This is a fun guest post from PK, a software engineer who writes at Don’t Quit Your Day Job…, a site which covers the intersection of personal finance, investing and economics. Follow DQYDJ if you care about the story behind the story.
Quick: what was the fastest production car that General Motors made in 1987?
The Corvette? A common answer – but the performance champion was the lesser known Buick GNX, which lives on today in the Buick Regal. (The Corvette lives on today in, of course, the Corvette)
Cars & Investing: A Universal Language!
So… why cars?
Well, first, I’ll be in fine company; this site has a history of well-reasoned articles about cars, what with the seminal 1/10th rule on car buying or its cousin, the 5% of net worth car buying rule. However, that’s not the full reason.
Like most engineers still in the workforce, I’ve spent a fair amount of time on Slashdot (tagline: “News for nerds, stuff that matters”) over the years. One of the tongue-in-cheek memes of that site (and, really, engineering-focused sites in general) is the venerable car analogy. No matter how complicated the topic, there will always be an argument as to how cars, trucks, traffic, roads, and other self-directed transportation-related items can somehow shine a (head)light on the topic. If the readers on those sites cared about investing, I’m sure you’d already have seen similar analogies put forward.
But, they don’t – and we do.
So, how would you describe the major classes of investors – passive, technical, growth and value – with car analogies? Let me take a shot first, then let’s hear your improvements in the comments!In Ferris Bueller’s Day Off, Cameron’s Father’s ‘choice’ Ferrari 250GT California was just a replica… (Wikimedia)
The Passive Investors
Excuse my mixed metaphors, but let’s bat lead-off with the easiest one!
Passive investors may just be the smartest investors of the group – whether they decide not to delve into the intricacies of the market due to academic research, comparative advantage, or merely intimidation or not knowing where to start – these investors aim to closely approximate returns of a widely diversified basket of securities.
The language of the passive investor reflects the philosophy: just deep enough to explain some asset classes and maybe a few types of funds. “Target Date Mutual Funds” are the ultimate signal of a passive investor, although many will want to balance asset classes themselves between International and Domestic Stocks and Bonds, plus Cash, and (for some), Real Estate Funds. It’s not a horrible strategy – note our own S&P 500 return calculator, which shows impressive results for even the laziest indexing strategies… and a related calculator which shows the S&P 500 returning 5% after inflation for 87.42% of all 40 year periods. You could do a lot worse.
The passive investor is the man or woman who goes to the car dealer and asks for the newest model year Honda Accord, Toyota Camry, Mazda6, Ford Fusion or Chevy Malibu. Our passive investing hero holds that car for 5-10 years, only to replace it with another example from the same class.
Maybe they deviate a bit sometimes – A Civic? An Altima? Buy Used? – but the philosophy doesn’t change, and it serves them well. Think about it – most issues are covered under warranty, and although they don’t have the flashiest, fastest vehicles… they avoid many of the problems faced by drivers of the more exotic choices available from the fine motor vehicle companies on this planet.
Those are some reliable vehicles and cheap to fix. They won’t stick out, but they can easily keep up with traffic.
The Technical Investors
I personally consider myself somewhere between the passive investing and value investing camp – I’m mindful of my lack of information on lots of asset classes (what… you really think you can pick individual Emerging Markets stocks from your couch?), but I’ll gladly invest in individual American companies. Technical Investing is my blind spot – I can understand, conceptually, how it is supposed to work, but just can’t see it working too well in practice.
Follow me here – technical investing generally ignores the fundamentals of a stock or security, instead concentrating on its price movements (and the derivatives of said movements). Its language is pseudo-scientific; technical investors would like nothing more than for stocks to obey equations and concepts derived from physical fields – momentum, gravity, inertia, resistance, spring constants and the like – but for every successful trade, there is a potential looming disaster.
It’s not that technical investing can’t work; I’m sure there are still exploitable patterns in the market that haven’t yet been arbitraged away – there are lots of recent examples of timed buying and selling which could have been traded upon. Again, could be – by a computer programmer smart enough to not only update signals at a fixed time… but not to a day trader drawing resistance lines on graph paper in the spare bedroom. Fact is, to exploit technical signals nowadays you need to make some crazy leaps of logic – if investors react a certain way, you can’t just trade against that… you need to know how computers will react, then how other computers will react to the reaction, so on, and so forth. Remember, up to 80% of trades in American markets are algorithmic… I just can’t see Bollinger Bands and 50 Day Moving Averages cutting it anymore.
