Before you start your investment portfolio, you may want to take a note from the groundbreaking research of three Americans who just won the Nobel Prize in economics.
Their work has laid the foundations for modern investing practices, mapping how stock, bond and housing prices change over time.
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But the work of this year’s Nobel Prize winners — Eugene Fama, Lars Peter Hansen and Robert Shiller — is far from lofty. There are several concepts everyone should know.
So how can you break it down? From what your house will cost in five years to what stocks you should invest in, take note. Here is your cheat sheet.
1. Their combined research could predict the value of your house in the long term. Shiller, who foresaw the housing bubble years before it burst, has advised the American public for years that buying a house is not a good investment. He has pointed to the minimal rate of return on housing prices from 1890 to 1990 as a key reason. If you buy in to his theory or not, as there are other benefits of owning a house, keep in mind that decades later, your house may not be worth much more than you bought it for.
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2. The prevalence of human error creates the boom and bust cycles that shape the markets, Shiller argues. But even in a seemingly erratic recession, the markets follow a pattern. That should assuage your fears that you are at the risk of an unwieldy market. It may have its ups and downs, but it follows a formula. And with a diligent focus on your portfolio, you can avoid the risks, too.
3. Fama proved that investors can’t glean returns better than the overall market’s performance in the short term because prices change too quickly to get investors the accurate information they need to make the right decision. His work helped popularize using index funds to invest in a wider set of stocks. So take note. Don’t bet on a few picks you think feel lucky. Instead, use an index mutual fund — like one in three American households did last year, according to the Investment Company Institute.
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4. The bottom line? The markets are driven by a combination of human error and math. Human error causes mistakes. And those mistakes contribute to an erratic market in the short run. But in the long run, returns stay virtually static.
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