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Eugene Fama Wins Nobel Prize in Economic Sciences

October 16, 2013

I am delighted that University of Chicago Professor Eugene F. Fama has been named a co-recipient of the 2013 Nobel Prize in Economic Sciences, in recognition for his contributions to the “empirical analysis of asset prices.”  I have actually waited for this recognition of Dr. Fama for some time, as he has been influential in my thinking and my career.  His groundbreaking empirical work inspired the founding of Dimensional Fund Advisors, a mutual fund company I use.  

Dr. Fama’s work in capital market theory has unquestionably enhanced my ability to help clients  have a successful investment experience and achieve their personal long-term investment goals.  Much of my understanding on how to identify and practically harness the relationships between market risks and expected returns is grounded in Dr. Fama’s work, which began in 1966, with the formation of the Efficient Market Hypothesis  In addition, Dr. Fama has made ongoing contributions to our understanding at Dimensional Fund Advisors’ public Fama/French Forum.

Nor has he worked in a vacuum. In his Nobel prize interview, Dr. Fama lauds his collaborators at the University of Chicago and elsewhere: “I couldn’t do what I did without the help of my professors at the time and colleagues since then and students since then.”  My finance professor at the University of Rochester was Michael Jensen,  one of Fama’s first graduate students.  Jensen, who carried out groundbreaking work on mutual fund performance, actually came up with the term “alpha”.  

Dr. Fama’s co-recipients are fellow University of Chicago Professor Lars Peter Hansen and Yale University Professor Robert J. Shiller.  For many on the inside of financial economic drama, the shared award comes with some bemusement, in that Dr. Shiller is often found at loggerheads with Dr. Fama regarding the role that market efficiency plays in investors’ decisions. In a Bloomberg column, 1987 Nobel laureate Robert Solow said that naming professors Fama and Shiller as co-recipients is “like giving a prize to the Yankees and the Red Sox.” 

As in any academic field, financial economists forever wrangle over points that may seem agonizingly granular to most of us, but that can still have significant impact on our daily lives – for good or for ill. In this case, the debate is approximately over whether overall market efficiency should lead us to patiently participate in the market throughout its volatile swings, or whether potentially predictable irrational investor behavior (bubbles) may justify trying to respond to shorter-term fluctuations. 

In light of the collective evidence available from professors Fama and others whose work I track, I remain convinced that your best financial interests are served – and your carefully planned goals most likely achieved – by avoiding the expenses involved in trying to profit from market irrationality. The practical hurdles continue to strike me as counterproductive in a long-term planning process. 

As we await the final denouement of seemingly endless shenanigans in Washington, let us celebrate thoughtful researchers who have helped us make sense of capital markets.  Their work has helped me sift through often-conflicting headlines related to financial economics and global news, by realizing that whatever information we are reading is very likely already reflected in current market prices.

The Right Investment Advice

March 14, 2013

While we only have a little more than two months under our proverbial belt, there’s no denying that it’s been a good run thus far in 2013.  Since January 2nd the S&P 500 Index has returned 9%.

In addition, all of the major indexes, the DJIA, the S&P 500 Index and the NASDAQ, have more than doubled since the low of March 9, 2009. This is a great reminder why you shouldn’t abandon your well-designed plan just because others are panicking.

On the flip side, any day now we can expect to see articles about why this is a good time to buy stocks.  Why few people were saying that in the depths of 2009 is a good question you might ask.

When the news was bad and markets were tanking, I advised staying the course and adhering to your investment plan.  Now I advise not getting too optimistic, thinking the “coast is clear.”

While we can all enjoy the recent successes, I certainly cannot take any credit for predicting the stock market rally.  The truth is that rallies come along quite randomly, as do stock market routs.  And as I’ve said on numerous occasions, no one can predict short-term stock market returns.  Just a reminder, stocks can go down as well as up.  Of course, you know that, but you also know that the long-term trend has been up.

So let’s bring up a subject I feel is critical to safeguarding your long-term investment experience: In good times and bad, there is an art to making quality decisions, and it may not be what you think.

