By Jason Sirman
So how can you have a better investment experience? Understand a few concepts and act on them consistently.
Investment advice is everywhere. The financial media churns out a constant stream of information and imperatives: “Retire Rich,” “Sell Stocks Now,” “The Looming Recession,” “The Top 10 Funds to Own,” “Market Hits Record High,” “Housing Market Boom,” and more. But far from helping you make wise investment decisions, this whirlwind of news and commentary often stirs anxiety about the future or tempts investors to chase the latest investment fad.
A far more effective approach is to focus on what you can control:
• Create an investment plan to fit your needs and risk tolerance.
• Structure a portfolio along the dimensions of expected returns.
• Diversify globally.
• Manage expenses, turnover, and taxes.
• Stay disciplined through market dips and swings.
Four considerations to help you focus on what is in your control
1. Market pricing includes all available information
Think of the market as an effective information processing machine that sets prices based on real-time information gathered through billions of dollars in trades between buyers and sellers. This ability to aggregate information from a multitude of data points makes it unlikely that mutual fund managers can outguess and consistently outperform the market through stock picking or market timing. In fact, only 14% of US-based equity mutual funds have survived and outperformed their benchmarks over the past 15 years. For the same reason, past performance does not indicate future success.
2. The markets will work for you over time
Focus on time in the market rather than timing the market. Historically, long-term investors in the equity and bond markets have been rewarded with a positive return on the capital they supply. As the chart shows, although markets react to political or economic events in the short-term, they bounce back, usually with little or no warning, to surge past previous highs. Attempting to avoid risk by leaving the market during times of market turbulence and timing your re-entry can cause you to miss out on the rewards of a strong rebound. Even a few missed days during these market rebounds can have a significant negative impact on your long-term returns.
3. Pursue higher expected returns through drivers identified by academic research
Tilting your portfolio towards certain risk factors has historically offered higher returns. (Obviously, you have to consider your individual capacity and appetite for risk.) A long-term investing horizon and diversified approach are important factors in realizing these premiums; as the chart below shows, you never know which market segments will outperform from year to year. These are the risk factors offering higher returns:
• Equity premium: stocks have a higher expected return than bonds.
• Small companies have a higher expected return, and carry more risk, than large companies.
• Value companies (those with market values lower than their book value) have a higher expected return than growth companies, and carry more risk.
• High-profit companies have a higher expected return than lowprofit companies.
Attempting to avoid risk by leaving the market during times of market turbulence and timing your re-entry can cause you to miss out on the rewards of a strong rebound.
4. Manage overall risk with smart diversification
Diversification is a way to mitigate overall risk. While it cannot eliminate the risk of market loss, it can protect your portfolio from disproportionate weightings in individual stocks and sectors, and better position it to benefit from the risk factors mentioned above. A properly constructed portfolio will diversify across individual securities, industries, countries, and risk factors.
While there is no silver bullet for ensuring a successful investing experience, consistently paying attention to the investing behaviours and approaches you can control will have a substantial positive impact over time.
First published in the March 2019 edition of The Business Advisor.