There are many factors that go into creating long term success for investors. Despite what the talking heads on CNBC or your broker or advisor may say, trading in and out of today’s hottest investments is not one.
Investors have struggled in finding out what it takes to succeed for long periods on Wall Street.
Just in the last decade and a half investors have been made to believe they are investing geniuses in 1999, only to be burned by 90% losses in the tech bubble of 2000. Thought they were real estate market wizards only to been stuck holding 5 houses in the real estate bust of 2008. Or, been scared to believe that the only viable investment is a shiny yellow metal, only to see a decline of $600 an ounce in gold since 2011 (this is just to name a few).
So when the founder and CEO of one of the most successful fund management companies of the last 30 years opens up about his firm’s investment philosophy, it’s probably in our best interest to listen.
His best advice is only one sentence long, simple to implement and takes less effort than pouring a cup of coffee:
From David Booth, founder and co-CEO of Dimensional Fund Advisors (DFA):
“The first key to investing is finding a philosophy to stick with through thick and thin.”
The quote comes from an interview Mr. Booth did on Bloomberg radio, which is a great listen if you have not heard it yet.
Retail investors as a whole have significantly underperformed the market, mostly due to constantly jumping to today’s hot fund or idea. Buying technology fund or stocks in 1999, real estate in 2007 gold in 2011…the list goes on and on. Not only does this increase investors costs due to trading commissions and creating additional tax liability, but typically means that investors are buying high and selling low, because today’s most hyped investment is rarely tomorrows best performing investment.
As we detailed over a year ago, according to the St. Louis Federal Reserve this performance chasing leads to an average underperformance of 2% every year.
How did Mr. Booth and DFA develop their investing philosophy and bravado to stick with that philosophy through thick and thin?
Dimensional Fund Advisor’s founder, David Booth came from a strong academic background, educated and mentored by Eugene Fama, a Noble Prize winning economist.
READ MORE – Our post: “Invest like a Nobel Prize Winner”
We are going to get into Dimensional Fund Advisor’s strategy in much more detail in our posts this week, with tomorrows chart of the day looking at their historical performance and then an in depth look at their strategy and make up of their funds by Friday.
But basically, their strategy involves using results of academic research on historical returns and constructing portfolios around the findings of that research. It has led them to diversify investments in small cap stocks, value stocks and highly profitable companies (again, much more detail on this later in the week).
They don’t do a lot of trading in and out of positions (turnover rates for their funds are typically around 10% or lower)
They accept that investments will go up AND down. They accept that some years they will be outperformed by today’s “one-hit-wonder” funds. And in order to invest in their funds you have to believe the same
In order for financial advisors to invest in their funds, they have to go through special training and screening to ensure that they hold the same beliefs as those fund managers in DFA. (Individual investors currently can not access their funds except through specific asset managers). Have a history of jumping from fund to fund in time of market euphoria or panic? DFA doesn’t even want your assets.
They have stuck to their philosophy and it has paid off greatly. As money is flowing out of equity funds as a whole, DFA has only seen increases in assets under management and today manages roughly $400 billion.
For investors who don’t have the time or desire to create an investment philosophy like DFA’s, have no fear. Even simple indexing (which DFA does not do) will work fine, as Mr. Booth says:
“Indexing has worked well, the idea is that you stick with it.”
Even investments in simple passive indexing has worked well, and outperformed a majority of professional investors over the past decade.
Want to implement DFA’s philosophies into your portfolio? Keep an eye out for the other posts this week to see how DFA does it.
In the end, no matter how exactly you allocate your assets, it turns out that the basis for a successful long term investing plan does not include trading those assets frequently or constantly trading them out for those with higher returns.
It does involve having one of the rarest abilities on Wall Street, patience.