Intelligent Investing, Part 1

“Instead of concentrating on the central issue of creating sensible long-term asset-allocation targets, investors too frequently focus on the unproductive diversions of security selection and market timing.” – David Swensen, chief investment officer of Yale University.

To many people, investing can seem a bit like a game of chance. Tracking the daily fluctuations in the equity markets can make it difficult (some might say impossible) to make any sense of investing.

Turn on the television to learn about the stock market, and too often, what you will find is talking heads.  They are no help; they are misleading, because they generally  speak only of the short term. These TV stock market commentators are always predicting future prices for stocks, bonds, currencies, etc.  It doesn’t matter if they disagree (which they regularly do, since it makes for more interesting conversation) or whether one or another turns out to be correct or way off. You never hear how their predictions turned out.

A Better Way

Modern Portfolio Theory (MPT) is a very different approach to investing. It does not depend on predicting the future or analyzing individual stocks. It is based on decades of academic research. In fact, several individuals have won Nobel prizes as a result of their discoveries related to the way securities markets work. MPT has also influenced the way many pension funds and college endowments are invested, including Yale’s.

Think of Modern Portfolio Theory’s message as the opposite of what Wall Street wants you to believe, which is that their analysts have the secret to successful investing through superior stock selection.

For a good solid introduction to the practical implications of Modern Portfolio Theory, you can view Henry Blodget’s recent interviews with Ken French, Professor of Finance at the Tuck School of Business at Dartmouth College.

The first video is Buy and Hold Versus Timing the Market.

The second video is Stock Picking Versus Index Investing.

Each video is about 5 minutes long.

Dimensional Fund Advisors

Ken French is not merely a prolific academic researcher; he is also the Director of Investment Strategy for Dimensional Fund Advisors (DFA). DFA applies academic research on capital market behavior to the practical world of managing investment portfolios. The firm maintains close ties with the University of Chicago and other research centers for financial economics.

DFA’s approach is firmly rooted in the belief that markets are “efficient,” and that investors’ returns are determined primarily by asset allocation decisions, not market timing or stock picking. DFA has no economists forecasting business cycles or interest rates, no investment strategists shifting allocations between stocks and bonds, and no analysts seeking “underpriced” stocks.

With $140 billion under management, Dimensional Fund Advisors is the leading provider of structured investment strategies in the world. DFA funds are carefully constructed to capture the returns of a well-defined asset class that has historically provided investors with a substantial premium for the risks those investors took.

DFA funds are only available to institutional investors and through a select group of fee-only financial advisors who subscribe to the passive asset class investment philosophy.

Along with other select funds, I recommend DFA funds be included in my client portfolios.