Here’s Part 2 from our Guest Blogger W. Ben Utley, CFP®,
In Part one, Ben covered his first investment strategy “Stop trading stocks; start owning markets.” Here are two more of his investment strategies:
2. Stop timing the markets. Start owning them (all).
If you have heard about index investing, you probably know about the S&P 500, a basket of stocks that represents the five hundred biggest companies in the United States. The index was made famous in the 80’s and 90’s as it ran up to the dot com bubble, then vilified in the ensuing “lost decade” when the ten year return on that index was very close to zero.
What index hecklers fail to realize, even to this day, is that there’s more than one index. in fact, you can gain exposure to practically all the stocks and bonds on the planet by owning as few as four mutual funds. Had investors done this during the past ten years, they would have avoided some of the tech wreck, found the lost decade, and enjoyed very decent returns after all.
Unfortunately, the average investor seldom receives average returns. According to a recent study by mutual fund data company Morningstar, “the typical investor gained only 4.8% annualized over the 10 years ended December 2013 versus 7.3% for the typical fund.” That’s a yawning 2.5% gap.
Why did investors miss out on fully one third of the market returns? It’s simple. They did the same thing with their funds that your colleague did with his stocks: they traded in and out of the market. To garner the returns advertised over the past decade, or even three decades, you would have to own them through thick and thin, no matter how dramatic nor dire the news.
3. Invest like a Nobel Prize winner.
The main argument against an index-only strategy is exactly that it generates merely average returns in the best case scenario. This logic appeals to doctors who have never once settled for things that are merely average, and that’s pretty much all the physicians I’ve met.
Thanks to the research of Nobel laureate Eugene Fama, we now know it’s possible to reliably beat the averages over the long run, but it’s not free.
Fama, a financial luminary who founded the first small cap index mutual fund way back when fax machines were the size of washing machines, discovered that the smaller a company is, the more likely it is to outperform a larger one. This is known as the “small cap effect” and it’s robust, having been observed in US market history as well as the return series of developed foreign stock markets and even emerging markets.
Fama and colleague Kenneth French, both researchers who hail from the University of Chicago’s renowned Booth School of Business, also found that the stocks of cheap companies, known as “value stocks,” tend to outperform their more expensive “growth stock” peers in what is known as the “value effect.” This effect is also robust in markets domestic and foreign, and is available to investors using index funds.
While a small cap value tilt may add up to four percentage points more than the average untilted portfolio over long periods of time, it brings more volatility too. When equity markets decline, those index funds filled with cheap little stocks take it hard, and you may wish you had never owned them. The only way to reliably garner the higher expected returns from small cap value stocks is to remain fully invested and stay the course even when times are tough.
This too is old news. Even though Fama won the Nobel prize in Economics just last year, his research on the small cap and value effects has been public knowledge since way back in the 1980’s.
These perfectly decent strategies are so mundane—so incredibly boring—that you and your colleagues may never have heard of them. After all, words like “diversified,” “tax-efficient,” and “cost-effective” make wimpy headlines. The good news is that you can start using a solid investment strategy and keep using it year after year, decade after decade, secure in the knowledge that you have found a permanent answer to a nagging question. Remember, the answer to good investing is more than where you put your money now. It’s where you keep it over the long haul.
About Our Guest Blogger
W. Ben Utley, CFP®, is an attending advisor with Physician Family Financial Advisors, a fee-only financial planning firm helping physicians throughout the U.S. to make a plan and get on track with saving for college and invest for retirement. Visit Physician Family Financial Advisors Inc. Any advice in this article is the Author’s opinion on investing and the opportunities available in today’s stock and bond markets.