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May 9, 2000

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Rule Breaker - Strategies

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Subject:  I must disagree...
Author:  heihojin

...with the "Buy What You Love" philosophy.

From Friday's rather esoteric RB column:

Juan (and I, by quoting him) is reminding us all that our portfolios should be natural expressions of ourselves.

You may believe as such, but I strongly disagree. According to my values, the purpose of a portfolio is to provide the maximum return in accordance with an investor's tolerance for volatility and loss of principal. Any other purpose isn't a portfolio; it's a waste of resources.

I have taken to saying recently that I should be able to pick up your brokerage statement and look at your stocks and know therefore a LOT about you.

Only if you knew my criteria for selecting investments. For example, you might see Philip Morris Cos. (NYSE: MO) in my portfolio at some point in the future. It could be there because I'm a smoker (I'm not, BTW). It could be because I invest in well-established companies with a high dividend yield and a low trailing P/E. It could be because it was selected as part of the "Dogs of the Dow" mechanical strategy. It could be because I put the names of the DJIA component stocks in a hat and picked one at random. It could be because I like stocks with ticker symbols that begin with the letter 'M'. In other words, you really know very little about me just by looking at my portfolio unless you know how they were selected, and even then you have only learned about my investment criteria.

There is no universal norm or law that declares that you should invest only in what interests you.

Conversely, I don't believe investing in a "good" or "hot" stock that someone else has told you about makes sense, because if you do well it's just luck and not repeatable...

Unless, of course, that person is willing to sell you "Portfolio Trade Alerts" for only $25.

Of course, his picks may just be attributable to luck as well.

...and if you do poorly you won't know what to do with the stock and you'll tap in here online with us and ask people what to do. Because you won't know yourself.

I am firmly unconvinced that "knowing yourself" has any relation whatsoever to making optimal investment decisions.

We can call it the heart check. It's the "do I really care about this thing succeeding?" question.

These questions are best handled piecemeal, as they all have a different relationship to the goal of optimizing investment returns.

I care about my investment "succeeding" only so long as it provides me with the return I am seeking, in accordance with my tolerance for volatility and loss of principal. In the case of AMZN; AMZN may very well "succeed" by someday becoming profitable, but the market may very well give it a low rate of return for someone investing today.

In which case, has the company succeeded? Perhaps.

Has the investment succeeded? That's an entirely different question.

"Will the world be better because of this company?"

According to whom? The economic principle of rational self-interest states that "people choose the options that give them the greatest satisfaction" (William Boyes and Michael Melvin, Macroeconomics, 4th Ed., p. 7). If 51% of the world's population get the greatest satisfaction by gambling away their life savings at casinos owned by Mirage Resorts (NYSE: MIR), who are you to say the world isn't a better place because of it?

People vote with their dollars, and ultimately will vote for "a better world" by determining a company's revenues. In the New York Times Magazine in 1970, Milton Friedman argued that "the social responsibility of business is to increase profits," (Boyes and Melvin, p. 14) and I couldn't agree more.

"Will I be smiling inside just as I smile outside as this investment becomes a world-beater?"

Only if I'm profiting from it.

"Will I love it enough to care?"

This is also irrelevant to providing optimal returns, and may in fact be detrimental.

As has been pointed out many times before, a common mistake is to become attached to your stock when it is no longer a good investment.

Let me provide an example of the converse. I am short AMZN. Does that mean that I "hate" AMZN? No. In fact, I believe they are providing a useful service. I just believe that for whatever reasons, the market will award them a significantly lower valuation in the future than at present.

In fact, I am rather indifferent to AMZN as a company. I've even ordered from them in the past, and I was a satisfied customer. My sole concern is with the stock price, because that is the only thing that affects the return on my investment. The fact that I have sold shares short has a negligible effect on whether or not the company itself succeeds.

You, on the other hand, may have a personal interest (other than financial) in whether or not the company succeeds. But when it comes to my investments, I am only concerned with optimal returns, and I recognize full well that in that context, personal emotions and prejudices only serve to render the decision-making process inefficient.


heihojin

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