The biggest problem with investment strategies


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We all know how poorly individual investors do in the markets. Just look at any Dalbar study and you’ll see just how most investors don’t come close to achieving market returns.

One reason (but not the real one) why investors perform so poorly

Market structures are part of the problem. For years, it wasn’t Wall Street with its capital source, individual investors. It was Wall Street versus individual investors.

Selling is Wall Street’s essence just as surely as buying is Main Street’s. Wall Street almost never tells you to sell   (The Indomitable Investor by Steve Sears)

It’s almost as if brokers and their clients were pitted against one another — brokers sold when their clients bought.

The real reason investors struggle

But, that’s not the main reason investors stink up the joint.

Beyond the tilted playing field, there’s a more organic reason investors perform poorly: they lack a strategy. Think about it this way: even if Wall Street and Main Street were better aligned, investors would still perform badly.

Why? Lack of strategy.

Investors come into the market without a gameplan, without a rule book to guide their reactions and responses to different market scenarios.

Because they lack this framework, they make short-term, sometimes irrational decisions.

Not enough to have a strategy…

But here’s the other thing: even if they have a strategy, THEY DON’T STICK TO IT!

So, all those armchair value investors or red-bulled up swing traders end up losing not because they don’t have a strategy. They mess up when they don’t stick to their strategy.

It’s pervasive.joel greenblatt and the magic formula

One of the best experiments was conducted recently by Joel “King of Investment Strategy” Greenblatt. You may know him better as the author of top-selling The Little Book that Beats the Market and the Magic Formula Investing website.

Greenblatt gives away “the secrets” to his investing riches in his book and website. By sticking to the Magic Formula Strategy and investing in a portfolio of stocks on his website, investors can significantly outperform the market (by how much is still up for discussion).

Strategies are hard to stick to

So, are people taking advantage of the Magic Formula and making bank on their returns?

Not so much.  Greenblatt’s parent firm offers investors 2 flavors of investing in the Magic Formula:

  1. A self-managed account: Investors can open an account with Formula Investing and pick their own stocks from a pre-approved list of stocks that fit the Magic Formula. Greenblatt calls this a benevolent brokerage.
  2. professionally managed account: For a fee, Greenblatt’s firm with take control over your assets and invest them for you using the Magic Formula.

From what I understand, the two options are potentially identical in terms of the limited universe of stocks they can choose from. But what actually happens is that the professionally-managed accounts trounced individual investors.

A compilation of all self-managed accounts for the two year period showed a cumulative return of 59.4% after all expenses. Pretty darn good, right? Unfortunately, the S&P 500 during the same period was actually up 62.7%….Well, a compilation of all the “professionally managed” accounts earned 84.1% after all expenses over the same two years, beating the “self managed” by almost 25% (and the S&P by well over 20%). (Joel Greenblatt)

Or, put differently, “[individual investors] took a winning system and used their judgment to unintentionally eliminate all the outperformance and then some!”

Greenblatt then offers 4 potential reasons why individual investors ruined their returns and most have to do with their failing to follow the strategy.by validea's john reese

Having a strategy — and sticking to it — are prerequisites for finding long-term success in the market. Individuals and professionals working with them should take this market experiment to heart.

Just how crucial is it to do whatever you can to stay disciplined and stick to your strategy for the long term, even when the temptation to bail is highest? It may just be the single most important factor in whether you succeed or fail == and that’s not an exaggeration .       —  (The Guru Investor by John Reese)


Adding your two cents may cost you a lot over the long-term (Magic Formula Investing)

HT: Insider Monkey


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