How can we pursue a better investment experience? Knowing how to invest is one thing but understanding how to get the most from your experience is another. As a result, there are many components that go into being a successful investor including knowledge of the market, practicing smart diversification, and focusing on what you can control.
In this episode, we break down those components to give you the knowledge and confidence you need to make good choices about your retirement portfolio. Listen in as Joe tackles the key principles to improve your investment experience.
What You’ll Learn in Today’s Episode about Investments:
- Embrace market pricing
- Don’t try to outguess the market
- Resist chasing past performance
- Let markets work for you
- Consider the drivers of returns
- Practice smart diversification
- Avoid market timing
- Manage your emotions and look beyond the headlines
- Focus on what you can control
Ideas Worth Sharing on Investments:
“It all comes back to we want market returns. Stock market returns consistently outperform bonds, treasury bills, GICS, and inflation, assuming we’re giving it enough time. The key is we need to be patient and disciplined.”
“Embrace market pricing. You want to diversify globally. You don’t want to be over-concentrated in any one area. You don’t want to try to time the markets.”
“We shouldn’t try to choose the best fund or the best manager who’s going to try to outperform the market for us. We don’t need to do that. And that’s because, at the end of the day, markets work.”
“We have all these professional portfolio managers and these companies with millions of dollars. They have analysts across the globe, very fancy expensive computer systems, and all the data they can get their hands on, and they still can’t outperform the market. That’s just the data telling us most people trying to outguess the market, at the end of the day, are not very successful in doing so.”
Resources In Today’s Episode:
“Pursuing a Better Investment Experience: Key Principles to Improve Your Odds of Success” Guide
Ep # 23 – Behavioural Finance and Scientific Based Investing with Christian Newton (Your Retirement Planning Simplified)
Carl Richards – Behavior Gap
Dalbar – leading financial services market research firm.
Pursuing a Better Investment Experience
How can we pursue a better investment experience?
Knowing how to invest is one thing but understanding how to get the most from your experience is another. As a result, there are many components that go into being a successful investor including knowledge of the market, practicing smart diversification, and focusing on what you can control.
Investments & The Market
The market is where stocks are bought and sold, and it’s made up of all the publicly traded companies in the world. There are individual markets, but we are addressing the global stock market. Every time we see the price move in the stock market, it’s a result of new information becoming available.
Embrace Market Pricing for Investments
Embracing market pricing means that whatever prices we see today, we can assume that the market’s considered all the information that’s out there. Therefore, we don’t have any additional information that will help us make a better decision about what the right price should be. Ultimately, we just want to embrace whatever prices we see in the market as the best guess at what the correct price for the company will be at any given time.
You Can’t Outguess the Market
This is taking embracing market pricing to the next step. Firstly, let’s go back and look at the period of 2001 to 2020 to US-based equity or stock mutual funds. If we look at all those mutual funds that were around at the beginning of 2001 and then we move forward to 2020, only 41% of those mutual funds are left. Generally, outperforming funds don’t disappear. They stay in business. Secondly, if we look at all of them, only 19% were winners. In other words, only 19% of the funds over that 20-year period outperformed their index.
There are professional portfolio managers with companies that have millions of dollars. Moreover, they have analysts across the globe and expensive computer systems. Ultimately, they have all the data they can get their hands on, and they can’t outperform the market. In other words, that is the data telling us that trying to outguess the market is not a successful endeavor.
How do we Choose a Fund?
People tend to look at past performance but, if we take data into consideration, we don’t want to chase past performance.
To clarify, we shouldn’t try to choose the best fund or the best manager who we think will outperform the market for us. We don’t need to do that. In short, at the end of the day, markets work. Ultimately, the stock market goes up over time. In the short term, we know it’s very volatile. Subsequently, we may even think of it as being risky in the short term. But, if we look at any longer periods of time, the types of returns we get from the stock market are remarkably consistent.
What this is telling us is, just because something has done well in the past, doesn’t mean it’s going to do well in the future. To sum up, it performs no better than if we were flipping coins, leaving it to chance.
Letting the Market Work for Your Investments
If we get returns that are the same as the markets we’re invested in, we’re doing well. In fact, we’re doing better.
Stock market returns consistently outperform bonds, treasury bills, GICs and inflation if we’re giving it enough time. Above all, the key is we need to be patient and disciplined. There are multiple ways that you can do it as far as getting market returns, but basically, index funds are a good starting point.
Drivers of Returns in Investments
We know that markets work, but is there something we can do to try to get additional returns beyond the market?
The academic research into what drives returns does show a few areas. Firstly, drivers of returns beyond the market itself are areas like company size. For instance, small cap and large cap. We know that, on average, given enough time small companies tend to do better than larger companies. Secondly, we also know that we can look at relative price meaning a cheaper company or a cheaper stock. Typically, we would look at the price of the company relative to its book value (its value on paper). Thirdly, a cheaper stock is referred to as a value stock. A more expensive stock is a growth stock. Over time, value stocks tend to outperform growth stocks.
Finally, the last driver is profitability. Companies that are more profitable tend to do better than companies that are less profitable.
Looking at all these factors we can try to overweight these three drivers of returns.
Smart Diversification for Investments
Most importantly, this relates to letting markets work for you. Canada only makes up about 3% of the percentage of the total stock market by value. If you’re in the US, it’s roughly 50% but there’s still a world of opportunity beyond the US. It’s best to spread your risk out among even more companies than just your home country. By globally diversifying you’re not necessarily giving up any higher expected returns.
Above all, smart diversification means we don’t really want to focus on any one sector or country. This is because we want to diversify our risk as broadly as possible because, again, we know markets work and we want to let them work for us without taking on any undue risk.
Market Timing & Smart Diversification
How does market timing relate to a globally diverse portfolio?
We never know which market segment is going to outperform from year to year. In addition, from a market timing standpoint, there are a couple of different ways to look at this. If there’s a coming recession you might try to get out of the market. If things look good, you may try to get in. This is another example of market timing – and it’s not a winning formula for investing.
To sum up, it all comes back to embracing market timing. If we’re globally diversified, in different sectors, and in different countries we know that when the returns show up, we’re going to be there. Finally, we don’t have to guess when to get in or get out of markets.
Manage Your Emotions
Investing is an emotional roller-coaster. How do we manage our emotions and keep calm and carry on amidst all the noise?
Most importantly, emotions play a big part in investor returns. It’s amazing how few people think that they’re subject to emotional bias but we’re all subject to making decisions based on our emotions. If we knew we were doing it, then we wouldn’t.
We need to be able to manage our emotions anytime we’re investing, and this comes down to having a plan.
Look Beyond the Headlines
For instance, an example of this might be the current fascination with growth tech stocks and cryptocurrencies. People are getting in on them because they’ve seen returns happening. It’s the fear of missing out. However, they get in when prices are already high and then are subject to a letdown when things take a tumble. In this situation, people are buying high and selling low, and for no other reason than they are using their emotions to make their decisions about investing.
Focus on What You Can Control
Ultimately, you have control over your investment plan. Based on your situation, you want to have an investment plan that fits your needs, your goals, and your risk tolerance where possible. Most importantly, embrace market pricing. Globally diversify and don’t try to time the markets.
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