Investment Discipline: Making Errors Is Ok, Repeating Errors Is Not Ok.

By Reto R. Gallati

Many highly paid investment gurus will insist that successful investing is a function of painfully collected experience, expansive research, skillful market timing, and sophisticated analysis. Others emphasize fundamental research about companies, industries, and markets.

Based on thirty years in the investment industry, I say the ingredients for a successful investment portfolio are stubborn belief in the quality, diversification, growth, and long-term principles from Investments and Management 101. Unlike MBA textbooks, which tend to be more theoretical, Investment Discipline provides more practical insight into what works and what does not, based on my own errors and success and includes recommendations of what to repeat and what to avoid.

Investment Discipline contains no secrets and no magic equations. It discusses the most common mistakes and provides advice on how to avoid these errors in order to become a successful investor. It will guide you in your decisions, from setting up your investment objectives, conducting research, and buying/ selling securities to adjusting your portfolio to achieve long-term returns that match your personal objectives.

You will learn how to:

Define your investment profile and your specific objectives;

Establish a sustainable investment process based on your objectives;

Analyze information and perform your own research; and

Make sound investment decisions.

Famous investment professionals, such as Warren Buffett and Peter Lynch, have made mistakes, but they did not repeat them. They held on stubbornly to their investment approach and showed discipline over a long time period, resulting in superior returns. Obviously they were lucky as well; however, they played the numbers right, and over time their performance was better than the performance of their peers.

In Investment Discipline, you will learn how to become a successful, disciplined investor.

• Language: English
• Publisher: Balboa Press
• Release date: Jul 17, 2012
• ISBN: 9781452552767

Reto R. Gallati

RETO GALLATI has held senior executive positions at several Wall Street firms including CRO and Head of Investments. Additionally, he has taught at prestigious universities, including MIT and the University of Chicago and has authored numerous investment publications. He earned his PhD from the University of Zurich. Reto resides in Chicago.

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Copyright © 2012 Reto R. Gallati

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ISBN: 978-1-4525-5277-4 (sc)

ISBN: 978-1-4525-5278-1 (hc)

ISBN: 978-1-4525-5276-7 (e)

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The intent of the author is only to offer information of a general nature to help you in your quest for emotional and spiritual well-being. In the event you use any of the information in this book for yourself, which is your constitutional right, the author and the publisher assume no responsibility for your actions.

Balboa Press rev. date: 7/12/2012

Contents

Acknowledgement

Introduction

1.   Sharpen Your Investor Profile

2.   With a Conservative Strategy to Success

3.   Learning Makes You an Investment Expert

4.   Watch Your Investments

5.   Understand Your Investments

6.   Do Not Rush

7.   Develop a Good Timing

8.   Think and Act Rational, Not Emotional

9.   Corporate Governance and Ethics in Investing

10.   Overconfidence Leads To Downfall

11.   Become a Contrarian

12.   Diversification Is Critical

13.   Costs Reduce Your Return

14.   Check the Quality of Your Information Sources

15.   Start Early and Invest Regularly

16.   Think Long-Term

17.   Donate as Part of Your Investment Strategy

18.   Investing Does Not Mean Trading

List of Rules

Quotes: Wisdom and Wit on Money

Endnotes

References

Glossary

About the Author

The views expressed in this work are solely those of the author and do not necessarily reflect the views of the publisher, and the publisher hereby disclaims any responsibility for them. The publisher and the author make no representations or warranties with respect to the accuracy or completeness of the contents of this work and specifically disclaim all warranties, including without limitation warranties of fitness for a particular purpose, no warranty may be created or extended by sales or promotional materials. This book is designed to provide accurate and authoritative information about finance and investing. The advice and strategies contained herein may not be suitable for every situation. The author and publisher will not be responsible for any liability, loss, or risk incurred as a result of the use and application of any of the information contained in this book. This work is sold with the understanding that the publisher and/or author is not engaged in rendering legal, accounting, or other professional services. Neither the publisher nor the author shall be liable for damage arising herefrom. If professional assistance is required, the services of a qualified professional person should be sought. The fact that an organization or website is referred to in this work as a citation and / or a potential source of further information does not mean that the author or the publisher endorses the information the organization or website may provide or recommendations it may make. Further, because of the dynamic nature of the Internet, any web addresses or links contained in this book may have changed since publication and may no longer be valid.

Raetia Investments, LLC., the Raetia logo are registered trademarks of Raetia Investments, LLC., and/or its affiliates in the United States and may not be used without written permission. All other trademarks are the property of their respective owners. Raetia Investments, LLC. , is not associated with any product or vendor mentioned in this book. All illustrations are copyright 2012 protected and owned by Raetia Investments, LLC.

Acknowledgement

Through the process of writing this book, I was fortunate to receive tremendous feedback from numerous colleagues and friends. I would like to take the opportunity to thank a few individuals in particular who encouraged me to publish my manuscript and make my thoughts available as a hard copy and ebook.

Celeste Cagnina has endured many evenings and weekends when I worked on this book. Without her love and unconditional support, I would not have finished this new book. Jeff Skelton, a dear friend and former colleague with vast academic and practical experience, was an invaluable sounding board throughout the process. Maurizio Ferconi, my good friend, who never hesitated to show me my errors along the way… as they are obviously all mine! Stefan Riesen, my friend with whom I have shared my joy and pain as an investor since we met at Goldman. Finally, my editor Michael Whatling from McGill University, for his patience and diligence with bringing this manuscript to its highest quality.

