The Art of Investing

The idea of the title originates from a book I am reading now, "The Art of Value Investing", compiled by Whitney Tilson along with several other reputable value investors. I would recommend this book for those who want to know more about the value investors in this generation. The term "value investing" may seem unfamiliar to many people, and for those who don't, it simply means a wiser and more correct mindset when it comes to making capital allocation decisions.

Investing should be a fairly simple idea. If you have a bag of cash on hand, and you wish to compound that money over time so it will not be eroded by inflation, you will look for places to invest your money. In the world today, there are a myriad of investment choices offered in the market- commodity, currency, real estate, stock, or even financial derivatives, etc. Each, obviously, offers various risks and returns. And it should be even more obvious that one should always look for investment that offers the highest return at a perceived risk, or the other way, lowest risk at a given expected return.

Here comes to the interesting part, too often human nature influences our investment choices. Herd mentality is one of the examples. People may begin to buy tulips or tea, confidently, for the sole intent to sell it in the near future at a profit! Their reasons behind this purchase at an extremely overvalued price are that the price will keep going up. Just like the real estate market in some popular cities or the internet stocks before its inevitable bubble. Herb Stein famously said, "If something cannot go on forever, it will stop." The mania of investing your capital at an obviously overvalued item may work for a few times, but will not work forever.

Therefore, when it comes to capital allocation (a.k.a. investing), value becomes the ultimate factor. Allocate your capital to wherever gives you the best value of every dollar you forego now. Smart capital allocation is vital to every individuals, and certainly not just to investors. Economists never get tired of emphasizing the importance of opportunity cost, because it can be applied to everywhere. Let's look at an example. Current 30-year Treasury Bond offers a low 3.3%. Most investors do not invest in 30-year bond with the intent to hold it till maturity (the full 30 years). While the herd flocks into treasury bond for safety, the 3.3% return definitely expose the investors at a far greater risk than some of the other investment choices. In my personal opinion, I would much rather buy Berkshire Hathaway or Microsoft at a price much higher than the current price than buying bonds. Not to mention many of these stocks already yield around 3% return, and is almost certainly to continue growing for the years to come. The "bond investors" may argue that U.S. government gives risk-free return. The risk of U.S. government go bankrupt may be negligible, but fixed income investment is now risky and lousy. Consider interesting rate has been artificially held at historic low, it is almost certainly going to rise. Inflation, too, is also at record low. When either one eventually (and inevitably) rise, the judgment day for those bond holders may find themselves swimming naked as the tide recedes. Interestingly, most of these bond buyers are well aware of the current rate being unsustainable, and they still consider it "low risk". Their adventurous nature of buying into fixed income should be applauded, but should not be encouraged. (Institutional imperative and business school-taught "asset allocation strategy" are another explanations)

This is not an article of a cynic. My reason is simply to urge my friends, when making financial decisions, to objectively evaluate its real value and make sure you don't overpay (whether that be buying insurance, house, car, or any form of investment). People that follow textbook rules or herd mindset without rational thinking are going to experience mediocre if not poor financial results.

I am simply using treasury bond as an example, and it does not mean it will continue to be a poor investment as it is at present. The article is simply pointing out the fact that there are a sea of investment alternatives that are far more un-investible than bonds now in terms of risk/reward. When making capital decisions, simply go back to Econ 101 and think twice on the opportunity cost of your dollars.

Cheers!