Graduation season starts this month. Thousands of young people will soon receive a diploma in one hand, and a notice to start repaying their student debt in the other. (There’s now more than $1 trillion in student debt outstanding.) At the same time they’ll find themselves competing in the jobs market with graduates from previous years: research shows that almost 54% of newly graduated bachelor’s degree-holders under the age of 25 last year were jobless or underemployed, the highest share in at least 11 years. The message is getting clearer by the day: we urgently need to rethink the kind of education that we encourage young people to pursue, and the costs and returns thereof. How do we give young people entry-level access to challenging professions that will allow them to earn adequate lifetime incomes? Technology and entrepreneurship belong to this category. Does investing belong there as well?
Tadas Viskantas runs the Abnormal Returns blog. The investing and economics news that he curates is on the daily must-read list of countless market players and commentators. He’s gathered some of what he’s learned over the years in a new book — Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere. Some pundits have named it an “owner’s manual” for today’s markets. Tadas and I spoke by e-mail about his attempt to give investors a common sense guide to today’s most relevant investing principles. We talked specifically about advice for young investors who are just getting into the game.
FA: In your book, Abnormal Returns, you describe investing as the “last liberal art.” What did you mean by this?
TV: If investing were all about the numbers, financial and economic, it would be pretty simple. Unfortunately that isn’t how markets work. The problem is that much of what is interesting about investing isn’t really captured in the numbers. If we look at ourselves as investors we see a raft of behaviors and biases that work against our ability to succeed. When we look outward we see that companies and the financial markets are buffeted by ever evolving trends. Therefore an understanding not only of finance and economics but history, political science, demographics, science, technology, popular culture, etc. all play a role in how markets evolve.
Let’s think about maybe the biggest finance story of the past year: the crisis in Europe. The economics of the situation in Europe are not all that much in doubt. What matters is how various countries react to the problem of debt and the periphery. Clearly there is a finance and economics component, but how they react has more to do with politics, history, culture and psychology.
FA: What are some of the historical investing / economic episodes that may hold particular lessons for today’s environment?
TV: We don’t have a lot of examples of financial crises in the United States paired with a deep economic recession. You have to look overseas for examples. Those examples show a slow recovery for an economy post-financial crisis. A slow recovery shouldn’t really be all that surprising. One need only look at the last two US recessions to see that the rebound from modern recessions are slow drawn-out affairs.
FA: Some say that the last decade was a “lost” one for investors. You’ve previously said that this all depends on one’s perspective. What’s the single most important lesson of the Lost Decade for a brand-new investor?
TV: Every model of past equity market returns would tell you that a decade of sub-par performance is possible. However actually living through it is a different thing altogether. One thing that saved investors during the lost decade was diversification. Small caps outperformed the headline large cap names. Bonds and emerging markets also provided positive returns. If nothing else the lost decade should reinforce the idea of Ben Graham that investors shouldn’t have a 100% equity portfolio.
FA: Ben Graham is also considered a hero of the “buy and hold” crowd. Yet in Abnormal Returns you emphasize the importance of having an “exit plan”. Can you expand on this?
TV: I honestly don’t know what “buy and hold” means any more. I think some people confuse it with the idea of “buying what you know.” In any event even investors with long time horizons need to be cognizant of what happens over the short run. In a certain sense the long run is simply made up of a series of short runs. Even the most hands-off investor has certain things they need to manage their portfolio on an ongoing basis.
FA: In the book you mention overconfidence as being just one of the psychological obstacles to actually doing well in the market. What concrete steps do you take in your own investing to guard against this?
TV: One of the biggest problems investors have is that their trading is ad hoc. Every trade they make is some sort of one-off. Traders should think about each and every trade as a series of experiments. Good scientists recognize that each experiment needs to have some test by which you can declare your hypothesis proven or disproven. Traders therefore have to have a plan for each and every trade. For some a simple stop loss is all they need to tell them when they wrong. For others it may be more complicated, for example some sort of fundamental measure. In either case you should never get into a trade if you can’t be proven incorrect.
FA: One thing that sticks out to me is your exceedingly humble approach to investing. What was your own biggest investment mistake?
TV: They say the worst thing that can happen to a novice trader is to start up with a series of winning trades. This emboldens the young trader to think they can do no wrong. Like any one else who has been investing for awhile I have made plenty of mistakes along the way. I note in the book “learning by doing” is really the only way to truly educate yourself. The challenge is making sure that your “tuition payments” don’t bust you out of the markets in the meantime.
FA: Abnormal Returns is a forecast-free blog but I can’t resist asking: what future market developments do you foresee that either frighten or excite you the most?
TV: I think crowd funding is going to be a really interesting development. I can see how it could be both a boon and a magnet for the unscrupulous. The big question is whether investors will do any better investing in early stage ventures than they do with more established companies.