As our costs of living rise and we are surrounded by news of our country and other countries in debt, I thought it was worth revisiting our approach to investing and how important it is to sit tight and not try to overreact as we learn about financial crises.
We, at James Harvey Associates, follow a new model of investing, one built on the scientific study of capital markets and NOT on speculation and we currently use Dimensional fund advisers, Vanguard and Legal & General to deliver it for us.
*Capturing what markets have to offer * is built on four key truths:
- Markets work
- Investing versus speculation
- Take risks worth taking
- Structure is the strategy.
Truth 1 – markets work – tending to drive prices to fair value
Markets worldwide have a history of rewarding long-term investors for the capital they supply. Companies compete with one another for investment capital. Millions of investors compete to find the most attractive returns. This competition tends to drive prices to a ‘fair value’ making it difficult for investors to achieve greater returns without exposing themselves to greater risk.
*Traditional investment managers strive to beat the market by trying to take advantage of pricing “mistakes” and predicting futures. This can easily go wrong and returns are missed by holding the wrong stocks at the wrong time. Meanwhile, capital markets thrive, not because markets fail but because they succeed.
Truth 2 – investing versus speculation – long term reward
When you reject costly speculation and guesswork, investment becomes identifying the risks that are likely to be rewarded in the long term and choosing how much of these risks to take. Financial economists have identified the risk factors that seem to drive investment returns and experience to capture them.
Truth 3 – take risks worth taking – not all risks carry a reliable reward
Evidence from practising investors and academics tells us that gain is rarely accomplished without taking a chance, but not all risks carry a reliable reward.
Financial research over the last fifty years gives us a powerful understanding of the risks that are worth taking and those risks that are not. Stocks are riskier than bonds and have greater expected returns
- Relative performance in stocks is driven by small versus large and value versus growth
- Small cap and value stocks outperform because the market rationally discounts their prices to reflect underlying risk
- The lower prices result in higher returns to investors as compensation for bearing this risk
- Relative performance in fixed income is largely driven by bond maturity and credit quality
- Extending bond maturities and reducing credit quality increases potential returns
- With this understanding, investors can plan the total risk / return profile of their portfolios, considering how much exposure they need to target their performance goals.
Truth 4 – structure is the strategy – reducing risk through diversification
Avoidable risks include:
- Holding too few securities
- Betting on countries or industries
- Following market predictions, investment fads and flavour of the moment ideas
- Speculating on information from rating services.
Diversification is key. It stops a reliance on individual stock picking and its related costs and captures the returns of the whole market for one cost.
Each of the funds in use diversify not only the number of securities * but also the range of capital market strategies it explores and develops.
Our conclusion? A low cost well-diversified spread of investments is a more reliable method in delivering an investment return.
We, at James Harvey Associates, follow this model of investing, one built on the scientific study of capital markets and not on speculation. This is known to be the best risk adjusted return investors can receive.
The value of your investment can go down as well as up and you may not get back the full amount invested.