My blog provides valuable insights into Nobel Prize-winning financial strategies for investors. By utilizing decades of worldwide peer-reviewed capital markets research and analysis, I demonstrate how to build better investment portfolios with lower risks. I also examine common financial media misinformation and how investors can make better financial decisions.
Over the past few decades, there has been a substantial shift from active to passive investment strategies. This shift has occurred as investors have become more aware of the persistent failure of active management, as demonstrated in the S&P Dow Jones biannual Indices Versus Active (SPIVA) reports.
A January 2019 Federal Reserve Bank of Boston study, “The Shift from Active to Passive Investing: Potential Risks to Financial Stability?”, found that “Passive funds made up 45% of the assets under management (AUM) in equity funds and 26% for bond funds at the end of 2017, whereas both shares were less than 5% in 2005.”
Wall Street has been attacking and ridiculing passive investing for decades. Among the arguments are that the rise of passive investing results in a reduction in price discovery efforts, leading to prices being distorted and capital allocated inefficiently. This occurs because indexing either has too large an influence on prices or it inhibits price discovery because it lowers aggregate market trading volume.
Investment opportunities exist all around the globe.
Across more than 40 countries, there are over 15,000 publicly traded companies. 1 If you listen to the news, however, some countries may seem like better places to invest than others based on how their economies and stock markets are doing at the time. Fluctuations in performance from year to year only add to the complexity, providing little useful information about future returns. Daunted by the prospects of sorting it out, some investors look to the place they know best—their home market. There can be good reasons, such as tax benefits, for prioritizing an investment close to home, but too much home bias could mean underweighting or missing out on part of the investment universe.
Many people dream of leaving the office as soon as they can. But the evidence suggests a lot of downsides. It may be time to rethink those dreams.
Most people look forward to retirement, a reward for decades of hard work. But like many other pleasures, it may be bad for your health. It may even kill you. How can that be? How can working longer be good for your health? After all, many people dream of—and plan for—retiring early. Strenuous, stressful work can wear people down and damage their health.
On the other hand, retirees can relax and reinvigorate themselves. They have time to follow their passions and pursue activities that enrich their lives. But in our rush to leave the office, we don’t realize that retirement also has a downside, especially over the long term.
Everyone needs to keep certain personal financial files more or less permanently. But which files should you keep, and why do you need to keep them? How long should you keep them and in what format?
This article serves as a brief guide to organizing your personal paperwork.
In this article
Why Keep All Those Papers?
A Structure You Can Use
Consider These Real-World Issues
Roadmap for Heirs
Why Keep All Those Papers?
You need to maintain personal financial files in order to prepare for any number of contingencies. These include:
Tax Audits and Calculations: Your tax return might be audited. Tax authorities at both the federal and state levels have the right to reopen your tax return at any time if there is a suspicion of fraud. However, most audits are designed to resolve less troubling discrepancies, with various audit deadlines typically set to occur within seven years. This audit risk creates the need to keep tax and supporting documentation in general for seven years.
Dimensional Fund Advisors launched the first factor based fund in 1981 – the US Microcap Portfolio. Since then financial factor research and products have mushroomed. Academic papers have identified over 400 equity factors. There are currently 130 open-end mutual funds and over 600 ETFs that are factor based.
The primary reasons for this radical change are the low cost of ownership and return attribution. In a diversified stock portfolio, academic research (as well as own internal studies) have shown that 90%-99% of return variability can be explained with just five financial factors: Beta, company size, relative value, profitability, and momentum. This fact has profound implications for investors because the research shows where the overwhelming majority of equity investment returns (and premiums) come from. It also means focusing on other issues such as individual stock selection, active manager selection, and market timing are unnecessary and very likely counterproductive. It then begs the question how does an investor put together a portfolio of equity factors designed to have the highest probability of success? The answer rests on four primary considerations:
Investors may be tempted to extrapolate recent returns into the future, which can lead them to abandon their investment philosophy at potentially inopportune times. While negative outcomes are disappointing, investors should view them with the proper perspective and stay the course.
When you leave your server a tip, do you round it to a whole-dollar amount and often in multiples of $5? Does a 60th birthday seem more significant than a 59th? If you answer yes to these questions, you’re not alone. Most of us prefer round numbers.
A quick online search for “Dow rallies 500 points” yields a cascade of news stories with similar titles, as does a similar search for “Dow drops 500 points.”
These types of headlines may make little sense to some investors, given that a “point” for the Dow and what it means to an individual’s portfolio may be unclear. The potential for misunderstanding also exists among even experienced market participants, given that index levels have risen over time and potential emotional anchors, such as a 500-point move, do not have the same impact on performance as they used to. With this in mind, we examine what a point move in the Dow means and the impact it may have on an investment portfolio.
IMPACT OF INDEX CONSTRUCTION
The Dow Jones Industrial Average was first calculated in 1896 and currently consists of 30 large cap US stocks. The Dow is a price-weighted index, which is different than more common market capitalization-weighted indices. An example may help put this difference in weighting methodology in perspective. Consider two companies that have a total market capitalization of $1,000. Company A has 1,000 shares outstanding that trade at $1 each, and Company B has 100 shares outstanding that trade at $10 each. In a market capitalization-weighted index, both companies would have the same weight since their total market caps are the same. However, in a price-weighted index, Company B would have a larger weight due to its higher stock price. This means that changes in Company B’s stock would be more impactful to a price-weighted index than they would be to a market cap-weighted index.
Dimensional’s Co-CEO and Chief Investment Officer answers questions about investment returns, benchmarks, and evaluating managers.
Investors often start the year by evaluating how their portfolios have performed. Gerard O’Reilly recently sat down with Scott Mardy, a Vice President and Investment Strategist with the firm, to talk about what investors should consider when evaluating investment performance.
Key Takeaways
Your performance evaluation framework should answer a simple question: Has your money manager delivered what they committed to deliver?
The point of analyzing performance data is to help investors make informed investment decisions. The noisier the data, the weaker the inferences you can make.
If you’re going to invest time understanding how a manager operates and potentially commit assets to them, you want a manager who is as committed to the long term as you are.
Over short time periods, outperforming or underperforming a benchmark is not necessarily evidence that a manager failed to deliver what they said they would deliver.
There’s no magic time frame for considering returns—different time frames provide different information.
