The film Tune Out the Noise ended up as a story of how a small group of “data freaks” gathered and analyzed a huge amount of historical data early on in the digital revolution, and made a series of big realizations. The one that most people know is that an S&P 500 index fund does a good job harvesting the “market premium” (the higher return of stocks over bonds) at a very low cost. Vanguard became a juggernaut by offering rock-bottom cheap access to this market premium.
But DFA went further and focused on other discoveries in the data like the “size premium” (smaller-cap stocks tended to outperform larger-cap stocks) and the “value premium” (low price/book ratio stocks tended to outperform higher price/book ratio stocks). This is what DFA does, it digs deeper into the data and charges more for their interpretation of the results. I personally view these as less reliable than the market premium, and at a slightly higher cost. Will they be worth it? I don’t know, and that is why I only place a smaller bet on them. But it is important to remember that the idea of stocks returning more than bonds is also a bet. There is no guarantee.
However, it’s also very useful to know what type of stuff doesn’t work. In fact, a recent NY Times article In the Stock Market, Don’t Buy and Sell. Just Hold (full gift article) highlights a study – done by the same DFA company of “data freaks” – that dug deep into potential market timing methods.
Most of us are better off living with the reality that the stock market moves down as well as up, and that we can’t beat it. A new study provides fresh evidence of why it makes sense to strive for an absolutely middling return. And the study implies that a simple, unspectacular strategy — buying and holding the entire market through low-cost index funds — is probably the best bet for most people.
Here is a DFA article We Found 30 Timing Strategies That ‘Worked’ — and 690 That Didn’t and the actual academic paper on SSRN, Another Look at Timing the Equity Premiums. From the abstract:
We examine strategies that time the market, size, value, and profitability premiums in the US, developed ex US, and emerging markets based on three common timing approaches: valuation ratio, mean reversion, and momentum. Out of the 720 timing strategies we simulated, the vast majority underperformed relative to staying invested in the long side of the premiums. While 30 strategies delivered promising outperformance at first glance, further analysis shows that their outperformance is very sensitive to specific time periods and parameters for strategy construction. Our results highlight the opportunity cost of mistiming the premiums and the importance of discipline for capturing the premiums.
Basically, they looked at 720 different ways that you could perform market timing. To start out, only about 30 out of the 720 actually created excess returns:
But out of those 30, if you tweaked just one of the variables, they mostly fell apart. For example, they found one that got you an extra 5.5% a year. Wow! But if you changed the rebalance period from annual to monthly, the excess return plummeted to only 1.5%. If you changed from international stocks to US stocks, you actually lost 3.8% a year.
In the end, the researchers couldn’t find a single way to time the market that was reliable.
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Old News right?!
At one point, I spent some time in stock market chatrooms, where people call out their buys and sells as they make them. I saw at least one trader who was consistently successful in short-term timing. The problem that successful timers have is that as soon as others learn their secret, and start doing the same thing…. like impatient drivers in traffic who notice one lane is moving faster than the others.
Tune Out the Noise is interesting — thanks, Jonathan, for recommending it. But it seems a bit too self-congratulatory. Also I couldn’t help notice that they gave credence to the efficient market hypothesis, that market prices reflect everything known about stocks. The obvious questions: known to whom, and known when? There are people who make money by knowing what most don’t know, or knowing it earlier. A classic case was the old Value Line service, where people on the East Coast made money from VL’s picks, but subscribers on the West Coast, getting their report 3 days later, didn’t. And, according to an investigative reporter, the people who worked for VL’s printing company did the best. But maybe I’m nit-picking.
I agree, and did you notice how they glossed over Vanguard very quickly? Now, I personally don’t believe that markets are perfectly efficient, and I do believe a small percentage of people can outperform. But they are pretty darn efficient, and that is enough.
My example is that people argue that a $100 bill found on the ground shouldn’t exist, because if markets are efficient then someone else would have picked it up already. My counterpoint is sure, the $100 bill may happen occasionally, but should you make it your job to search for $100 bills on the ground? Should you pay someone else to find them for you?
I went to a presentation in New Orleans about 18 years ago where they were teaching prepared methods of making money in the stock market when it was gaining big time and to where it was on the decline to just not loose money or to line out where the SP and Dow were plummeting. They showed us proven methods to use and at the end wanted you to join one of their teams for a sort of ridiculous price. I made notes during the 4 hour meeting, went home and started doing basically what they were suggesting. Results were during the 2008 stock market drop where the bottom fell out, I almost lined out, where most were losing 30-40% I came out smelling like a rose and lined our or maybe only lost 2% if that much, so I felt blessed after going to that class. Since then, I’ve noticed many actuarial claiming to do the same thing for their clients and I’m guessing they are doing the same basic thing. Along about the same , a good friend of my wife was into Reits and we invested into what she was investing in two weeks later, we lost and she gained. We got out and years later, her explanation was she didn’t know what could’ve happened as we invested in the same Reit. I told her she must’ve not understood completely about what she was doing for you to make money and us loose. She isn’t doing investments anymore.
Do you not believe in valuing stocks as businesses and selling the ones that rise in value relative to their worth to buy ones that are less expensive? Do you think the skill of being an analyst working with a small sum will provide no better return than a committee picking which 500 large market cap stocks can be in an index?