The Difficulties Of Discipline


In a June 1999 interview with Businessweek, Warren Buffett is quoted as saying, “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing.”

Michael Mauboussin, director of research at BlueMountain Capital Management (and prior to that, head of global financial strategies at Credit Suisse and chief investment strategist at Legg Mason Capital Management), seems to agree with Buffett. In his book, “More Than You Know,” Mauboussin wrote: “Investment philosophy is really about temperament, not raw intelligence. In fact, a proper temperament will beat high IQ all day long.”

Temperament is critical to successful investing because markets persistently test investor discipline with periods, often long ones, of volatile and/or poor performance. In my more than 20 years of > SEE MORE

Financial Planning for the Person Who Has Everything


Is that you? Are you fortunate enough to be in the tiny minority of people who don’t have a financial care in the world?

If not, I’ll bet you know that person who, to the best of your knowledge, lacks nothing. You probably even have a picture of them in your mind right now.

They’re financially independent. They have all the material possessions they could want, take all the vacations they want, dine wherever they want. They live where they want, in the house that they want, with all the upgrades they want. And they certainly drive the car they want.

All earthly goals … CHECK!

In that case, there’s no need for financial planning, right?

Well, let’s put that question to the test with a simple exercise I believe will deliver meaningful insight, whether you have everything—or not.

Scenario #1:

Imagine that you wake up tomorrow morning and everything about your life is the same as it was today—your professional calling, your relationships, your interests—except for one thing: Other than the clothes on your back, you have no possessions whatsoever.

How do you feel?


Know Your Investor Personality


In his book, “The Only Guide You’ll Ever Need for the Right Financial Plan,” Larry Swedroe has a detailed discussion on how investors can choose the right asset allocation for them, with the focus being on determining one’s ability (capacity), willingness (tolerance) and need (the rate of return required to achieve a goal) to take risk.

To help with issues surrounding the willingness to take risk, risk tolerance questionnaires have become a very popular. Unfortunately, as Joachim Klement showed in his article, “Investor Risk Profiling: An Overview,” published in the June 2018 CFA Institute Research Foundation brief “Risk Profiling and Tolerance: Insights for the Private Wealth Manager,” the “current standard process of risk profiling through questionnaires is found to be highly unreliable and typically explains less than 15% of the variation in risky assets between investors. The cause is primarily the design of the questionnaires, which focus on socioeconomic variables and hypothetical scenarios to elicit the investor’s behavior.”

He went on to explain that there are three problems questionnaires typically fail to address: Our genetic predisposition affects our willingness to take on financial risks, the people we interact with shape our views, and the circumstances we experience in our lifetimes—in particular, > SEE MORE

Look Past Expense Ratios

The evidence is clear that investors are waking up to the fact that, while the past performance of actively managed mutual funds has no value as a predictor of future performance, expense ratios do—lower-cost funds persistently outperform higher-cost ones in the same asset class.

That has led many to choose passive strategies, such as indexing, when implementing investment plans because passive funds tend to have lower expense ratios. Within the broad category of passive investment strategies, index funds and ETFs tend to have the lowest expenses.

Based on my experience, most investors tend to believe that all passively managed funds in the same asset class are virtual substitutes for one another (meaning > SEE MORE

The Battle of the Passive Strategies

My first book, The Only Guide to a Winning Investment Strategy You’ll Ever Need, was first published 20 years ago, in May 1998. With its 20th anniversary in mind, let’s see how my recommendations worked out for investors who followed them.

The book had two main themes. The first was that, while markets were not perfectly efficient, they were sufficiently efficient to make active management a loser’s game. While the game was possible to win, the odds of doing so were so low that, even before taxes, it was not prudent to try. That led to my recommendation to avoid actively managed funds. Instead, I suggested investors use passively managed funds, such as index funds and other structured portfolios, that eschew both individual security selection and market timing.

If the battle between active and passive strategies were a prizefight, the judges would have long ago declared a TKO. Year after year, the S&P Dow Jones Indices SPIVA scorecards show that, no matter the asset class, the majority of actively managed stock and bond funds underperform their benchmark indices – and the longer the investment horizon, the greater the failure rate. That’s even before considering taxes, which are often actively managed funds’ largest expense. Several recent studies, including Eugene Fama and Kenneth French’s “Luck Versus Skill in the Cross-Section of Mutual Fund Returns,” have found similar results; today, only about 2% of actively managed funds are generating statistically significant alpha. That’s down from about 20% 20 years ago. Again, that’s before taxes.

Using passive strategies was clearly the winning strategy and, thus, was the right recommendation.

The second theme was based on research, specifically, Fama and French’s “The Cross-Section of Expected Stock Returns,” showing that, in addition to market beta, equities had two other unique sources of risk and expected return: size and value. Not only did small and value stocks have higher expected returns, but, as unique sources of risk that added incremental explanatory power to the cross-section of equity returns, they also provided diversification benefits. Thus, my recommendation was for investors to consider “tilting” (that is, having more than the market’s exposure) their portfolios to small and value stocks both domestically and internationally. This was a very different strategy than the total stock market approach recommended by John Bogle (the father of index investing). Thus, this dichotomy is the “battle of passive strategies.”

The following table shows the results investors could have earned using both strategies. The data covers the 20-year period from May 1998 through April 2018. It shows the annualized returns, volatility and Sharpe ratio for Vanguard’s three total market funds (U.S., international and emerging markets) and the structured asset class portfolios from Dimensional Fund Advisors (Dimensional). (Full disclosure: My firm recommends DFA funds in constructing client portfolios.)