In the arsenal of sales tools the finance industry uses, the backtest is surely one of the most paradoxical.
Investopedia defines backtesting as “the process of testing a trading strategy on relevant historical data to ensure its viability before the trader risks any actual capital.” Essentially, it’s a simulation of the past with the added benefit of hindsight bias. Jason Zweig in The Devil’s Financial Dictionary, is more acerbic, if not accurate, with his definition:
Backtest, v. and n. To comb through financial databases to determine which investing strategy would have worked the best if anyone had known about them at the time. Many asset managers then use the backtest as a way to extract money from clients in the present—and disappoint them in the future.
Backtesting is placing the bet after the race. This is, perhaps, a little unfair as backtesting has the potential to yield interesting, if not always useful, insights. Still, much depends on the quality of the backtest and, particularly, its timeframe. The self-selective nature of backtests means that one tends to hear a lot more about investing strategies that worked under certain parameters and specific timeframes than those that didn’t. In this way, the backtest offers little in the way of learning for the new investor.1
Might then I propose the concept of forward-testing, wherein you take a past prediction and see how it actually performed.2
Continue reading “Forward-Testing: Teaching Myself to Test Different Investment Portfolios”
It’s amazing how much can be learned from reflecting on seemingly innocuous and unrelated experiences.1 Nostalgia undoubtedly paints the past in rosier hues, but I’m often left smiling at memories’ unintended lessons. Recently, I chanced upon the following sentence in William Bernstein’s The Investor’s Manifesto:
I emphasize three main principles: first, to not be too greedy; second, to diversify as widely as possible; and third, to always be wary of the investment industry.
As my eyes scanned the passage, the words to not be too greedy brought with them a flash of memory—hours upon hours during childhood spent in the basement den playing Mighty Bomb Jack on the original Nintendo Entertainment System. It was not a particularly interesting or good game, to say the least, and I was not very good at it. It did, however, possess a most curious feature for a video game; players were sometimes “punished” for doing too well.
Continue reading “What a Video Game Taught Me About Investing”
Most investment writing focuses on optimization—how to get the greatest returns, how to outperform benchmarks and earn so-called alpha. And why not? Who doesn’t want beat the market? Who doesn’t want to win? However, many articulate and persuasive writers have pointed out that investing should focus less on winning and more on not screwing up.1 When such a strategy is followed, your short-term highs may not be as high (as those who take on greater risk), but your aggregate gains over the long-term will be enviable.
Continue reading “When the Worst Case Scenario Still Leaves You a Millionaire”
There is a certain type of person. They are the kind that asks complicated questions about simple things without ever knowing what they mean. They conflate sounding smart with being wise. Despite the veneer of their ersatz expertise, I like to say these people know just enough to be dangerous.1 What do I mean?
Continue reading “Knowing Just Enough to Be Dangerous”
Before starting this blog (a whole week ago), I spent most of my time and energy learning about personal finance through good, old-fashioned books. To a lesser extent, I included a steady stream of newspaper and magazine articles in my diet, but I mostly stayed away blogs.1 In order to best acquaint myself with my online neighbors, I recently began to check out the personal finance blogosphere. It started as mere curiosity, but before I knew it I found myself mad like Kurtz in Conrad’s Heart of Darkness, meekly whispering, “The horror! The horror!”
Continue reading “Why I Won’t Use the Personal Capital App To Manage My Money”
I never took a class on economics or personal finance in high school or college.1 I believe this more a reflection on the American educational system than own leaning prejudices, but I also believe that schools should teach children how to swim and teenagers how to drive stick shift. Until my mid-twenties, my formal financial education consisting of learning how to write a check in home economics in middle school; informally, it consisted of my father instilling in me with the idea that so long as one spent less than they made they’d get along just fine in life.
Continue reading “Where to Begin Learning About Economics, Finance and Investing”