The Prudent Investor Has Changed Over The Years
Sep 5, 2003
The definition of a prudent investor has undergone major changes during the past century.
One hundred years ago, prudent investors would have considered investing other people's money in the stock market as insanity.
Before 1945, prudent investment professionals and the law governing their liabilities, condemned stock investing as imprudent speculation. Later, as inflation became a way of life and the legal view of stock investing changed, stocks became the core holding in most investment portfolios.
In more recent times, as it became apparent that few investment professionals could outperform the stock market (as measured by broad based indexes), the law came to accept passive investing, or indexing, as a prudent strategy. Advisors were no longer required to diligently search for outstanding investment opportunities. The simplified (read lazy) road to investing became the norm.
As the market soared during the 80's and 90's those 'average' returns were acceptable. The recent three consecutive years of negative stock market returns has, once again, made average returns undesirable.
Some actively managed investment strategies (those used by hedge funds) have outperformed the averages during these recent years. To achieve those returns, hedge funds used leverage through the strategy of borrowing on margin, They also used hedging with options or futures.
Recent superior returns by users of these strategies, especially when compared with the negative returns of passive indexing, have given these strategies increasing acceptance and attention. Among these strategies is covered call writing, precisely the strategy so highly recommended on this web site and the strategy carefully explained in The Short Book on Options.
Since 1830, laws in The United States rely on the principle that a prudent investor must act like other prudent investors managing similar portfolios with similar investment objectives. Thus, as today's hedging strategies become more and more accepted, will they become the new standard for the prudent investor? Only time will tell, but we believe that is the direction in which we are headed. Options, we believe, will soon be widely accepted as the correct investment tool for the prudent investor.
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