. 2021. Andrew W. Lo and Stephen R. Foerster. Princeton University Press.
Between the introductory and concluding chapters of this book, each of the ten famous financial superstars receives their very own chapter.
In the order wherein they seem and with their major contributions to what we find out about investing, they’re Harry Markowitz and Portfolio Selection, William Sharpe and the Capital Asset Pricing Model (CAPM), Eugene Fama and Efficient Markets, John Bogle and Index Investing, Myron Scholes and Options Pricing, Robert C. Merton and Options Pricing, Martin Leibowitz and the Bond Market; Robert Shiller and market irrationality, Charles Ellis and mutual index funds, and Jeremy Siegel and the long-term stability of real stock returns.
However, two names are conspicuous by their omission: the Omaha, Nebraska-based value investing team of Warren Buffett and Charlie Munger. Munger’s name is missing, and Buffett’s is simply briefly mentioned five times, perhaps attributable to his instruction to the trustee of his estate: “Put 10% of the cash in short-term Treasury bonds and 90% in a very low-cost S&P 500 index fund.”
Given this recommendation, it’s price noting that an investor who bought 100 shares of Berkshire Hathaway common stock at $15 per share after Buffett gained control of the corporate in 1965 and who still holds it will be holding a share as of this writing price almost $56.4 million. This corresponds to a mean annual return of 20.3%. If the identical investor had purchased 100 shares of an S&P 500 index fund for $173 per share in January 1965, that investment could be price about $469,000 today, a mean annual return of slightly below 6%.
I emailed Lo and Foerster to inquire concerning the omission of Buffett and Munger. Everyone responded promptly. One wrote that the rationale for her exclusion was because a lot had already been written about her. The other noted that “the focus of our book was to help readers understand how to think about portfolio construction” and that “most of these highly successful investors have spent very little time and effort educating investors about investing .”
The book’s opening chapter, “A Brief History of Investing,” begins with an especially helpful graphic showing the connections between the superstars, e.g. e.g., whether or not they were fellow graduate students, forwarded or initiated another person’s work, and received the Nobel Prize in the identical yr, etc. The chapter incorporates short sections on the event of investing, in addition to sections titled “Early Diversification” and “The Science of Investing in the 20th Century.” . century”.
Three chapters specifically, two of which deal with investment pioneers—Sharpe and Bogle—and the ultimate chapter, “So What is the Perfect Portfolio?”, are particularly compelling.
The Capital Asset Pricing Model
The first paragraph of Sharpe’s profile rightly states this CAPM was “an idea that forever changed the way portfolio managers approach their trading.” And that “Sharpe narrowed the focus of Markowitz’s portfolio idea and did more than any other financial economist to shape the investment process for us to make everyone more accessible.”
After graduating with a bachelor’s degree in economics in 1955, Sharpe applied for jobs at banks. They all rejected him because, he believed, they wanted B students, not ones who got straight A’s. He stayed at school, received his master’s degree in 1956 and joined the RAND think tank that very same yr.
Sharpe discovered he had a knack for programming, which he really enjoyed. While at RAND, he took evening classes toward a doctorate in economics, which he received in 1958. Professor Fred Weston hired him as a research assistant and have become considered one of his mentors. A second, Armen Alchian (later referred to as “Alchian and Demsetz”)“taught Sharpe how to question everything and how to analyze a problem from the ground up.” This, in turn, enabled him to “critique his own work and play devil’s advocate when necessary.”
“Portfolio Analysis Based on a Simplified Model of Relationships Between Securities” was the title of Sharpe’s 1961 dissertation. The final chapter of that paper, “A Positive Theory of Security Market Behavior,” ultimately led to the event of the CAPM. This in turn gave rise to the market portfolio that we all know today in the shape of index funds. In September 1964 he published his paper “Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk”. As of 2021, the paper had generated over 26,000 citations.
Index investing
Most investors who attempt to “beat the market” don’t. This failure eventually led to the emergence of index funds, or “passive investing.”1 The idea of an index fund got here about a three-page essay by Paul Samuelson from 1974. Bogle then founded the primary index mutual fund, the First Index Investment Trust, in 1975. He began with a fortune of $11.3 million, a far cry from the $160 million that Bogle wanted to boost. The first index and a second fund became the Vanguard Group.
When Bogle died in 2019, the 2 funds had greater than $5 trillion under management.
So what’s the proper portfolio?
After sections delving into each luminary’s idea of the “perfect portfolio,” Lo and Foerster reiterate the plain: There isn’t any such thing. They note that perfect health is the parallel to such a portfolio: there is no such thing as a such thing, only degrees of it.
However, the authors offer a checklist of seven principles that investors can use to construct their very own “perfect portfolio.” These include sound recommendations resembling determining the extent of 1’s financial planning expertise and the time and energy one is willing to devote to managing a portfolio, defining a comfort zone regarding profits and losses, and avoiding mistakes resembling paying unnecessarily high fees, etc Investing with energetic managers based on friendship.
Lo and Foerster also summarize the book in a table of 16 investor archetypes that classifies people based on their risk tolerance, income and spending habits, while also considering the economic environment. Based on the category that best applies to them, individuals should pursue courses starting from investing mostly in stocks and holding out to cutting back on spending and consulting a financial advisor immediately.
All in all, I highly recommend this book. I imagine it’s well worth the time for each newbies and experienced investors.
1. The topic was first published in 2004 as “The Case for Indexing” by Nelson Wicas and Christopher B. Philips. Unfortunately the unique version isn’t any longer available. However, You can find a superb explanation of index funds, their origins, etc. on Investopedia.
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