This post is the first of a two-part post which will deal with the 10 items that all investors need to understand in order to be a successful investor. This post will deal with the first five ideas followed next week by the second post discussing the remaining five ideas.
These ideas are grounded in rigorous financial science, almost nine decades of data and analysis, and developed from close relationships with leading academic institutions and Nobel Laureates.
The first five ideas deal with highlighting facts regarding the global stock markets and fixed income markets, and what investors should do to capture the historic returns available to investors.
- Embrace market pricing – the various stock markets are an effective, information processing machine. Millions of participants around the globe buy and sell securities in the world markets every day and the real information that they bring help set current prices. The world equity trading 2014 shows us that the daily average for the number of trades is a staggering 60 million with a US dollar volume of $302 billion. Yes billion with a ‘B’.
- Don’t try to outguess the market – the markets pricing power works against mutual fund managers who try to outsmart other participants through stockpicking or market timing. As evidence, only 19% of the US equity mutual funds have survived and outperform the benchmarks over the past 15 years. 15 years ago there were 2,711 funds at the beginning.
- Resist chasing past performance – some investors select mutual funds based on past returns even with the omnipresent warning concerning “past performance is no guarantee of future results”. In fact past performance alone provides little insight into a funds ability to outperform in the future. The academics have documented this fact.
- Let markets work for you – the financial markets have rewarded long-term investors. People expect a positive return on the capital they supply (through investing ), and historically the equity and bond markets have provided growth of wealth that has more than offset inflation.
- Consider the drivers of return – academic research has identified specific dimensions in the equity and fixed income markets which point to differences in expected returns. These dimensions are pervasive, persistent, and robust and can be pursued in a cost effective portfolios. Most importantly, these dimensions have been verified not just in the United States markets but in overseas markets as well.
The four dimensions for the equity markets are the following: 1) investors in the stock markets require a premium for money invested there versus the bond and cash markets; 2) investors require a greater return for owning shares in small companies versus large companies; 3) investors require a greater return for owning shares in value companies than growth companies; and lastly, 4) companies with greater profits today will likely have greater profits tomorrow and thus earn a higher rate of return.
The two dimensions for the bond markets are the following: 1) the longer the term of the bond the greater the risk (Term) , and 2) the lower the quality of the issuer of debt the greater the risk (Credit).
Most investors need in a financial advisor who understands these five ideas and how to use them for your benefit. In addition a credible financial advisor will also help you modify your behavior to ensure that you get the benefit of the ideas and we will discuss those in the next five key ideas to being a successful investor.
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