An Introduction to Quantitative Finance — Investing, Pt 1
Note: This is a 2 part series on Basic Investing, Python and Quantitative Algorithm as part of our quant meetup in Raleigh-Durham. This was adopted form our presentation deck on our first meetup. So its a summarized version of our actual presentation.
Investing is defined by investopedia as:
Investing is the act of committing money or capital to an endeavor (a business, project, real estate, etc.), with the expectation of obtaining an additional income or profit.
Why Invest ?
3 Simple reasons — Inflation, Taxes and Compound your wealth
Power of Compounding: 1000$ invested every month through your working career in S&P 500 starting 1987. Guess how much would it be?
we will come back later in the post for the answer above
What all you can Invest in — Asset Classes?
Living in the United States gives you the opportunity to invest in ANY thing you can imagine (Though this may not necessarily be a good thing). Lets see the possibilities:
Stocks: US, Developed Markets, Emerging and World Equities
Bonds : Corporate , Governments and Municipal bonds
Gold, Precious metals and Commodities: Any thing you can imagine
Currencies: Everything from Indonesian rupiah to crypto-currencies including Dogecoin
Real Estate: You want to invest and get rent from FBI ?, it is possible (DEA)
How to invest?
Following instruments are available : Stocks, Futures, Options, Exchange Traded Funds, Mutual Funds, Fund of Funds to all sorts of complicated names to puzzle you.
Asset Allocation
“Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon.” — Investopedia
It is important to understand this. We will be using common allocation strategies such as 60/40 (60% Equities, 40% Bonds), Lazy Portfolio’s such as 3 Fund portfolio (US stocks, World stock and Bond) etc. These can serve as good starting point to understand why certain strategies are better than others.
Active and Passive Investing
In the 21st century, no finance related discussion is not complete without Active vs Passive debate. We will summarize the entire debate in few words:
- Active Investing : Actively picking stocks (+other assets) through analysis of some sort of information , data for your investing purposes.
Before we go into passive investing, Its important to know what an index is!,
Index : Basket of stocks (or assets) which are selected based on certain rules (like 500 largest or high dividend or the most liquid etc).
- Passive investing is investing in an index through an instrument like Mutual Fund, ETF or others. Usually buy and forget is the reason its called passive.
No investment is truly passive, but lets just say this is cheaper, less time consuming and definitely lot less active .
In a 15 year period, 92.2% active funds under perform their benchmark” .so that is basically 1 out of 20 funds beat the market.
If you are thinking “You are throwing lot of information!” — If you take one thing from us. Just follow the quote:
Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors, whether pension funds, institutions or individuals -who employ high-fee managers.
— Warren Buffet
Power of Compounding and Benchmark
Remember we had asked this question -1000$ invested every month through your working career?, this is where you would be?
“Our favorite holding period is forever.” — Warren Buffett
So above method of investing is what we call Buy and Hold. So if our strategies are not yielding anywhere close to annualized 9% (usually 6–11% depending on your horizon), going passive is better. We can save our time, reduce our effort and concentrate on something else ;) . This is our Benchmark for our algorithms typically. Choosing benchmark matters, but that is a topic for different day. For our algorithms, this benchmark should cover 95% of our algorithms.
BEHAVIORAL FINANCE
Emotion and psychology influence our decisions, causing us to behave in unpredictable or irrational ways. Especially when money is involved, even smartest of people including Issac Newton cannot control their behavior.
Take a look below — Harry Markowitz is a Nobel price winning economist who came up with Portfolio allocation, he developed the entire theory on diversification with non correlated asset classes. Won a Nobel price for the same but in the end what he did?.
“I visualized my grief if the stock market went way up and I wasn’t in it or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.”
So just try not to do stupid things! (Its tougher than you think).
What Next?
I know we discussed a lot about investing , assets and behavior. We are yet to even touch the Quant aspects! but what we saw above is essential for any sort of investor. That is why this is a good primer for our new members. We will be starting with our first algorithm in the next post.
We had a great first meetup @ pfQuant . Looking forward to meeting you!. Subscribe to our updates here ->
