the academic and the businessman: two views on investing

In case there was every any doubt: investing is not an exact science. After all, it depends quite literally on predicting the future, and as the Galbraith quote goes: “The only function of economic forecasting is to make astrology look respectable.” So it’s no surprise that there are as many ideas on investing as there are people, which can make for a lot of confusion. Let’s take a look at two of them: what I’ll call the Academic and the Businessman.

The Academic looks at investing in a very abstract sense. His main goal is to balance risk versus reward, using his knowledge of Modern Portfolio Theory. He knows that the two often go hand-in-hand, but that diversification is key, which will greatly reduce the risk while still keeping a good reward over time.

The Businessman, however, knows that owning stock is like owning a business. He does a good deal of research on each purchase he makes, and he makes sure to understand the business model of each company he invests in.

When purchasing a stock, a Businessman will often look at the “fundamentals”, aspects of the company such as earnings, cash flow, debt, assets, and dividends. The Businessman is especially interested in stocks that are priced lower than they should be — either because the company is out of favor (e.g. Ford during late 2008), or because its growth is even higher than expected (e.g. Apple, starting at around the same time). They look down on “di-worsification”, buying stocks in companies without a rock-solid reason for each purchase.

An Academic, however, rarely purchases an individual stock. He concerns himself more with the proportion of various asset classes (large and small, domestic and international, “value” and “growth”, and most importantly, stock and bond) in his quest to balance risk and reward. He believes that in this modern era of free-flowing information, picking an individual stock that significantly outperforms its current price is generally due to luck, and thus that consistently doing so is nearly impossible.

If you’re looking at investing sites on online, you’ll find a lot of Businessmen in the “Motley Fool” community, as well as in the sizable group of those who look to Warren Buffett for their investing inspiration. Meanwhile, the community known as the “Bogleheads” (after Jack Bogle, founder of Vanguard) fall firmly the Academic camp, along with academic researchers exemplified by Eugene Fama and Kenneth French.

Me? I’m an Academic…mostly. The research is compelling, and I trust it more than I do Wall Street or most financial publications. That said, I keep a small part of my portfolio set aside for specific companies to scratch the Businessman itch!

How about you? Are you an Academic, a Businessman, both, or neither?

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7 thoughts on “the academic and the businessman: two views on investing

  1. Definitely an academic. The idea of picking stocks sounds like fun, but I’ve never been sufficiently motivated to try it out…

  2. Businessman only. But then, I’ve been reading Motley Fool for 12+ years… Go read “When Genius Failed” to see why I’m deeply suspicious of Academic approaches to investing.

  3. Yeah, Long-Term Capital Management is definitely a cautionary tale regarding the mix of hedge funds and ivory towers (and I’m pretty sure I first heard the story from you, David).

    However, I’m equally suspicious of active investing; I’ll see your Genius Failed and raise you a Burton Malkiel, William Bernstein, Larry Swedroe, Eugene Fama, Kenneth French, and a Jack Bogle (though he might be somewhat biased at this point).

    Not that this has kept me completely out of the Businessman mindset, of course!

  4. Business mindset is fine as long as it doesn’t take up more than 5-10% of your portfolio. I’ve done it and it’s really easy to forget the losers, and remember the winners.

    I still haven’t seen a ‘stock picker’ that will tie his compensation to his performance. Until they don’t even fully believe in themselves, why should I?

    • Well, technically, hedge fund compensation is often (kind of) tied to performance, getting paid “2 and 20”, 2% of assets managed + 20% of profits above a certain benchmark. But you’re right in that they don’t *lose* money if they go below that benchmark…

      • Individual stocks are about 50% of my portfolio; I haven’t forgotten the losers, and try to understand what I did wrong so I don’t repeat the mistake. Even though my individual stocks consist of mostly large-cap well known stocks, I’m more comfortable holding them — with concomitant “ownership mentality” — than a bunch of “anonymous” index funds.

        Buffett is probably the closest to a stock picker whose compensation is/has been tied to his performance, although maybe Lou Simpson at GEICO probably did more true stock picking in recent years.

        Most fund managers – hedge or otherwise – are in a “heads I win; tails you lose” arrangement.

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