely different reasons. People tend to get more cash to invest when times are good, and less when times are bad. That means that the average person is going to buy more when the market is high, and less when the market is low. I don't ever see this accounted for in studies. Even if you were to drop your money in an S&P-500 index fund whenever that money becomes available to you, you're still going to underperform the S&P-500 long-term by a moderate amount.

Limiting profitability to increase probability of success is one of the principles of professional trading. Take for example, every single spread that's bought and sold.

The good thing is, people have studied this. Because your argument is certainly plausible. What you leave off is that while you may "miss out" on upside, you also bank credit every month that you reinvest and compound.

I called making money in stocks a 50/50 bet, but it's not. It's biased toward the upside, a premium you're given to invest instead of lending (bonds). I've seen it calculated from 3-5%. So lets call the probability of profiting when you buy a share of stock 53%.

So let's talk about this study: * It's not part of the study but, we're in a 5 year bull market. So if your point about missing out on upside is true, it would certainly apply in this market.

* At the beginning of the year, purchase 100 shares of every company in the Dow * Each month sell the nearest OTM call, banking the credit received * Compare P&L with a uncovered long position.

By selling covered calls you reduced your basis by an average of 8% and increased your Probability of Profit to 73%.

Here is a link to another website that has a write-up about the study. I emailed the research team at TastyTrade to get a link to the study itself. I've seen it on their website but can't find it now. http://probabilitycapitalgroup.com/market-studies/using-cost...

And of course the wonderful thing is anybody curious can backtest this themselves. There's a lot of ways to do it, but the trading platform Think or Swim is free.

I'm not advocating what I don't understand, or what I don't have experience with personally. Honestly, i don't buy long stock very much, I prefer options strategies, but for example I'm long AAPL stock, and I've sold the $110 covered calls.

Addendum: I understand the resistance. Most peoples first (and only) experience with options is buying an OTM call or put. They almost always lose their money, think 'wow what a racket' and swear it off. Moreover a general distrust of market makers, hft, etc, and people stick with the status quo. But the reason I love trading with options is because I get to pick my own probability of profit.

You are right on one thing, though: The style of trading I do does not enjoy or rely on the "big win" of holding a big position that goes up huge. My style of trading is: 50 small positions in uncorrelated underlyings that give me a number of individual occurrences to let probabilities work in my favor -- to eliminate statistical variance.

Edit: To be totally clear, I do not advocate buying OTM calls and puts. I'm talking about taking the other side of that trade.

Did anybody stop to notice the date of the article? I'm confused by the conversation herein. I thought this was posted as a sort of mockery of the author. After-all, if you put your money into an index right when this guy told you to, you would have lost your shirt.

If you had a while until retirement, that wouldn't be a big deal, since it would now be back along with more, but what about the folks moving their IRA out of balanced bond and commodity based funds with some growth stocks, etc. (i.e., hedged) and essentially into the S&P 500, at 60 years old... like my parents did.

The best advice to anyone is to buy indexes after a major market crash; only then will you reap rewards without nearly as great a risk. Here's the catch: most of you will disagree; that's why 10% play and the other 90% pay.