“The failure of others to take and be faithful to a long view toward investing is what provides the opportunity for you. Don’t let it slip by.”
—James B. Cloonan, Ph.D.
It took me a while to feel ready for it, but I finally read AAII founder James Cloonan’s career-spanning book, “Investing at Level3.” When I started at AAII in 2017, the book was already in the hands of many investors and has been updated with fresh data a few times since. Cloonan demystifies and denounces various theories that the financial industry has historically relied on to conclude that the individual investor doesn’t need a ton of bells and whistles to become a successful manager of their portfolio.
I admired Cloonan for his quick wit. One time when we were chatting, he referenced Oscar Wilde’s “The Picture of Dorian Gray.” I’m sure he saw my eyes light up at the mention; I used to carry my laughably large, 700-page copy of “The Collected Oscar Wilde” around the hallways in high school because it was too big to fit in my bag! Though he founded AAII, he didn’t like too much public attention (introverts unite!). I felt a kinship with him in this regard and respected that he didn’t feel the need to fit into a mold because of his title.
In the introduction, Cloonan outlines the book’s objectives: 1) To show how most of the investing analysis used today doesn’t cut it for individual investors’ returns; 2) To provide alternatives to these theories that are based in reality; 3) To define and control “real risk” for the long-term investor; and 4) To create a structure for these ideas and empower the individual to ignore the unhelpful noise from the investing industry.
I’m sure you’re wondering by now: “If this book is about Level3 investing, what are the other two levels?” Cloonan defined Level 1 investing as an investor who is acting purely on emotion and “following different advice at different times.” An example of Level 1 investing is everyone who was using Robinhood during the meme-stock craze of 2021. At least it was entertaining! Level 2 investing is the industry standard: a portfolio with 60% in large-cap stocks and 40% in bonds. Officially, Level3 investing uses reality-based instead of theoretical models to increase the individual investor’s returns and retirement income over the long term.
I found the thread of risk that Cloonan weaved through this book to be the most interesting part. Risk is an investing concept that, though I’ve read about it a thousand times, doesn’t register as anything specific in my mind. It all started to make sense when Cloonan wrote, “Every book and article on investing is telling you how to measure risk and the measures don’t make sense in the real world.” Essentially, volatility can be defined as “‘the likelihood of (returns) shifting quickly and unpredictably,’” while risk is “‘the chance of (financial) injury, damage, or loss.’” Volatility seems to be part of the investing process and is more important to the short-term trader than the long-term investor, but risk is more of a bad outcome of investing.
For the long-term investor, Cloonan concludes that risk doesn’t necessarily need to be measured, “we just have to avoid it as much as possible.” He also notes, “In fact, because volatility can add to the return on investment, it can actually reduce real risk. This is because over time additional return will continually increase the value of the portfolio until even in the worst-case scenario the portfolio will be able to maintain a higher value than its lower-return alternative. This is real risk reduction … In short, the long-term investor has almost no risk.”
Two asset classes that Cloonan believed did not fit the Level3 strategy are long-term bonds and international stocks. His case for avoiding long-term bonds “is that they have lower returns over the long run and they provide no significant risk reduction for the long-term investor.” I was relieved to not have to think about bonds because I still don’t understand what they are anyway 😂! Cloonan wasn’t entirely opposed to international stocks, he just didn’t think they should be used purely for diversification purposes.
“Investing at Level3” solidified many of AAII’s teachings I’ve consumed over the years and added more depth to my understanding of risk—it’s nice to know I have one less thing to worry about for my own long-term investing strategy! There was also great attention given to an aggressive investing approach, meaning a portfolio that is mostly allocated to stocks. Cloonan writes, “Going to a more conservative strategy has significant cost, and that cost must be compared with the likely loss from such a scenario.” With this, Cloonan inspires the long-term individual investor to take more “risk” by only investing in stocks, as long as they can stomach it when things turn sour. Here’s to Cloonan’s decades of dedication to educating investors and taking alternative routes to get there.
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I was always invested in stocks both Ira and regular accounts then to my dismay I was encouraged to invest with Vanguard using their tactics Foreign investment and 60/40 splits. During the pandemic my accounts declined significantly and my individual stock managed by myself had less of a decline. My stock account did much better. Now looking forward l am not sure but in my heart I want to return to stocks across the board, also to avoid paying management fees.
Thanks for sharing, Robert! That is a great real-world example of the return difference Cloonan was talking about. If you return to stocks soon, let me know how it goes!