Wednesday, May 6, 2009

The most dangerous book on investing


After watching the equity market carnage over the last year, you have to ask for the reasons why so many kept holding stocks. I believe that it has to do with the long-term ideas planted in the heads of investors. These are the ideas not given through a sales pitch but through consistent repetition.

One of the keys recurring themes is that in the long-run you will make money in stocks. Buy and hold and you will do fine. Look at the history of the US. If you do not panic, your portfolio will be fine. Stocks for the Long Run is a perfect example of the idea generation that passive investing will work. This is a very fact-filled book and Jeremy Siegel is a very good researcher, but we often find that only a single idea is taken away from most books. The idea here was that you have to hold stocks and if you just put them in the drawer they will do well. O course, there is business cycle risk and valuation, but the main argument is that if you hold in the long-run you will do fine.

We have seen the result even with the recent gains in equities. Now we have to live in a new world. The current data tells a different story. You can lose a lot. You look beyond the US and you find that their are many periods and countries where you will not make money for long periods. The passive strategy may not work. Of course, many passive investors will tell you that if you just hang on now everything will be fine, but can you take that risk in this new environment?

This is why the idea of active investing has more appeal. Active investing does not have to mean that you trade your way to retirement, but prudent diversification and playing the odds across the business cycle will make sense.We need a new book on active investing for everyman.

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