Sunday, November 8, 2015

Slow and Steady


Why is it that every time you hear your average investor talk about markets, it’s usually about the latest high flying glamour stock? It’s because our lizard brains get lured by the thrill of fast gains and bragging rights.  

Let’s look at Apple for a moment. Apple is now the largest company in the world by market cap. It has more cash than the GDP of New Zealand or combined GDPs of Vietnam, Morocco and Ecuador. If Apple were a country, it'd be the 55th richest country in the world.  There is no doubt this company can be considered one of the greatest tech success stories in history.

If someone were lucky enough to put money into Apple when it IPO’ed back in late 1980, they would have enjoyed an almost 300-fold gain on their investment. In comparison, had that same investor put their money in the S&P 500, it would have gained 15-fold – which is puny in comparison.

This leads your average retail investor to ditch investing in broad market ETFs and chase the next Apple. But these “investors” don’t realize how extremely difficult it is to correctly predict which micro/small cap stock will become the next giant success story. Nor do they seem to realize how much risk they are taking on by holding concentrated positions in volatile growth stocks.

I remember from 2012-2013 how much hype there was around the company 3D Systems Corp (DDD). Watercooler chatter, CNBC pundits and Twitter – everywhere you looked there was feverish excitement over DDD. The stock gained over 10-fold in those two years. Where is it today? Back to square one. 

Likely even fewer people realize there are ways to invest systematically in large & diversified market indices that can outperform even Apple! Global Equities Momentum (GEM) is one such strategy, which I argue is the best (very simple, robust and stable while having low portfolio turnover, maintenance and costs).

The chart below shows what I mean.

Update (Nov 27, 15): I realized the S&P 500 data in this graph does not include dividends. With dividends, the S&P 500 would have grown 3,900% from 1981-2014.

Since Apple’s IPO, GEM has outperformed Apple in terms of total return. Not only that, but it did it with much less volatility. The tables below show the drawdowns for both Apple and GEM:

We see that Apple investors would have had their faith severely tested numerous times. There were four torturous periods where investors would have lost between half to more than three quarters of their portfolio. In comparison, GEM had fewer and much less severe drawdowns - all of which were under 20%.  

Isn’t this neat? It shows that systematically trading broad indices is more important than finding and holding a basket of home-run stocks. Yet most of Wall Street and most retail investors are blindly doing the latter.

By investing systematically in broad markets, you not only achieve better risk-adjusted returns but also save yourself a lot of time and stress. No more spending countless time pouring through company financials, listening to CNBC or forecasting market trends in search of the next great stock. No more holding concentrated positions in volatile stocks and having night terrors about company-specific risk.

You just can’t put a dollar value on stress reduction. Welcome to the wonderful world of systematic index investing. 

Results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Additional information regarding the construction of these results is available upon request. Past performance is no assurance of future success. Please see our disclaimer page for more information.