mahikarnam

Many investors get a lot of anxiety chasing mutual fund returns, hoping that history repeats itself while they are in the fund. In fact, a fund which has already yielded large returns has less of a chance to do so again when compared with its peer group. A better idea, rather than stressing out over the vagaries of the financial markets, is to look for wisdom in time-tested, academic methods. Once your high-quality investment plan is set up, relax. Let your investment compound, understanding that the plan is rooted in knowledge, not hype.

Good Soil

As when growing a garden, you want to invest in good soil (strategy). Accordingly, you can expect there to be some rainy days (bear market) with the sunny (bull market). Both are needed for overall growth. Once a garden (money) starts to grow, don't uproot it and replant, lest it wither and die.Set up your investment wisely and then let it grow.

Academic research creates good soil. The body of knowledge about the market goes through a rigorous review process whose primary goal is truth or knowledge rather than profit. Thus, the information is disinterested - something you should always look for in life to make wise decisions.

Greatly distilling this body of knowledge, here are a few key points to remember when it comes to investing in the stock market.

Risk and return

This concept is similar to the saying "there is no free lunch". In money terms, if you want more return, you are going to have to invest in funds that have a greater probability of going south (high risk). Thus, the law of large numbers really comes into play here, since investing in small, unproven companies may yield better potential returns, while larger companies which have already undergone substantial growth may not give you comparable results.

Market efficiency

This concept says that everything you need to know about conventional investments is already priced into them. Market efficiency supports the concept of risk and return; thus, don't waste your time at the library with a "Value Line investment" unless it provides entertainment value. Essentially, when you look at whether or not to invest in a large corporation, it is unlikely that you are going to find any information different from what others have already found. Interestingly, this also gives insight into how you make abnormal returns by investing in unknown companies like "Bob's Tomato Shack" if you really have the time and business acumen to do front-line research.

Modern portfolio theory (MPT)

Modern portfolio theory (MPT) basically says that you want to diversify your investments as much as possible in order to get rid of company- or stock-cspecific risk, thus incurring only the lowest common denominator - market risk. Essentially, you are using the law of large numbers in order to maximize returns while minimizing risk for a given market exposure.