Read this first

Who is this book for?

It is for investors everywhere who have several things in common:

• They feel that they are not getting value for money from the finance industry and find it opaque, but realise how important investments are to their lives. They read about phenomenally wealthy finance types, but feel that in paying fees, for example, the results are poor. Thinking about the great phrase ‘Where are the customer’s yachts?’, they don’t even have a rowing boat.
• Ideally, they would like a simple portfolio of investments, but also want to feel that they can expect the best possible return for the risk they are willing to take.
• They may well have investments with typical investment managers as (despite themselves) they fell for the snazzy ads that showed great historical performance, which perhaps wasn’t matched post-investment.
• They may have shares in blue chip companies like Google, Apple, Exxon or Vodafone, but at the same time recognise they are not expert stock pickers and consider that is something best left to the professionals.
• They may have been left confused by the many opinions and options for investment/savings strategies and decided to more or less copy what a few friends have done while knowing that this is not the best solution.
• They may also know a lot about finance and have a genuine interest in it, but with a busy day job are unable to devote a lot of time to their personal portfolio. They need a portfolio that helps them sleep better at night, knowing that their savings are well looked after without having to spend too much time on it.
• They may have been directed by an adviser who they had retained to help simplify the jungle of investment products and were left unable to understand their portfolio mix. Perhaps without knowing if the adviser took a share of the high fees they were paying.
• They probably also think about investing longer term. While this book certainly has many immediate action items it is the opposite of the ‘Spot the next hot stock’ or ‘Make $10,000 a day without getting out of bed’ genre.
• They want a book on how to do a little bit better every year financially, with a big cumulative impact over time. If a hedge fund manager is a turbo-charged Ferrari, this book is akin to the grey Volkswagen that is a far better bet to get you safely to your destination in one piece.

So this book is about taking something as opaque and impenetrable as the financial market sector and demystifying it: thus Investing Demystified. Once investors realise that they do not have the investing edge to outperform the markets, and know that this is perfectly acceptable, the rational next step is quite logical and simple. I call this next step being the rational investor and the portfolio for that investor the rational portfolio.

So what is a rational investor?

While I’m not expecting readers to know about finance, some basic knowledge is helpful. Someone without any finance knowledge may find it harder to distinguish between an unglamorous book that promises improved risk-adjusted performance over the long term and other appealing-looking products from the well-marketed finance industry that tell us we can all be Warren Buffett – or at least that we should try. No wonder that most people would rather aim to be a billionaire superstar.

However, to keep it an easily readable finance book, we will be relatively light on theory and complex maths. They play a central role in supporting the arguments made in this book as I’m keen that you understand that what I suggest is a practical implementation of the best theory on getting the optimum portfolio. But in the interest of readability I have tried to keep theory and maths to a minimum, and put some of it in boxes that you may choose to skip; likewise there are a limited number of footnotes and references for those who want to explore further.

There are two major differences compared to the first edition of this book. To make the arguments a bit more streamlined there are now a number of appendices for the more tangential points. If you have the appetite or want further explanation of the various points, I’d recommend you read these. Also, I have downplayed the suggestion of adding other government and corporate bonds to the portfolio. I felt that the reasoning of adding the complexity of these asset classes to the portfolio took a bit away from the central message of this book; namely that you can have an incredibly powerful portfolio that is also remarkably simple. For those who can handle the complexity I still think there is merit in adding other government and corporate bonds to the portfolio, but I also don’t want readers to think this complexity is strictly necessary.

This book uses words like estimate, guess, approximately, around, roughly, fairly, reasonable quite a lot. This is because the discussion is often about what will happen in the future and claiming certainty would be misleading. Most points are fair estimates of what we can expect and hopefully a framework of how to think about the issues. Reality will almost certainly turn out differently from what we forecast here, and perhaps even make a mockery of our logic if we try to be too exact. I use £, $, €, etc. interchangeably in the examples and discussion. This is deliberate as most of the topics discussed do not depend on currencies. Investors obviously care a lot about their specific currency exposure, but the issues faced by a sterling investor are very similar to those faced by a euro-based one.

To accompany this book, and perhaps spread the word to people who are not inclined to read a 250-page book on investing, there are some videos on Kroijer.com and on my YouTube channel outlining the arguments, and I will also use the site to keep you updated on recent developments and thinking. Please have a look and feel free to share the videos. You can also follow me (Lars Kroijer) on Facebook and Twitter (@larskroijer) where I will also keep you updated and post things I hope will be relevant to you.

Who am I to write this book?

This book draws heavily on my experiences managing a hedge fund and practically implementing investments, but also relies on academic research in portfolio construction. A one-time hedge fund manager writing a book about investments without edge may seem like a priest writing the guide to atheism. In my view, however, it is not at all inconsistent. The fact that some investors have an edge on the market does not mean that most people have it. Far from it. ‘Edge’ is confined to a very small minority of investors who typically have access to the best analysis, information, data and other resources. Most other investors simply can’t compete, and would be worse off trying.

Surprising, perhaps, for those who know me as a hedge fund manager (I wrote a book called Money Mavericks about my experiences of starting and running a hedge fund), I was interested in optimal portfolio theory before I even really knew about hedge funds. For a while I planned to get a PhD in the field and perhaps teach. As it turned out, I graduated from university with a lot of debt and had a lucrative offer from Wall Street. From there, I got my MBA and ended up being interviewed at a hedge fund. Events happened, as they say. So I have a lot of experience with optimal portfolio and general financial theory, but also experience operating in the financial markets. Since I stopped running my hedge fund in early 2008 (fortuitous timing) I have mainly focused on investing my own money along the lines discussed in this book, and have extensive experience of trading the products discussed.