Jonathan Davis: Let me list all the reasons to listen to this advice

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The Independent Online

Like most of you, no doubt, I like to think of myself as a suave and sophisticated professional, someone never knowingly sold a pup and who is perfectly capable of arriving at rational and informed decisions about most of the things in life that matter.

I also have serious weaknesses, of which the most puzzling is a penchant for collecting lists and taking them seriously. Anything with a heading "the 10 best" this, or "the 10 worst" that, I find hard to resist. Anyone who has read and enjoyed Nick Hornby's book High Fidelity will be familiar with this peculiar syndrome.

Open any financial magazine, or even the stately Financial Times at the weekend, and you will find page after page of league tables, best buys and so on. Most of these are downright misleading. Anyone who chooses a mortgage or picks an investment fund on the basis of published best-buy tables needs a head examination.

This is because the small print is always more important than the headline number or characteristic chosen to determine the rankings. The real point about lists is that they are of lasting value only if you already understand what you are looking for and can control the entry criteria; everything else is marketing. Taken out of context, lists are of little or no value. But if they remind you of important broader truths you have already understood, then it is a different story. In terms of stock market investment, I can think of lists of dos and don'ts from great investors which bear re-reading.

The four luminaries are: Warren Buffett, Sir John Templeton, Jack Bogle and Charlie Ellis. To this list, I would probably also add Anthony Bolton's list of dos and don'ts for DIY investors. If I had to pick one list, it would probably be the 10 helpful hints for individual investors by the American investment consultant Charles Ellis in his classic book Winning the Losers Game.

They are, in many cases, counter-intuitive, or at least they run counter to what people are driven to want to do by their instincts. Two examples would be first, don't buy on tips. Ever. The only good tips depend on having really important inside information. And using inside information is illegal. Second, don't invest in new and interesting investments. They are often designed to be sold to, rather than owned by, investors.

In a Charlie Ellis interview with the American investment author Jason Zweig (go to www.money.com and search under the author's name for the text), he makes three key points. First, most rational investors should be rooting for share prices to fall rather than to stay at today's elevated levels. Only those who realise all their invested wealth swiftly are helped by exceptionally strong stock markets; far better to buy cheap and sell low. Wealth is the difference between the price you pay now and the price you realise when you sell, so bull markets are dangerous conditions into which to commit new money.

Second, over-confidence in particular, and emotions in general, remain the worst enemy of the serious long-term investor. In Charlie's words: "Trying too hard to win eventually means losing." In a rapidly rising market, the more you trade the better you will do. The trouble is that this tends to make you believe trading actively is ipso facto a sensible policy. Charlie quotes the old RAF adage: "There are old pilots, and there are bold pilots, but there are no old, bold pilots."

Third, he says that there are three ways to succeed as an investor, but only one which is a practical option for most. The three paths to success are (a) being smarter than everybody else; (b) working harder than anyone else; and (c) controlling your emotions so that you recognise that most of the time "the best thing to do is nothing". The third route, which points towards buying low-cost index funds and forgetting what the market is doing from day to day, is in his view "the only reliable way I know to succeed".

To try to succeed on points (a) and (b) is brave, but almost certainly foolhardy. In any event, he asks, why take on the best of the professional industry when, by picking an index fund, you can hire the best professionals for yourself? That way, the pros are all working for you ­ and "for free, because stock prices express the best judgement of all the investors out there". He adds: Most of the time, those prices are approximately right, so most of the time you'll be wrong if you second-guess them. Factor in fees, trading costs and taxes, and you have to do about 20 per cent better than average before your costs just match the index after your costs. Stock-picking is a loser's game, but Wall Street loves creating the perception you can win at it."

Finally, I offer one other Charlie Ellis observation: "Investing is a continuous process. It isn't supposed to be interesting; it's a responsibility. If you go to the stock market because you want excitement, sooner or later you will lose."

Knowing my own predilections, I have written that on the wall behind my phone; perhaps you should consider that.

davisbiz@aol.com

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