Friday, December 27, 2013

The Paradigm of Passive Asset Allocation

In the quest of not having to work until death, many have adopted the ancient tradition of saving money.  Yet dissatisfied of the pittance from CDs, almost all attempt to speculate on a cornucopia of risky assets.  Surprisingly, these people who work hard at their regular jobs and take them seriously suddenly stop giving a shit when it comes to building their savings.  Perhaps it is out of ego or ignorance, but study after study shows the clear ineptitude of the general investing public.  Whether always too early or too late, the average investor just sucks.  If he were a movie, he would be Final Destinations 5, the paragon of mediocrity and indifference to what should be the most important part of building his future.

Perhaps it is unavoidable.  After all, do professional traders skip medical school and start operating on people?  Yet this is what regular people do.  With no real education of the markets, they dive in the deep end without taking a swimming lesson.  Any other outcome where they don't finish last would be a direct affront to capitalism itself.

Yet it seems we are finally turning over a leaf.  Passive investing is now catching on as a viable alternative to whatever the fuck people have been doing.  But promoting passive investing as the superior way misses the whole point of the game: the markets are not here for everyone to get free money, but to trade off risk/bet on probabilistic outcomes.  As an example, the guy holding shares has two meaningful risks: prices going higher after he sells or prices collapsing before he sells.  When he bets that the latter to be likelier than the former, only then does he sell.

Thus, the first question should always be: what do you want to bet on, where do you want to risk?  The average person should rationally want to bet on nothing and absolutely distrust his valuation of risks in the financial markets, as he knows nothing.  If that person still wants to play, the only logical decision should be to cast as wide a net as possible, essentially passive asset allocation.  By using hundreds of years of correlation data and historical returns of different asset classes, laymen can place the hedgiest bet of all time: the sun will come up tomorrow.