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DOs (with caution)

On this page I discuss four topics pertaining to things that are worth doing, provided there are certain caveats. Hence, "with caution".


"Buy what you know"

Expertise is worth a lot. Warren Buffett has said that it does not matter how wide your expertise is, it matters how well you describe the relevant parameters within your field of expertise. In other words, it is better to be very good at a few things, than to be rather average at everything (The Essential Buffett, Robert Hagstrom 2001).

When buying what you know, watch out for positive bias as a result of the familiarity. Many people put money in the company they work for because that is the company they think they know best. Yet, for example, even the employees of Enron could not foresee the Enron debacle.


Mutual funds

The good thing about mutual funds is that they provide an easy way to diversify. The same holds for index funds, which are usually cheaper.

You have to be cautious though. Mutual funds on average do not outperform the market, and many charge a lot for it.

One reason you will not beat the market by buying mutual funds is that mutual funds together own most of the stock in the S&P500. Secondly, the fund has to overcome operating expenses and trading costs before there is any return. And when a fund does perform well, it is not likely to continue, for the following reasons:
- Good managers switch jobs.
- More money is invested. The dilemma arises that if the mutual fund buys more of the same stocks, they become dangerously overvalued. If it buys new companies, it has more more things to watch, so research cost grows.

What distinguishes the few good funds?
- The managers are major shareholders
- They are cheap (really: funds with higher fees have been proven to give lower returns)
- They don't advertise.

When should you sell your fund?
- Upon a radical change in strategy
- Upon increased in expenses
- Upon large tax bills (excessive trading)
- Sudden change in returns (gain or loss, both suspicious)