Investor's Edge

Investing does require a competitive edge, but the “information edge” set forth by rational-agent economists is not the only kind of edge that emerges in the real world. Other kinds of edges:

1. Temporal — willingness to hold one type of instrument, such as stocks or cash, for a very long time, i.e. years, until conditions are right to switch.
2. Emotional — ability to sleep at night while holding a highly volatile instruments.

These sound trivial on paper, but are actually rare and valuable enough to confer a big advantage. Illustrative example:

Since the 1870s, a simple rule to outperform the market has been to buy 100% into the index when its P/E ratio falls below 9, then sell 100% (go all cash) whenever the index P/E ratio is above 22. This rule outperformed the index by a factor of 7.

But this is so simple. What critical edge could be involved? The discipline of inaction. The temporal and emotional wherewithal to make only 9 trades in 125 years. This rule would have had you sitting on the sidelines since May 1995. It might require making no investment moves for most of your adult life. It would be impossible to be an investment adviser, or to hire one: who would pay a fee to a manager who did nothing for 15 years?

This strategy is impossible to execute unless you are currently very young, and prove to be exceptionally long-lived. Thus almost no one has the necessary edge to pursue it.

In a way the investing edge is like marketing strategy: there are many different paths to advantage, but they all involve being unique in a significant and sustainable way.

Comments are closed.