# The Investor's Dilemma Decoded

## Recognize Misinformation, Filter the Noise, and Reach Your Goals

1. Auflage April 2024

368 Seiten, Hardcover*Wiley & Sons Ltd*

**978-1-394-22035-9**

Few aspects of life are as important as personal finance, as subject to your control, and as suffused with misinformation, noise, and confusion.

Now, authors Dr. Roger D. Silk and Katherine A. Silk cut through that confusion and share with you the fruits of their knowledge and experience developed over the last 43 years. After completing a Ph.D. at Stanford where he studied at the cutting edge of finance theory, Dr. Silk's experience includes managing billions of dollars at the World Bank and running a family office for one of the nation's wealthiest families. For the last 26 years as CEO of the nation's leading firm which advises high net worth individuals on financial and other aspects of their philanthropy, Dr. Silk has worked with countless individual investors and financial professionals. Katherine Silk, who holds a master's in history from Stanford, adds a valuable and often-missing historical perspective.

Their weekly blog, dealing in depth with a variety of financial, economic, and planning issues, is read by thousands.

Unlike many authors in the Personal Finance space, the Silks have the deep technical expertise (it's hard to get a graduate degree from Stanford without it), decades of experience, and the rare ability to express complex ideas in clear, easy-to-understand prose.

When Gary Taubes wrote The Case for Keto, he considered calling it "How to Think About How to Eat." Similarly, The Investor's Dilemma Decoded could be titled "How to Think about How to Invest." Investor's Dilemma gives you the tools that 99.9% of investors never master -- these tools allow you to understand how to think about almost any category of investment, and almost any investment product or program.

In addition, the authors take a deep dive into topics including

* What actually generates investment returns (it's probably not what you think)

* Is owning a home an investment (you'll learn why the answer is sometimes yes, and sometimes no)

* Should you own gold (clue: the largest gold holders in the world are central banks)

* What is a hedge, and are commodity funds an inflation hedge

* What many well-known investment personalities get wrong on about returns (they tell the truth, but it's the wrong truth)

* What risk is, and isn't, and why the "safe" course might be the riskiest (but the government says it's safe).

* How professional financial advisors can add huge value to their individual clients (it's not by picking the best stocks)

Should you read this book? If you want to understand how professionals think about investing, about what is realistic and unrealistic, and learn to spot the difference between a Bull Market and Bull-xxxx, the answer is yes.

