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Monday, April 09, 2007

Review: The Wall Street Self-Defense Manual

For those so young they missed the internet bubble, Henry Blodget was the internet analyst who achieved instant fame in 1998 when he predicted that AMZN would go to $400. It did so in less than 2 weeks, winning Blodget guru status on Wall-Street, along with Mary Meeker.

His fate took a turn for the worst, however, when he was accused of securities fraud after the internet bubble burst, and he had to settle with the SEC and was barred from the securities industry for life. His columns in Slate, however, have been interesting and responsible (unlike many other financial journalists), and his arguments about stocks, trends and industry on his blog, Internet Outsider, are cogent and interesting, if not entertaining.

When he published his this book to help the consumer invest intelligently, I read the internet excerpts and found them to be intelligently as well as simply written, so I placed a hold on the book at the library and forgot about it until it came in.

The book's divided into 3 parts: part one focuses on trying to convince you that the common marketing pitches made by most financial firms, advisors, and journalists are false and not in your best interest. Part 2 covers common investment approaches and points out the pitfalls of each of them. Part 3 (the shortest), covers what to actually do with your investment. What's fascinating to me is that part 3 assumes that he failed to convince you in parts 1 and 2!

This lack of self-confidence, perhaps, is justified, since I have run into any number of intelligent folks who are convinced that they can beat the market. And to a large extent, they do --- for a short while. Blodget's coverage of the common fallacies of active investors covers no less than 25 percent of the book. This is good material, and exceptionally well-written. There's no mathematics or equations to scare away the casual reader, but the examples are well-chosen and easily understood. The casual references to his prior life as a securities person also make for good entertainment.

Blodget's coverage of asset allocation and how you should approach it, however, is sadly lacking. He does point you at David Swenson's, so at least you're not stuck with nothing. He does provide 2 example portfolios, but I suspect that most new investors will be left at a loss to extrapolate from this. The subject of asset allocation, how rebalancing works, and how you change your risk profile over time is definitely worth spending more time on, and I wish Blodget had done so.

Part 2 covers the traditional ways of managing investments (investment advisors, mutual funds, hedge funds, paying for research, and reading financial press), and covers why most of these managers do not have their interests aligned with yours. This is valuable reading, and definitely worth reading. Beginning investors ignore Blodget's advise here at their own peril, and this section is written so well that I think it will actually be read and followed. In one section, for instance, he analyzes the package a financial adviser prepared for him, and points out the over-optimistic assumptions, hidden costs, and sales pitches were. This section is worth reading and reflecting upon, if you ever decide to go the adviser route.

Part 3, where Blodget provides his solution for the typical consumer, is extremely short (about 5 pages or so). He assumes that parts 1 and 2 of the book was completely in vain, and that you will want to go ahead and do some speculation anyway, and so advises that you at least do 95% investing, and spend the other 5% proving that you can beat the market. He then advises using the investment account to get some help from Vanguard or TIAA-CREF with low cost funds and get a portfolio evaluation from them. He does bring up the excellent life-cycle funds, which I think are an excellent solution.

All in all, I think this is an excellent book for beginning investors, and the biggest problem I see is that not enough people will read it. He could cover asset allocation in more detail, but as others have demonstrated, that subject could be an entire book all by itself, and Blodget's prose-style-no-numbers approach would not work well there. In any case, the book is well worth the price for the average beginning investor.


DV said...

Thanks! I will pick this up soon.

srini said...


Do u have a post on your investment strategies?. Do u do DCA or are you keep cash on the side lines waiting for the market to cool?


Unknown said...

I don't time the market, so I don't keep cash on the sidelines usually. But I don't DCA except in my 401k account (though I don't even really do that, since I try to max out my 401k savings as early as possible in the year, to get the match as early as possible).

What happens is that as I get lump sums to invest, I set aside an allocation for taxes, and then reallocate the remainder to match my desired asset allocation. In this way I try to stay invested in the market to the extent that my desired allocation says I should be. Since I use an 82/14/4 stocks/bonds/cash mix, that means I'm as close to 82% invested in stocks as possible at all times. In good investing years (like this one so far), the stock portfolio outstrips the bond and cash portfolios, so new lump sums (from salary, dividends, interest, etc.) tend to go into the cash and bonds section of the allocation. In bad investing years, the opposite will be true.

The important thing is to set aside money for known large expenses (like taxes, or a new car, or a potentially expensive vacation). Otherwise, you might find yourself suddenly with cash flow problems and have to sell in an inopportune time.

srini said...

Neat..Thanks for the detailed explanation. Does your stance indicate a short term bullishness or an indifference to the current market with a longer term view..Now for the flood of follow up questions :) What is your split amongst growth/value, large cap/small cap, US/Intl... I think you are big on treasuries too, how is that accounted for ? I know you feel strongly about rebalancing, how often do u do that?.

Thanks Again,

Unknown said...

My asset allocation reflects what I consider to be an appropriate one for my age, ability to withstand risk, and proximity to the efficient frontier for my time horizon. I don't consider myself bullish, bearish, or to have an opinion on short or long term performance on any markets that I'm in. I've long been disabused that I have any prescience about markets (or anything with respect to the future).

I don't actively look for ways to "slice and dice" my portfolio either. My general rule is to as quickly as possible hit the $100k Admiral shares qualification zone at Vanguard. So my inclination is to naturally go for the aggregate funds (e.g., Total International Index, Total Stock Market Index).

I'm actually not big on treasuries, since I'm in a tax bracket for which Tax-Exempt funds make sense. I am big on I-bonds.

I rebalance my portfolio the lazy way: as I receive lump sums, I put more into losing assets and less into winning assets. This avoids paying taxes by churning funds. You have to remember that asset allocation is not an exact science. If I'm 83% equity and 13% bonds and 4% cash I'll still be comfortable. Obviously, if the equity portion dropped by 50% I might be forced to rebalance, but I will probably build some inertia into the process to avoid doing anything rash.

srini said...

Thanks Again Piaw,

What effective rates do you get with the I-Bonds? Are they better than VCTXX on an effective basis even with current rates?

Unknown said...

You can find I bond rates at the Treasury Direct site. Note that I bonds are tax deferred instruments. That means that you only pay taxes when you cash them out. On top of that, the interest is state tax exempt, and if you use it to pay for qualified expenses (such as college tuition), it is entirely tax free! This makes them exceedingly good deal for many people.

Unknown said...

Thanks Piaw...