There is no single correct way to invest but there are many wrong ways that should be avoided, and doing so can improve your long-term results. Below I will list some key points of our investment strategy here at Meredith Wealth Planning so you can decide if we are a good fit for your needs.

Like professionals in most other industries that provide advice, we go with what the evidence suggests, and try to leave personal opinions out of the equation.

Diversification

Picking stocks can be a fun game to play, but also a very tough one. A 2018 paper by Hendrik Bessembinder of the W.P. Carey School of Business at ASU showed that from 1926 – 2016, just 42.6% of all stocks that have ever been listed have a return in excess of 1-month Treasury bills.

Only 30.80% of all stocks ever listed have outperformed a strategy of owning the broad market index, which means your odds of picking an out performer are about 3 in 10. Now if there was a way to identify characteristics of the 30.80% of stocks that have outperformed over time, then we would be on to something. . .

Size matters. . . along with price, profitability, and momentum

From January 1964 – November of 2018, the U.S. stock market outperformed 1-month U.S. Treasury bills by 5.22% annualized. This is referred to as the “equity risk premium”. Your portfolio’s “market beta” is a measure of exposure to this premium. For example, a market beta of 0.50 would have capture roughly half of the equity risk premium, or 2.61% annualized over the rate of Treasury bills.

During that timeframe other factors have been discovered that help explain excess returns and market anomalies. Stocks that exhibit high relative profitability tended to outperform those that were less profitable. Small cap stocks outperformed large cap stocks (size premium), and stocks that traded at low relative valuations outperformed those that traded at higher ones (value premium). There is also strong evidence of momentum in stock prices, meaning those stocks have done well recently have outperformed those that have done poor recently.

If you break US stocks into 10 deciles based on company size (such as the Center for Research in Security Prices has done using the indices below) you’ll notice that deciles 1&2 have had noticeably lower returns than the other 8 deciles throughout history. This isn’t a free lunch however, as each rung you go down to smaller companies, you get more volatility.

 

	Annualized Return: 1/1964 to 5/2019	Standard deviation
CRSP Decile 1 Index	9.39%	17.25%
CRSP Decile 2 Index	10.77%	19.94%
CRSP Decile 3 Index	11.71%	21.63%
CRSP Decile 4 Index	11.59%	22.57%
CRSP Decile 5 Index	11.71%	23.54%
CRSP Decile 6 Index	12.19%	24.54%
CRSP Decile 7 Index	11.92%	26.66%
CRSP Decile 8 Index	12.20%	28.63%
CRSP Decile 9 Index	11.54%	30.84%
CRSP Decile 10 Index	12.05%	35.56%

You may say that buying smaller companies doesn’t seem to be worth the risk, and I’d agree with that. Buying on size alone has not exhibited any significant premium after you get past decile 2, only more volatility. But what if we look at small companies that have robust profitability, or small companies that trade at a low relative price?

Data Series	Annualized Return: 1/1964 to 5/2019	Standard Deviation
Fama/French US Small Robust Profitability Research Index	14.06%	20.32%
Fama/French US Small Value Research Index	15.45%	28.09%

This data is based on indexes that were created after the fact with the benefit of hindsight, and they do not include trading costs, expense ratios, or taxes. But other research has shown that companies with robust profitability have outperformed those with weak profitability, and companies that trade at a low relative price have outperformed as well.

Dimensional Fund Advisors constructs funds to target factors such as these that have displayed excess returns. All of these factors go through periods of underperformance, and sometimes for quite extended periods. Picking which factor would be best to own or avoid for the near future is very hard to predict, which is why Meredith Wealth Planning recommends diversifying across all factors.

Costs Matter

Study after study has reiterated that actively managed mutual funds have consistently underperformed passively managed or index fund strategies, but it is not always because they are poorly managed. Morningstar discovered years ago that there was a strong inverse relationship between fund expense ratios and future performance. The cheapest funds generally did better as a group than the expensive funds.

Taxes Matter

Using funds with low turnover can help limit unwanted taxable distributions. The more you pay in taxes, the less of your return you get to keep. Optimally placing assets in certain accounts can help control the amount you pay to Uncle Sam.

Avoid Market Timing

We will not recommend going in and out of the market based on current economic conditions, political climates, earnings expectations, global worries, or anything else. Evidence suggests market timing is quite difficult and very few people have been able to do it consistently throughout their careers.

We believe it is more prudent to develop a strategy that aligns well with you ability, willingness, and need to take risk, and then stick with the strategy as you progress towards your goals.

Markets are very efficient

Markets are very good at setting prices, not perfect, but very good. The prices we see in the market are determined by the collective wisdom of all participants. Finding anomalies or inefficiencies are very difficult to come by on a consistent basis.

Evidence of this is seen in the fact that most active managers tend to underperform an index over time. Many of the active money managers are people who have dedicated their entire lives towards identifying and exploiting mispriced securities, and if that level of dedication has not materialized in outperformance then I don’t think many of us have reason to think we will be the exception.

Behavior matters. . . a lot

Selling at the bottom or buying at the top can ultimately ruin someone’s lifetime investment returns. This goes hand in hand with market timing. There is evidence that retail investors have not done very well at controlling their emotions when markets get a little crazy, but working with an advisor to talk through the tough times can be quite valuable.