I remember picking up my one and a half year old daughter from her nanny’s house a few years ago. I walked into the backyard to find my daughter climbing a tall “jungle gym” – the nanny was watching from about 40 feet away. I immediately ran over to catch my daughter in case she fell. When I asked the nanny (who holds a college degree in education) why she was not right behind my daughter to catch her if she fell, she said “statistics show that children are more likely to fall if there is someone behind them”. Of course this made sense, but my reply was something to the effect of, “I don’t care about the statistics, this is my daughter we are talking about – please stand behind her when she is climbing”.
How does this story relate to the investment world? Investments based on statistics and academics are occupying a larger share of investor portfolios. “Smart Beta” funds and “factor” investing are increasing in popularity*. These funds are based on “back-tests” which take a look at past data to find “types” of stocks that have beaten an index like the S&P 500.
Individuals are not the only ones flocking to these funds, advisors are also swept up in academic based investing**. Dimensional Fund Advisors (DFA) is a mutual fund company (managing hundreds of billions) that only distributes their funds through financial advisors. These mutual funds are invested based on the research of two professors that showed certain types of stocks outperformed the S&P 500 over a certain time horizon.
The problem is that investors need to make money going forward to meet their retirement goals – past performance does not matter. I love this blog post from Research Affiliates (post here) – it shows that “the out-performance observed before a typical smart beta index is launched virtually disappears once it’s live”. Put another way, once the “model” or “theory” is put to work in the actual market the great returns disappear. Why? There are lots of reasons which I will not go into, but I think the point is this: investing in real life with real dollars is harder than a model can predict. Relative returns for DFA funds over the last decade prove the point, in my opinion.
Your retirement account is just like my daughter in the opening story. If my daughter falls off that ladder and severely injures herself, the “statistics” that said she shouldn’t fall, go out the window. Your account is your baby – your only goal is to watch it grow big and strong! Statistics only show you the past, and you cannot afford sub-par investment returns going forward. Nurture your retirement account – be wary of funds or firms advertising investment strategies based on “models” or “academic research”. Real life investing is much more complex than a computer or professor can comprehend.
Charles Brown is a Portfolio Manager and Financial Advisor at M. Brown and Associates in Naperville, Illinois
**The above article is informational in nature only and is not a recommendation to buy or sell securities. All information is gathered from sources believed to be reliable, but neither Charles Brown nor Ausdal Financial Partners, Inc guarantees the accuracy of the information. All investments carry a degree of risk. Individuals should consult with their tax and investment professionals before making changes to their investment portfolios.
***Securities and Investment Advisory services offered through Ausdal Financial Partners, Inc, 5187 Utica Ridge Road, Davenport, IA 52807 (563)326-2064. Member: FINRA/SIPC. M.Brown and Associates and Ausdal Financial Partners are independently owned and operated