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Quest for Alpha: What You Need to Consider When Handling Your Own Investing

(The following comes from the appendix Doing It Yourself in Larry's most recent book, The Quest for Alpha, which presents compelling evidence on the failure of individual investors, mutual funds, pension plans, venture capital and hedge funds in their efforts to outperform the market. To see what you need to consider when choosing someone to help you with your investments, see Friday's post How to Get the Right Help with Your Portfolio.)
Warren Buffett said: "Investing is simple, but not easy." Investing is simple. To be successful, you only need to follow the 30 prudent rules of investing laid out in Appendix A. However, it is not easy because there's actually more to investing. Writing in the Winter 2003 edition of the online journal The Ef�cient Frontier, author William Bernstein laid out these four additional requirements for investors to be able to succeed on their own:
  • "An interest in investing. It's no different from cooking, gar­dening, or parenting. If you don't enjoy it, you'll do a lousy job. Most people enjoy ï¬?nance about as much as Carmela Soprano enjoys her husband's concept of marital ï¬?delity."
  • "The horsepower to do the math . . . The Discounted Dividend Model, or at least the Gordon Equation? Geometric versus arithmetic return? Standard deviation? Correlation, for God's sake? Fuggedaboudit! "
  • "The knowledge base- Fama, French, Malkiel, Thaler, Bogle, Shiller-all seven decades of evidence-based ï¬?nance back to Cowles. Plus, the 'database' itself-a working knowledge of ï¬?nancial history, from the South Seas Bubble to Yahoo!"
  • "The emotional discipline to execute faithfully, come hell, high water, or Bob Prechter. Mr. Bogle makes it sound almost easy: 'Stay the course.' Alas, it is not."
Bernstein noted: "An optimist might guess a 30 percent success rate on each count, in which case 1 percent of the population can make all four. Perhaps I overstate the case. After all, these four abilities are not entirely independent: If you're smart enough, it's more likely you'll be interested in �nance and be driven to delve into the appropriate �nance literature. But even if true, more than a little luck is involved. Head down to the personal-�nance section of your local Barnes and Noble, and you're more likely to run into Suze Orman than Jack Bogle. You'll need a telescope to �nd the really important stuff."

Bernstein concluded: "I wish I had a nickel for every smart, savvy, and motivated �nancial type I've met who simply could not execute."

This last point is extremely important. Investing is simple but not easy because, while staying the course is easy when everything is going well, when bear markets inevitably arrive, the best-laid plans can end up in the trash heap of emotions. In other words, it is much easier to establish a good investment plan than to adhere to it. Peter Lynch advised: "Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your invest­ments to succeed. It isn't the head, but the stomach that deter­mines the fate of the stockpicker."

There are some individuals who can do it all on their own. If you think you are one of them, make sure you meet the four requirements laid out by William Bernstein. And be sure you are not falling prey to the all-too-common human tendency toward overcon�dence.

Excerpted with permission of the publisher John Wiley & Sons, Inc. from The Quest for Alpha: The Holy Grail of Investing. Copyright 2011 by Larry Swedroe. This book and e-book is available at bookstores, through Amazon and Barnes & Noble and from the Wiley Web site.
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