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Five timeless lessons from a life in investing

US businessman, investor and philanthropist David Booth, who founded global asset management firm Dimensional Fund Advisors 40 years ago, has brought together five timeless lessons from his decades in the finance industry.

Dimensional, which manages about $850 billion globally, is closely linked to several Nobel laureates in economics, including Merton Miller, Eugene Fama, Robert Merton and Myron Scholes. 

Here are his five lessons for investors.

Lesson 1: Gambling is not investing, and investing is not gambling

Gambling is a short-term bet. If you treat the market like a casino, and you’re picking stocks or timing the market, you need to be right twice - in an aim to buy low and sell high. Professor Fama showed that it’s unlikely for any individual to be able to pick the right stock at the right time, especially more than once.

Investing, on the other hand, is long term. While all investments have risk, there are things you can do as a long-term investor to manage those risks and be prepared. As Nobel laureate Merton Miller said, “Diversification is your buddy.” Investing is buying a little bit of almost every company and holding them for a long time. The only bet you’re making is on human ingenuity to find productive solutions to the world’s problems.

Lesson 2: Embrace uncertainty

Over the past 100 years, the US stock market, as measured by the S&P 500, has returned a little over 10% on average per year but hardly ever close to 10% in any given year. The same is true of dozens of other markets around the world that have delivered strong long-term average returns.

Stock market behaviour is uncertain, just like most things in our lives. None of us can make uncertainty disappear but dealing thoughtfully with uncertainty can make a huge difference in our investment returns, and even more importantly, our quality of life.

The way to deal with uncertainty is to prepare for it. Without uncertainty, there would be no opportunity to do better than a relatively riskless return like that from a money market fund. We always emphasise that risk and expected returns are related, which means you can’t have more of one without more of the other. Make the best-informed choices you can, then monitor performance and make portfolio adjustments as necessary.

Come up with a plan to get back on track in case things don’t go as expected. And remember, you can’t control markets, so don’t blame yourself for results outside your control. Try to relax knowing you’ve made the best-informed choices you can. A trusted financial adviser, a fiduciary who puts your interests first can help you cultivate this sort of discipline and long-term perspective.

Lesson 3: Implementation is the art of financial science

I was compelled to approach investing differently by the research Fama and other leading academics were doing to better understand markets and returns. There’s general agreement on what financial science tells us, yet so much can be gained or lost in application. Just as some sports teams can consistently execute their strategies better than others, investment professionals can consistently add value by dealing better with market mechanics.

Bob Merton and Myron Scholes were recognised as Nobel laureates for their options-pricing model, which shows that flexibility has value. Great implementation requires paying attention to detail, applying judgment, and being flexible.

Lesson 4: Tune out the noise

If an investment sounds too good to be true, it probably is. When people ask me if I’m investing in the latest shiny investment idea, I tell them, “If I don’t understand something, I don’t invest in it.” That’s because I’ve seen a lot of fads come and go.

TV pundits handing out stock tips? Friends letting friends in on their next big investment? I see these more as entertainment than information.

Stress is induced when people think that they can time markets or find the next winning stock, or that they can hire people who can. There is no compelling evidence that professional stock pickers can consistently beat the markets. Even after one outperforms, it’s difficult to determine whether a manager was skilful or lucky.

The good news is you can still do well without having to find what markets might have missed. While markets are unpredictable and may even seem chaotic at times, they have an underlying order. Buyers and sellers come together and trade, which is the activity that sets market prices. Unless each side agrees to a price, they don’t trade.

New information and expectations about returns are quickly incorporated. Consistently finding big winners is difficult, but everybody can have access to the expected returns that a diversified, low-cost portfolio can generate.


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Lesson 5: Have a philosophy you can stick with

It can be difficult to stay the investment course during periods of extreme market volatility. At the end of March 2020, the S&P 500 was down nearly 20% for the year. Record amounts of money exited from equity mutual funds and went into money market accounts. Those investors who stayed out of the equity market missed out on the subsequent 56% gain in the S&P 500 over the next 12 months. We will all remember 2020 for the rest of our lives. It serves as an example of how important it is to maintain discipline and stick to your plan.

By learning to embrace uncertainty, you can also focus more on controlling what you can control. You can make an impact on how much you earn, how much you spend, how much you save, and how much risk you take. This is where a professional you trust can really help. Discipline applied over a lifetime can have a powerful impact.

 

David Booth founded global asset management firm Dimensional Fund Advisors 40 years ago this year. He was a Research Assistant at the University of Chicago Graduate School of Business, which was renamed the Booth School in 2008 after a $300 million pledge from the Booth family.

 

7 Comments
Mohan
May 06, 2021

Great article and timely advise to not get carried away

MB
May 02, 2021

How many timeless principles have you read in your life? Too many!
How many failed ‘investors’ have you met in your life? Too many!
It’s not about what you know but what you do. It’s not an intellectual issue, it’s emotional issue and that’s how it needs to be approached.
Therefore, the only principle you need to stick with is finding a third-party investor behaviour coach who will guide you and stick to their advice for the rest if your life.
You’re welcome.

Foz
May 03, 2021

That's some handsome advice. Graham - what are you thoughts on dollar cost averaging in relation to lessons 2, 4 and 5? Useful or are their better tools?

Jo
June 04, 2021

https://www.morningstar.com.au/Video/dollar-cost-averaging-doesn39t-work/197515
Why dollar cost averaging doesn't work.

Damien Parker
May 02, 2021

Great article and brilliant ‘touchstones’ but somewhat mystical when not backed up by greater detail when not followed by the ‘which means that’. This is where mere mortals like myself learn how to practically apply the touchstones.

phil eley
April 29, 2021

re lesson No 5 . How many times have we seen over (my) 35 years as an adviser- markets fall and then substantially rebound next year. We remind clients when things are booming to consider isolating a few years of their income needs now when things are going well so they are prepared for the inevitable fall. it also fends off those who think we should have seen it coming..... as I remind them - were not that good, otherwise, we would be retired in the Bahamas knowing when to get in and out. Great article guys

Mart
April 29, 2021

David (and Graham) - thank you, this is one of the best articles I have read on Firstlinks as it very simply and really concisely summarises "what to do" (and what not to do). Fabulous. I shall be printing it off and blue-tacking it to the inside of my eyelids !

 

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