Introduction

Many highly-paid investment gurus, with a straight face and a gleam in their eye, will insist that successful investing is a function of painfully collected experience, expansive research, skillful market timing, and detailed technical analysis. Others emphasize fundamental information about companies, industries, and markets. That’s what they tell you.

I say the ingredients for a successful investment portfolio are these: stubborn belief in the quality, diversification, growth and long-term principles from Investments 101, and operations that employ the planning, leading, organizing, and controlling skills introduced in … your grad class!

So, what is this book about? This book contains no secrets and no magic equations. It tells you about the most common mistakes (including my own personal errors), and provides advice on how to avoid these errors in order to become a successful investor. Key ingredients are patience, willingness to learn, some homework to understand your investments, and to top your investment process … discipline.

To some people, investing is a mystery, an unpredictable world of formulas and strange terminology. Others will tell you that it is simply a matter of luck that depends on a hot tip or picking the right investment at the right time. These perceptions are common, but they are generally wrong. In fact, the principles of long-term investment success are available to anyone.

This book will guide you in your decisions from setting up your investment objectives, research, and buy/sell transaction, to adjusting your portfolio to achieve a long-term return that matches your personal objectives.

Famous investment professionals, such as Warren Buffet and Peter Lynch, have made mistakes, but they did not repeat them. They held on stubbornly to their investment approach, and showed discipline over a long time period resulting in superior returns. Obviously they were lucky as well, however they played the numbers right, and over time their performance was better than the performance of their peers.

Reto R. Gallati

Chicago, June 2012

SHARPEN YOUR INVESTOR PROFILE

01-Final-Large.jpg

Figure 1: Investor Profile, Mirror, mirror on the wall, who is the prettiest investor of all? Illustration by Catherine Satrun. Copyright © Reto R. Gallati 2012.

investment objective

The financial goal or goals of an investor. An investor may wish to maximize current income, maximize capital gains, or set a middle course of current income with some appreciation of capital. Defining investment objectives helps to determine the investments an individual should select.

[Source: Wall Street Words: An A to Z Guide to Investment Terms for Today’s Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved.]

1.   Sharpen Your Investor Profile

One of the first steps to become a successful investor is to write down your Investment Objectives and your Investor Profile. It begins with the development of an investment plan. The first step is the identification of personal goals and objectives, and having a time frame for goal achievement. The end result should be a near autopilot, long-term and increasing wealth. Asset allocation is used to structure the portfolio so that it operates in a goal-directed manner. The finished plan must be flexible in design (to adjust for economic, political, and personal reasons), be based upon reasonable expectations, be simple in structure and operation, and be easy to supervise.

The options for investing your savings can be easily categorized according to three fundamental characteristics – safety, income and growth – which also correspond to types of investor objectives. While it is possible for an investor to have more than one of these objectives, the success of one must come at the expense of others. Here we examine these three types of objectives, the investments that are used to achieve them, and the ways in which investors can incorporate them in devising a strategy.

•   Safety: How much safety do you need? How risk-averse are you? Obviously a retired investor needs more safety than a freshly graduated investor who can take a lot more risk as he/she have more opportunities to exploit volatility and absorb some losses through time. Perhaps there is truth to the axiom that there is no such thing as a completely safe and secure investment. Yet, we can get close to ultimate safety for our investments through the purchase of government-issued securities in stable economic systems, or through the purchase of the highest quality corporate bonds issued by the economy’s top companies. Such securities are arguably the best means of preserving principal while receiving a specified rate of return.

The safest investments are usually found in the money market, and include such securities as Treasury bills (T-bills), certificates of deposit, commercial paper, or bankers’ acceptance slips; or in the fixed income (bond) market in the form of municipal and other government bonds, and in corporate bonds. The securities listed above are ordered according to the typical spectrum of increasing risk, and, in turn, increasing potential yield. To compensate for their higher risk, corporate bonds return a greater yield than T-bills.

It is important to realize that there’s an enormous range of relative risk within the bond market: at one end are government and high-grade corporate bonds, which are considered some of the safest investments around. At the other end are junk bonds, which have a lower investment grade, perhaps possessing more risk than some of the more speculative stocks. In other words, it is incorrect to think that corporate bonds are always safe, but most instruments from the money market can be considered very safe.

•   Income: However, the safest investments are also the ones that are likely to have the lowest rate of income return or yield. Investors must inevitably sacrifice a degree of safety if they want to increase their yields. This is the inverse relationship between safety and yield: as yield increases, safety generally goes down, and vice versa.

In order to increase their rate of investment return and take on risk above that of money market instruments or government bonds, investors may choose to purchase corporate bonds or preferred shares with lower investment ratings. Investment grade bonds rated at A or AA are slightly riskier than AAA bonds, but presumably also offer a higher income return than AAA bonds. Similarly, BBB rated bonds can be thought to carry medium risk, but offer less potential income than junk bonds, which offer the highest potential bond yields available, but at the highest possible risk. Junk bonds are the most likely to default.

Most investors, even the most conservative-minded ones, want some level of income generation in their portfolios, even if it is just to keep up with the economy’s rate of inflation. But maximizing income return can be an overarching principle for a portfolio, especially for individuals who require a fixed sum from their portfolio every month. A retired person who requires a certain amount of money every month is well served by holding reasonably safe assets that provide funds over and above other income-generating assets, such as pension plans, for example.

•   Growth of Capital: This discussion has been concerned only with safety and yield as investing objectives, and has not considered the potential of other assets to provide a rate of return from an increase in value, often referred to as a capital gain. Capital gains are entirely different from yield in that they are only realized when the security is sold for a price that is higher than the price at which it was originally purchased. (Selling at a lower price is referred to as a capital loss.) Therefore, investors seeking