Accelerate the Investment Learning Curve

When I began to invest in stocks years ago, the only way to do research independently from a broker was to write to the company for a copy of its annual report.

Thanks to Internet-based news and data services, individuals investing in stocks today are swamped with information. "Trial and error" methods of processing this information could be expensive (think of all the stocks you shouldn't have bought, or stocks you should have sold and didn't). How can new investors learn to invest without spending tuition on lost time and money?

The Learning Curve

The Learning Curve (or Experience Curve) is an academic concept derived from studies of industrial processes. Specifically, economists noted that costs of production decline over time as factory workers gain experience by repetitively making the same product (for example, an airplane). Such experience cuts down on the duplication of mistakes and increases the efficiency of the process.

The chart below demonstrates the principle for different rates of improvement. For example, the green line shows a 20% cost reduction between the first and second units, another 20% cost reduction between the second and fourth units, and further 20% reductions each time total units double.

Applying the Learning Curve Increased efficiency lowers costs

Source: Dr Martin Starr, "Operations Management: A Systems Approach"

In recent years, the Learning Curve concept has been applied to nonindustrial processes: training programs that use the experience of past or existing workers to accelerate the learning curve of new employees. Programs exist for journalists, miners, police officers and even traders.

For those trying to quickly develop investing skills, here are some resources that could be part of your own training program.

The Classroom

Anyone seriously interested in investing should take a basic accounting course. These classes are available at any continuing education college or university, and part of most undergraduate curriculums. Accounting is a core requirement of any MBA program. If you don't understand balance sheets, income statements and, most importantly, statements of cash flow, the fundamentals of investing won't make sense to you.

Hundreds of training courses for traders exist. For example, a "trading course" search on Google lists about 2,300. The difficulty comes with choosing the more useful courses. Any course taught by someone whose primary job is trading (and who works for a major brokerage or bank) will likely be helpful. Courses taught by someone whose primary job is to introduce you to a software product, an exchange or a brokerage house will not teach you much. Courses taught by someone promising you unbelievable wealth if only you follow a few simple rules -- well, you should know better by now.

New York Institute of Finance (which was recently renamed FT Knowledge Financial Learning) offers good classes. Even if you don't live in New York City, you can take advantage of their distance learning programs.

American Association of Individual Investors offers a terrific self-study program. You can buy the courses individually, or you can pay the $49 annual membership fee to be able to sign up for seminars in most major U.S. cities. One of the best components of this site is a series analyzing the investment styles of famous portfolio managers (Buffett, Lynch, etc.) and deconstructing their approaches into the following categories:

Philosophy -- rarely more than one sentence.

Universe -- the stocks they're willing to consider (e.g., small-caps, U.S. only).

Quantitative Criteria -- with corresponding screens.

Qualitative Criteria -- subjective factors.

Times to Sell

The course shows how these investors, representing the top 1% in the all-time rankings, follow different strategies. What better place to find a strategy that will work for you?

If your career goal is to manage money for others (as opposed to investing for yourself), you'll need an MBA from a reputable school just to get in the door. The other entrance requirement these days is the Charted Financial Analyst designation granted by the Association of Investment Management Research. To accelerate the process, take CFA level 1 after the first year of business school, level 2 after the second year, level 3 the year after that.

The Library

In addition to the daily news wire, newspaper and magazine articles on the financial world, you can develop some big-picture thinking by reading books on investing. At Amazon.com, a search on "portfolio management" turns up 578 entries. Here are about 10 books that I recommend from my personal library:

Market Wizards and The New Market Wizards -- Jack Schwager, a former director of futures trading at Prudential, interviewed 35 top traders in stocks, futures, commodities, options and international stocks in these two books.

Investment Gurus: A Road Map to Wealth from the World's Best Money Managers -- Peter Tanous, an investment consultant, interviews 18 money managers.

Random Walk Down Wall Street -- Burton Malkiel explains why it's hopeless to try to beat the market, and then gives strategies for doing so anyway.

Trader Vic -- Methods of a Wall Street Master -- Victor Sperandeo describes the differences between and tactics for gamblers, speculators, traders and investors.

One Up on Wall Street -- Peter Lynch, the classic growth manager of the '80s for the Fidelity Magellan Fund, outlines his investing philosophy.

Winning on Wall Street -- Martin Zweig, former newsletter writer and current money manager at Zweig Funds, describes his investing techniques.

What Works on Wall Street -- James O'Shaughnessy scrupulously analyses the major quantitative strategies (e.g., dividend yields vs. price-to-book ratios vs. relative price strength).

How to Make Money in Stocks -- William O'Neil, publisher of Investor's Business Daily, outlines the Canslim methodology for selecting growth stocks.

Trading for a Living -- Dr. Alexander Elder, a psychiatrist who became an investor, focuses on short-term trading strategies, risk management and removing emotions from your investment decisions.

Don't Underestimate the Work

Some years ago a client who had just retired stopped using me as his investment manager, saying, "Now that I have free time, I'm going to read up on investing and do the job myself. It's easy, right?" My reply: "Sure, and when I retire, I'm going to read up on dentistry and do root canal myself. It's easy, right?"

When you buy or short stocks, you're competing against millions of other investors. Many are inexperienced. But quite a few aren't. They also have talent, knowledge and some hard-working computer systems to back them up. You'll need to work very hard to be in the latter group.

Not sure if your skills are there yet? Trade stocks on paper or enter a stock trading competition. Put up real cash only when you're satisfied with the results.