Acknowledgments xix

Introduction xxi

Chapter 1: Time Value of Money 1

The Standard Theory 1

Assumption: You Can Save Money at No Cost 2

Assumption: You Can Save Money at No Risk 3

Time Value of Money and Compound Growth 4

Comparing Values Across Time 6

Real-World Compounding Versus "Pure" Theory of Time Value of Money 6

Appendix 8

The Math of Compounding 8

More Frequent Compounding 8

Exercises 11

Answers 12

Chapter 2: Basic Investment Analysis 13

Basic Terminology 13

Modeling an Investment as a Series of Cash Flows 14

Net Present Value 15

Valuing a Stream of Cash Flows 17

Easy Way 18

Harder Way 18

Present Value of a Growing Perpetual Stream of Cash Flows 20

Duration: A Measure of Interest Rate Sensitivity 21

How Is Rate of Return Calculated? 23

Simple Annual Rate of Return Versus Compound Rate of Return 23

Arithmetic Versus Geometric Mean 24

Appendix 26

Internal Rate of Return 26

IRR Defined 26

Some Limitations of IRR 27

Chapter 3: Bonds/Fixed Income/Loans 31

Bonds 31

What Are Bonds? 31

Bond Terms 32

What Determines Bond Returns? 32

Return Versus Yield 33

Short to Medium Term 34

Inflation Adjusted or "Real" Returns 38

Risks to Bonds 41

Credit Risk 41

Historical Experience of Defaults 44

Interest Rate Risk 46

Bond Math - The Absolute Minimum 46

Inflation Risk 48

Low Interest Rates as Financial Repression 50

Chapter 4: Equities 51

What Are Equities? 51

Equity 52

Additional Equity or Equity-Like Asset Classes That Might Be of Interest 53

What Generates Stock Returns 53

Medium- and Short-Run Returns 55

Individual Stocks Versus "The Market" 56

Markets and Indices 56

Valuation Measures for Individual Companies 57

Valuation Changes and Returns 59

Noise - Information Versus Signal 60

Valuation Changes 61

Historic CAPE Versus Returns 61

What About Momentum? 62

What Has Generated Historical Returns in the US Market? 64

Long-Run Source of Returns to US Stocks 65

What Returns Can We Expect from US Stocks from Here? 66

Valuation Risk 69

Medium-Term Expected Returns 69

Variability 70

Takeaways Regarding Returns 72

Chapter 5: Real Estate 73

Kinds of Real Estate 74

Farmland 74

Falling Interest Rates Explain Half the Real Increase Since 1967 . . . 76

. . . But Falling Interest Rates Explain All the Real Increase Since 1987 76

Price/Earnings Ratio for Farmland 76

All Farmland 78

Farmland - Summary 80

Longer-Term Returns to Farmland 80

What Returns Should We Expect from Farmland? 84

Timber 85

Office Buildings 85

Returns to Land 86

Homes 88

Owning Apartments as Investments 90

Source of Return 90

Economic Theory 91

Summary 96

Chapter 6: Gold and Gold Stocks 99

Is Gold in a Class by Itself? 99

A Brief History of Gold 100

Gold's Place in a Portfolio 104

What About Gold Stocks? 106

Silver 107

Summary 108

Chapter 7: Futures and Commodities 111

Arbitrage 111

Futures Contracts 112

Pricing of Futures Contracts 113

Commodities 116

Monetary Regime Matters 122

Are There Commodity "Yields"? 123

Collateral Yield 126

Commodity Index Funds Have Negative Expected Real Returns 127

Managed Futures Funds 127

Barclays CTA Index 129

Chapter 8: Mutual Funds 133

Open-Ended Funds Versus Exchange Traded-Funds (ETFs) 133

Advantages of Fund Investing 134

Index Funds 134

Sector Funds 135

Hedge Funds 136

Individual Bonds Versus Bond Mutual Funds 136

Are Mutual Fund Expenses a Good Value? 137

Chapter 9: Basic Portfolio Theory 139

Markowitz Model 139

Capital Asset Pricing Model 142

How and Why Diversification Can Reduce Risk 143

Mathematical Underpinnings of the Capital Asset Pricing Model 144

Don't Mistake Beta (Returns Correlated with Risk) for Alpha (Risk-Free Returns) 146

Assessing the Risks and Returns of the QQQ Versus the Spy 147

Drawdowns 149

Random Walk 150

Efficient Market Hypothesis 151

Significant Exception to the Efficient Market Hypothesis: The "Value Anomaly" 154

Value Versus Growth Stocks 154

International Evidence 155

What About the "Size" Effect? 157

"Cheap" or "Expensive"? Volatility of Stock Prices Versus Earnings or Dividends 158

