What Makes Factors Endure

There are two big, ongoing debates relative to index (or, more broadly, passive) investing. The first is whether active or passive (which I define as neither market timing nor individual security selection) management is the winner’s game (the one most likely to allow you to achieve your goals). The overwhelming evidence shows that passive investing is the prudent choice.

The other debate that rages on is if a total-market approach (with John Bogle often seen as the standard-bearer) is “best,” or whether “titling” a portfolio to well-documented factors is likely to produce higher returns, and perhaps higher risk-adjusted returns.

During discussion about this second issue, perhaps the most-asked question I hear goes something like this: We know the historical evidence shows premiums for these factors, but how can you be confident that factor premiums will persist after research about them is published and everyone knows about them? After all, we are all familiar with the phrase “past performance does not guarantee future results.” I thought it worth sharing my answer.

Argument For Persistence

The first thing I point out is that we live in a world of uncertainty. There is simply no way to know for certain whether a factor premium will persist in the future; that goes for all factors, including market beta.


Financial Illiteracy’s High Cost


It’s a great tragedy that despite its obvious importance to everyone, our educational system almost totally ignores the field of finance and investments. This is true unless you go to an undergraduate business school or pursue an MBA in finance.

Eighteenth-century English poet Thomas Gray wrote, “Where ignorance is bliss, Tis folly to be wise.” When it comes to investing, ignorance certainly is not bliss—it pays to be wise. Just ask investors who lost tens of billions of dollars in the Bernard Madoff scandal. Without a basic understanding of how capital markets work, there is no way individuals can make prudent investment decisions.

The sad fact is that surveys have shown fewer than half of U.S. workers have even attempted to estimate how much money they might need in retirement, and many older adults face significant retirement shortfalls. While educational achievement is strongly > SEE MORE

What If Your Plan Fails?


Retiring without sufficient assets to maintain a minimally acceptable lifestyle (which each person defines in their unique way) is an unthinkable outcome. That’s why, when investors are planning for retirement, their most important question is usually something like, how much can I plan on withdrawing from my portfolio without having a significant chance of outliving my savings?

The answer generally is expressed in terms of a safe withdrawal rate (SWR)—the percentage of the portfolio you can withdraw the first year with future annual withdrawals adjusted for inflation.

Simulating Retirement Portfolio Returns

While historical returns can provide insight, it’s critical that investors not simply project the past into the future. Current valuation metrics should be used instead. Additionally, investors must address issues involving our limited ability to estimate future returns > SEE MORE

Is a Million Bucks Enough to Retire?


“Wow, those guys must be millionaires!” I can recall uttering those words as a child, driving by the nicest house in our neighborhood—you know, the one with four garages filled with cars from Europe.

The innocent presumption, of course, was that our neighbor’s visible affluence was an expression of apparent financial independence, and that $1 million would certainly be enough to qualify as “enough.”

  1. Now, as an adult—and especially as a financial planner—I’m more aware of a few million-dollar realities:
    Visible affluence doesn’t necessarily equate to actual wealth. Thomas Stanley and William Danko, in their fascinating behavioral finance book, The Millionaire Next Door, surprised many of us with their research suggesting that visible affluence may actually be a sign of lesser net worth, with the average American millionaire exhibiting surprisingly few outward displays of wealth. Big hat, no cattle.
  2. A million dollars ain’t what it used to be. In 1984, a million bucks would have felt like about $2.4 million in today’s dollars. But while it’s quite possible that our neighbors were genuinely wealthy—financially independent, even—I doubt they had just barely crossed the seven-digit threshold, comfortably maintaining their apparent standard of living. To do so comfortably would likely take more than a million, even in the ’80s. > SEE MORE

How Investors Undermine Returns


There is a large body of academic evidence demonstrating that individual investors are subject to the “disposition effect.” It has been documented among U.S. retail stock investors, foreign retail investors, institutional investors, homeowners, corporate executives and in experimental settings.

Those suffering from this phenomenon, which was initially described by Hersh Shefrin and Meir Statman in their 1985 paper, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence,” tend to sell winning investments prematurely to lock in gains and hold on to losing investments too long in the hope of breaking even.

Standard explanations for the disposition effect—such as tax considerations, portfolio rebalancing and informed trading—have been proposed and dismissed, leaving explanations that rely on investor preferences, such as prospect theory. Prospect theory implies a willingness to maintain a risky position after a loss and to liquidate a risky position after a gain. It also requires that investors derive utility as a function of gains and losses rather than the absolute level of consumption.