A technical investor is a strange type when it comes to cars – instead of asking to test drive the car, a technical investor will look at a graph of the distance traveled by one vehicle. Since the derivative of position is speed, and the derivative of that is acceleration, the technical investor can create a ton of pseudo-scientific numbers by just playing around with a price chart. The investor will then try to guess if a car is a good buy on just a simple graph of the car moving around.
Is it safe? Was it souped up illegally? Was it in traffic? Was it going downhill in a hurricane with wind at its back? Was it a replica made for a movie and not worth $10,000,000 (see picture 1)? Uhh… do the brakes work?
These questions matter not to the technical investor!
So, although the investor will sometimes end up buying a super-car, technical investors are also liable to end up with Ford Pintos, Yugo GVs, or late 80s Ford Mustangs and Chevy Corvettes (the latter holds the dubious award of being the most dangerous – in terms of deaths – car in American history).
And, seriously, if you’re a technical investor – care to educated us on the difference between a Hanging Man and a Hammer?
The Growth Investors
Growth investors are, ostensibly, people who recognize the (perhaps lofty) valuation of a firm’s shares but believe that it is justified (or undervalued) because of the growth prospects. In their purest forms, Value and Growth sort of blend together if you squint hard enough – people like Peter Lynch fall into the “Growth at a Reasonable Price” camp, and Growth even has some claims on Warren Buffett (as opposed to Benjamin Graham’s and David Dodd’s pure value methods). The ‘Reasonable Price’ in that phrase is, of course, a nod to value.
In practice, growth investors don’t normally behave like the GARP framework predicts they will. Instead of looking for, say, stocks with low prices versus their earnings growth rate, they instead buy stocks which have already made huge moves (Fear of Missing Out!), take stock tips from acquaintances at parties (and from brokers), and invest in the biggest “names” in the market instead of putting money in the undervalued performers.
A Growth Investor Car Buyer is most likely to end up with a vehicle which he or she knows lots of others are buying. That doesn’t mean a bad car, per se – but our growth pal just bought an Audi after driving a Lexus Rx in the mid-to-late 2000s and a Hummer H2 before that, preceded by a Jeep Wrangler. Toyota Priuses, mid-2000s Volswagen Beatles, and later-2000s Mini Coopers also entered the discussion when they were hot… along with whatever his or her cousins and friends were buying.
Fine cars, all – but at a reasonable price? That’s what separates the adherents from the pretenders, my friends!
The Value InvestorsWhere we’re going, we don’t need P/E ratios… (Wikipedia)
“Value Investor” is another label that people like to wear… yet fail to live up to. A pure value investor is most concerned with the margin of safety… a nebulous term which really means asking “what are the odds I get my money back… or make money on this?”. They concern themselves with dividend discount models and discounted cash flows.
All value investors love ratios and numbers pulled from company quarterly reports – the worst value investors invest directly on those numbers, while the better value types will concern themselves with history, trends, and, yes, Growth at a Reasonable Price. Good value investors care about esoteric things like 13F Filings and changes over time in company report footnotes. And they usually pay attention to company Q&A sessions.
Value Investor Car Buyers are, of course, the ones most likely to answer weird car-related questions like the one that lead this piece. They buy the car no one has heard of, or the used car from the nameplate that no longer exists or went through bankruptcy. They may buy cars just to be contrarian (think Subaru drivers or Audi-before-2008 drivers) or just buy cars that were an amazing deal (anyone who bought American cars during the financial crisis). They also love cars that go against the grain for a brand – sporty Turbo Volvo, anyone?
Value investors love used cars – combine it with another stereotype and you’ve found Value Driver Valhalla – think of a fallen hero like a DeLorean DMC-12, or a used classic like a Porsche 944.
Of course, if their car gets too popular, they’ll sell it.
We All Want Similar Things
We all want similar things from our investments, just like we all want similar things from our transportation. You can summarize the entire universe of investing and transportation goals as “getting from point A to point B”. Sure, passive investors and drivers demand efficiency in expense ratios and gas mileage, technical investors and drivers like speed and volatility, growth investors and divers want to own what others enjoy, and value investors and drivers want safety before speed. Hopefully that means everyone makes it to the same place without crashing or breaking down… even if the individual journeys differ wildly.
It’s time for you to comment now. Start with which investing camp you most closely align with, and tell us what you (and your significant other, if you have one) drive. Make sure to tell us where you agree and disagree with the comparisons – and feel free to take a shot at some of the rarer investor types (here’s a freebee – do Activist Investors!).
FULL DISCLOSURE: I drive a SAAB 9-3, my wife drives a Jeep Liberty, and we have no plans to buy any cars mentioned in the article in the next 72 hours.
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Updated for 2017 and beyond.