THE SCIENCE OF INVESTING
Consider what the famed father of value investing, Ben Graham, said near the end of his life (in an interview* with Charles Ellis of Yale Endowment investment committee):
Charles Ellis: In selecting the common stock portfolio, do you advise careful study of and selectivity among different issues?
Ben Graham: In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I'm on the side of the "efficient market" school of thought now generally accepted by the professors.*
Markets are efficient. The proof is in the numbers. The vast majority of "active" fund managers do not "beat the market." The benefits of indexing are undeniable, and are well served by low internal expenses, low turnover and tax efficiency. Tiltings with an eye to sector weightings, value vs. growth, large cap vs. mid/small, US vs. International, along with periodic re-balancing all add to its potency.
Asset allocation is key. Diversifying intelligently across asset classes is of primary importance. Then it is a matter of discipline and patience. Indeed, these are investment platitudes, but how terribly difficult it is to invest by such virtues. The truth of this is quantifiable. Go to Morningstar.com and look at a metric called "Return to Investors." It shows that all too often investors end up with returns that are considerably less than the performance of a given fund. Why? Because of that nemesis that we know all too well: human emotion. Somehow, it always feels better to buy when the market is up and to sell when the market is down.
Again, the proof is in the numbers. Go to Morningstar.com and look at a metric called "Return to Investors." It shows that all too often investors end up with returns that are considerably less than the performance of a given fund. Why? Because of that nemesis that we know all too well: human emotion. Somehow, it always feels better to buy when the market is up and to sell when the market is down.
Antidote: The Science of Investing.
The Science of Investing is really counterintuitive when it comes to investing and investing well over the long haul. Modesty and patience are "social" virtues: we do them better with a little help from our friends and counsel. In the investment advisory relationship, we need to be clear on both the soft (relational, psychological) elements as well as the hard (analytical, data driven). At Butler Financial, we apply foresight and care in our work with our clients, via the careful crafting of a specific Investment Policy Statement, so that expectations about risk, return, and the game-plan support our work together.
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*: *Benjamin Graham, senior author of Security Analysis, needs no introduction to the readers of this magazine [Financial Analysts Journal.] The Journal thanks Charles D. Ellis, a member of its Editorial Board, for making available this presentation, in question-and-answer format, to a recent Donaldson, Lufkin & Jenrette seminar.
