Our investment management strategy is grounded entirely in academic, historical, and Nobel Prize winning research; not Wall Street predictions. Primarily our strategy revolves around the decades of research conducted by Nobel Laureate Eugene Fama, along with others.
Based on the research, We Believe That:
Markets Are Efficient
In layman’s terms this means that current stock and bond prices are fair. We can arrive at this conclusion because the stock and bond market is made up of millions of investors who collectively process all of the available information to determine the current price. Another way of saying this is that current prices are quickly reflective of all available information.
Several decades ago, information traveled more slowly and you could argue that there was an advantage to having certain information that others didn’t have yet. However, in today’s world, information is exchanged so rapidly that we have to conclude that stocks and bonds are instantly priced to reflect all such available information. And as a result, the price is fair.
Notice that we didn’t say that the price of all investments is “correct”; we simply said they are fair.
In reality, we know that markets are not correctly priced because stocks and bonds will rise and fall over time. However, the current price is the best estimate of the accurate price.
Based on this knowledge, it’s very risky to search for mis-priced investments. The research shows that the majority of money managers who do this also under perform the market. Even if you felt a stock or bond was “mis-priced”, the millions of investors out there would have to catch up to your “knowledge”.
Based on our belief that markets are efficiently priced, it’s also very risky to wait for a better time to invest and very risky reacting to hot investment tips.
Investment Portfolios Should Be Tilted Toward Areas of Higher Expected Return
By accepting that markets are efficient and that the current price is the best estimate of the accurate price, this frees you up to target certain areas of higher expected return. Decades of research by Nobel Laureate Eugene Fama, along with others, reflects that over time:
- Stocks outperform Bonds
- Small Stocks outperform Large Stocks
- Value Stocks outperform Growth Stocks
- High Profitable Stocks outperform Low Profitable Stocks
As a result of this research, we tilt the stock section of our investment portfolios to these areas in order to capture higher expected returns.
Although we also target certain areas of higher return within bonds, the primary purpose of bonds is to reduce risk. And we do this through the use of high quality bonds.
Investment Diversification is Essential
Even though we tilt toward certain areas of higher expected returns, we don’t put all of our eggs in one basket. For example, even though small company stocks tend to outperform large company stocks over time, we don’t invest 100% into small company stocks. Reason being is that you don’t know when or if the higher returns are coming. Nothing is guaranteed. This is why we would own many different types and sizes of stocks and bonds.
Investing Mangement Involves Balancing Risk and Return
The more risk you take the higher you expect your return to be. However, you don’t want to take on unnecessary risk. In other words it doesn’t make sense to take extra risk if you aren’t expected to earn more. The historical research shows that focusing on the areas of higher return is worth the extra risk. If taking on more risk is not in your appetite, not necessary, or not your goal, then the investment portfolio will have to be structured accordingly to reduce the risk.
Emotional Investing Decisions Will Likely Reduce Your Returns
How many times have you been upset and said something you didn’t mean? Or did something you later regretted? Emotional decisions in life are generally not wise and the same holds true for emotional investment decisions.
The DALBAR study shows that the stock market (S&P 500) over the last 20 years (1994 to 2013) returned 9.22% per year. However, the “average investor” returned only 5.02% per year during that same period. The reduced return is a result of the “average investor” getting out of the market when it is going down and they are fearful (i.e. selling low) and getting in the market when it is going up and they are confident (i.e. buying high). This is a recipe for disaster.
You may be thinking that a 5.02% per year return is still really great, but don’t be fooled. If you had $100,000 invested at the beginning of 1994 and you earned the market return of 9.22% per year, your money would have grown to $583,000. But if you were like the average investor who only returned 5.02% per year, your money would have only grown to $266,000.
The Media Is Not Your Friend
The media is notorious for “selling fear”. Think about it for a minute. If you were in charge of getting people to watch your television show or read your magazine, you would likely use a headline like, “The Death of Stocks” versus something like “Steady Eddie Investing”.
Please do yourself a favor and don’t confuse entertainment with advice.
Please note that past performance is no guarantee of future results and that there is no assurance that these previously mentioned techniques are suitable for all investors or will yield positive outcomes.