Can You "Beat the Market"? 159

Why Don't Professionals Beat the Average? 160

Effect of Fees 160

Effect of Cash Holdings 160

Enhanced Index Strategies 161

Which Index? 163

Conclusion 164

Chapter 10: Financial Leverage 165

Reg. T. 166

Effect of Leverage 166

Securities Lending 169

Payments in Lieu of Dividends 169

Securities Lending Is a Complicated Tax Area 170

Rehypothecation Risk 171

Real World Leverage, Again 172

Chapter 11: Risk 175

Fear of Losing Money 175

Risk Versus Uncertainty 175

History 177

Using Statistics to Understand Risk 179

Explanation - Arithmetic and Geometric Means 179

So What? 181

Variance 182

Another Important Implication of Volatility 183

Modeling Likely Future Values 184

Modeling Future Wealth 184

Mathematical Approach - A Very Short Course in Statistics 185

Sample Mean 186

Standard Deviation 186

Population Standard Deviation Versus Sample Standard Deviation 188

Standard Error 188

Standard Error and DMS 189

Projecting the Likely Range of Future Values 190

Skewness 191

Percentiles 192

Expected Value Revisited 194

Chapter 12: Assembling a Portfolio 195

Forget About "Best" or "Optimal" 196

Reasonable Estimates for Expected Returns - Equities 197

Two Defensible Ways of Estimating Expected Returns 198

"Naïve" Long-Run Historical Average 198

Historical 201

Argument for Continued Outperformance 202

Argument Against Continued Outperformance 202

Role of Valuation 203

Valuation-Based Expected Return for Equities 203

Other Valuation Approaches 206

The Price/Book "Formula" 207

Expected Return 207

Our Preferred Methods 208

Reasonable Estimates for Expected Volatility 208

Time Frame 208

The VIX 209

Implied Versus Realized 210

The Case for 20% Long-Run Stock Market Volatility 211

Expected Returns and Volatility - Bonds 212

Expected Returns and Volatility - Cash 212

Expected Return and Volatility - Gold 213

Expected Return and Volatility - Gold Stocks 214

Expected Return and Volatility - Managed Futures 214

Cautions 216

Expected Returns and Volatility - Real Estate 218

Covariance Matrix 219

What Covariances/Correlations to Use 220

Covariances and Portfolio Formation 221

Stock Market Return Correlations Over Time 222

Calculating Expected Returns and Volatilities for a Multi-Asset Portfolio 225

Calculating the Return and Variance of a Portfolio 226

Return 226

Variance (Volatility) 226

Example with Six Assets 227

Matrix Algebra 228

Expected Returns 229

Variance 230

Chapter 13: Portfolio Simulations 233

Simulating a Variety of Portfolios Based on Cash and the World Equity Market 233

Portfolio 0 235

Implications 243

Conclusion 246

Chapter 14: Professional Advice 247

Personal Financial Planners 248

Who Should Consider Professional Advice 248

Financial Literacy 249

FINRA's Quiz 249

Interpreting the FINRA Quiz 251

Numeracy 252

Aside on the Rule of 72 252

Financial Literacy and Professional Advice 253

How Professionals Add Value 254

How Much Value Financial Planners Add 255

Planner Value Added - "Gamma" 256

Factors to Consider When Selecting an Advisor 257

Alpha 258

Beta 258

Gamma 258

Advisor Characteristics 259

Integrity 259

Incentives 260

Skill 260

Personality 261

Checklist 263

Chapter 15: From Theory to Practice 265

Appendix: Some Math of Diversification 269

Variance 269

Standard Deviation 270

Examples Using Bet of Coin Flip with Positive Expected Value 271

Independent Events - The Key to Reducing Risk 273

Random Variables 274

Binomial Distribution 276

Normal Distribution 277

Covariance 278

Sum of Variances 279

Binomial Expansion 280

Weights 280

Variance of a Portfolio 281

Correlation Coefficient 281

Demonstration That If Assets Are Correlated, Risk Can Never Be Eliminated 282

How Much Diversification Is Enough? 283

Equal Weighting Versus Market Capitalization Weighting 285

Reasons to Prefer Equal Weighting 286

Theory 286

Market-Capitalization Weighting 288

Market-Cap Weighting and Statistical Bias 289

Diversification Within an Asset Class and Between Asset Classes 290

Within an Asset Class 290

Unified Asset Classes 290

Gold 290

Treasury Bills and Money Market Instruments 291

Sovereign Government Own-Fiat-Money Bonds 291

Dispersed Asset Classes 292

Bonds 292

Theoretical Example of Diversifying Bond Default Risk 292

Asymmetrical Risk 294

Stocks 294

Across How Many Stock Markets Should You Diversify? 294

How Stable Are the Parameters? 298

Conclusions: How Many Countries? 299

Statistical Normality 299

How Many Stocks Within a Country? 302

Median Expected Return 303

The Effect of Errors in Parameter Estimation 306

Error in Estimation 306

Another Point of View 307

Index 311

Three Free Offers for Readers 339

KATHERINE A. SILK has an MA in history and BA in economics from Stanford. She was a management consultant prior to founding Strategic Startup Advisors. Silk is a frequent contributor to Sterling Insights blog.