The Conceptual Foundations of Investing

10INVESTMENT SUGGESTIONS AND POSTSCRIPT

We would be remiss to write an entire book on investing and end it without offering investment suggestions. One problem with so doing is that everyone is different. They have different skills, disparate knowledge, differing net worth, different risk aversion, and different tax liabilities. All those factors will affect the optimal choice of investments. Therefore, the best we can do is offer some broad advice and leave it to the reader to fill in the gaps.

Perhaps the most important advice we can offer is, “Know thyself.” Or even better, in the words of Clint Eastwood's Dirty Harry in the movie Magnum Force, “Man's got to know his limitations.” The most dangerous thing in investing is thinking you know things that you don't know. Bill Sharpe's arithmetic drives that point home. If you think you are a superior active investor, then you are concluding that you can make those superior profits at the expense of counterparties who are also active investors. Is that a reasonable conclusion? If you cannot answer yes, then the best path is a probably a passive investment strategy. In that context, our first suggestion is to follow what we call a diversified passive strategy.

A DIVERSIFIED PASSIVE STRATEGY

In his letter to shareholders, Warren Buffett recommended that most investors are well advised to passively hold the S&P 500. We basically agree with Mr. Buffett, but think that a more diversified passive strategy would be a better solution ...