Wednesday, August 31, 2016

Lessons of History for Your Portfolio

I am an avid reader of books and articles related to investing and personal finance, and every now and then I come across real jewels in terms of investment lessons and examples of people who have achieved real success. These lessons and success stories not only motivate, but they can really help individual investors boost their returns and avoid common investing pitfalls.


Image credit: CC0 Public Domain - Pixabay

In this blog post, I would like to share such a jewel in the form of a collection of history lessons by Tony Isola. 

Tony is a CFA and is currently heading the Educator/403(b) Division at Rithholtz Wealth Management. He also runs a blog called A Teachable Moment.   

I believe every investor should read and keep these lessons in mind when investing in stock market:

How can investors act as applied historians and use this skill set to create wealth?
There are several minefields that could easily be avoided with some knowledge of the past:
  • Most market corrections don’t turn into bear markets.
  • Using leverage to boost investment returns often ends badly.
  • The president has very little control over the global economy.
  • Buying new financial products at market peaks is a poor idea.
  • Bull markets last much longer than bear markets.
  • Stocks are six times more likely to be up 20% than down the same amount. (Michael Batnick)
  • Uncertainty is always present and it is not a wise choice to use it as an excuse not to invest.
  • Stocks will do the best job of protecting future purchasing power over long periods of time.
  • Investing in the fastest growing world economies will not guarantee higher investment returns.
  • Most recessions haven’t turned into depressions.
  • Investment costs, savings rates and time in the market are the biggest components in generating healthy investment returns.
  • Factor investing won’t work for most people because of their cognitive deficiencies.
  • There is a large behavior gap between total mutual fund returns and what investors actually receive.
  • The great majority of mutual fund managers will under perform low-cost index funds because of costs.
  • Diversification works, just not every year.
  • Stocks can stay massively over- and undervalued for very long periods of time.
  • Real returns after inflation are the only returns that matter.
  • Stocks are in a bull market 85% of the time.
All of the following can be proven with applied historical analysis. This is a much better strategy than relying on your gut, or believing a compelling story, when allocating money.

I have been following most of the above lessons in my own investing approach. However, this one is new to me:
  • Factor investing won’t work for most people because of their cognitive deficiencies.
In Factor Investing, a portfolio is aligned to a single or multiple factors such as growth vs. value, large cap vs. small cap, and risk. The idea is that by focusing on specific factors, one can gain higher returns than the broader market, given they pick the right factor/s at the right time. It's like if you are on a sail boat, you need to know which way the wind is blowing so that you can point the sail in the right direction to maximize speed while staying the coarse. Investing in dividend paying stocks is a type of Factor Investing where dividends and long-term approach are the key factors driving the portfolio return. 

It's a game of patience and long-term focus to stay on the path what makes the real winners. Most people nowadays are short-term focused, they want instant gratification. I believe that's the real reason why long-term factor based investment strategy would not work for many people. There is just too much focus on quick returns, no matter how big the risk maybe or how flawed the underlying premise of the investment. 

Here is an interesting story I read recently on CNBC of a janitor who amassed an 8 million dollar portfolio by simply living a frugal lifestyle and investing most of his income in blue-chip dividend paying stocks and holding on to those stocks for the long haul:  janitor-secretly-amassed-an-8-million-fortune.html. The best part, he gave away all his money to a library and hospital. 

That's pretty impressive. I know most people, including myself can't live at the level of frugality he may have had lived, but still it is a good point of reference and food for thought for anyone who is making a decent income and still can't save enough for retirement.

Disclaimer: Author of this article is not a licensed/registered financial or investment advisor and does not provide investment advice. This article is for informational purpose only. Please use your own judgment or seek a licensed financial advisor before investing. You, the reader, bear responsibility for your own investment and financial decisions

5 comments:

  1. YES! I love your article that you referenced. I read that article in business insider and it just goes to show that ANYONE can reach financial independence, no matter what the income!

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  2. Exactly! It's a reachable dream for anyone. Also, I want to point out that one does not have to deprive themselves of good things in life to be FI. They just have to find the right spending/savings balance and investment plan, and then stick to it and let the time do the magic of compounding. That's how anyone can build wealth carefully over time.

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  3. There was a guy who never made more than 14,000 a year invested in the stock market he died in his 90s and had amassed almost 90 million. He left most of it to his alma matter university.
    I'm pretty much buy buy more and almost never sell. I did sell some this year but they were all non dividend stocks.

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  4. Wow that's amazing. Yes, I have the same rule, I buy to keep forever, and that forces me to do my homework well before buying any stock. I would only sell if the stock gets grossly overvalued or if any of the fundamentals deteriorate.

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