Among the many roles of your financial advisor, one is to remind you (repeatedly) that the quality of your financial decisions contributes as much or more to your investment success as do the fleeting outcomes of hot or cold markets. In Carl Richards’ book, Behavior Gap, we are reminded of an important related insight: 

“The outcomes of our decisions may vary. In fact, you can make a good decision and have a bad outcome. But sensible, reality-based choices are our best shot at reaching our goals.”

To illustrate, you could take your life savings toLas Vegas, bet it all on a single very lucky spin and strike it outrageously rich. That would be a great, albeit improbable, outcome … to a very horrendous decision. In contrast, you can maintain a low-cost, globally diversified portfolio that reflects your personal goals as well as the latest academic evidence on capturing market returns. Fantastic decision, even when market conditions deliver disappointing results.

This is where your financial advisor comes in especially handy. Whenever you may be tempted off-course by undesirable outcomes — or, on the flip side, by random bursts of success — you need to objectively assess what, if any, adjustments might be warranted within your plans and your investments.

As Larry Swedroe points out:

“If you have done a good job developing your plan, and it has anticipated the risks you are likely to face, you should ignore the noise of the market, not getting caught up in either the hype or the fear that bull and bear markets can cause. Just stick to your plan.”

Making confident, quality decisions toward achieving your long-term goals regardless of past-tense outcomes — that is good advice any time of year.

Health and Wealth Resolutions for 2013

January 3, 2013

If weight loss is one of your New Year’s resolutions (and it almost always is for quite a few of us after the triple whammy of the Thanksgiving, Christmas and New Year’s holidays), here’s a handy tip: A team of international scientists, analyzing recent health data from more than 25,600 U.S. survey participants, concluded that people who read food labels weigh less than those who don’t (this is especially true of women participants, who averaged nearly 9 pounds less).

I would argue that you need to know what to look for on a food label.  “Natural” “healthy” “cholesterol-free” are, in my opinion, meaningless.  Depending on your goals and specific diet, “wheat-free”  “soy-free” and “dairy-free” may be important.  And once again in my opinion, the amount of sugar (and the carbohydrates which convert to sugar in the body) in any food is extremely important. 

You’re probably asking yourself what has food got to do with finance?  The answer is all about information and interpretation.

What you need: Your investment experience is greatly improved by a sound philosophy and consistent exposure to meaningful facts. For example, in 2012 despite continued global economic uncertainty and political gridlock, stocks quietly rewarded patient investors with double-digit gains. Not too shabby after all for a stay-the-course investor, an approach we have consistently advocated.  Investors who believed the negative headlines and pulled their money out of equities into safer havens suffered accordingly.

What you get: Slick advertising showcases a product’s most appealing features. If they’re there at all, the blemishes and boring but very important details for the long-term investor are buried in the fine print.  Just as understanding metabolism is important for weight control, knowledge of how markets and investments work is key to a successful investing strategy.

What counts: There is a reason the Securities and Exchange Commission makes sellers of investments say that “Past performance is not a guarantee of future results.”  Why?  Because it is true.  Why then do so many investors pay attention to the Morningstar ratings of mutual funds?  Those much ballyhooed Morningstar Star ratings are based on past performance. 

What you must know: There’s no law in our free market system against promoting what’s popular, irrespective of how bad it might be for you. It’s up to you, not the product provider, to make informed choices that are in your best interests.  Understanding fee structures and tax implications are up to you (or your objective investment advisor).

How we help: We live in a world of up-and-down markets in which useful financial disclosures are often opaque to non-existent; and the next upset — the next fiscal cliff or its economy-busting equivalent — seems to forever threaten our best-laid plans. Our greatest role is to provide you with solid, steady, evidence-based advice. Like an objective nutritionist for your wealth, it is our privilege to champion your best financial interests alongside you, help you read wisely between the promotional lines, and chart out a healthy, happy lifestyle that suits your personal tastes.

We look forward to remaining at your side throughout 2013.