Not a day passes when I don’t come across some investing advice about the next big thing. Something I should be investing in. The latest is factor investing.
This is a way to invest where different shares are chosen based on certain characteristics that are associated with higher returns. There are lots of different ones to chose from. These include growth, momentum, small, medium, and large to name but a few. Perhaps the most famous factor is value. This is where you chose to invest in shares with an intrinsic value greater than their market price. Basically, this means you buy cheap shares.
Fame
This method was popularised by Benjamin Graham through his book the Intelligent Investor, considered by many to be the bible of investing. It was made even more popular by one of Graham’s students, a certain Warren Buffet. Many consider Buffet to be the most successful investor of all time. He is famous for being a value investor, which is why his advice to his trustees about what to do when he is no longer around is intriguing. It has no mention of value investing! On the contrary, his instructions are simply to invest 10% in short-term government bonds and 90% in the S&P 500.
The bad
Why is the most famous value investor not advocating value investing? Especially, because various studies have shown that historically over the long term this approach would have beaten the market. It is also just as easy to invest in a cheap index of value stocks as it is the S&P. For starters, those same studies have shown that at certain periods this method underperformed the market, which basically means sometimes it is a good idea to buy value stocks, but sometimes it isn’t. If investors are going to pick value stocks they need to pick the right time to buy them. This is called ‘market timing’ and market timing is notoriously hard to get right.
The creator of the first two factor funds
Jack Bogle, the creator of the first two factor funds and founder of the world’s largest mutual fund company, the Vanguard Group, has this to say: “Sometimes [investors] will pick the right factor, sometimes they will pick the wrong factor, but to the extent that investors pick the hot factor, they almost assuredly will be wrong.”
The first problem investors face is that they don’t know what’s going to happen during their investing period. It might be a great time to invest in value stocks. It might be a terrible time to invest. We simply don’t know.
Another thing to think about is that once a factor is known, the likelihood of being able to use it to beat the market in the future is diminished. The multi-trillion dollar investment industry is full of extremely bright knowledgeable people, with a wealth of experience, funding, software and piles of information available to them. If there is something worth investing in, they will be investing in it. Remember, they are the market! That’s not so say that there aren’t going to be factors that work sometimes. It’s just that they are unlikely to be ones the average investor gets to hear about.
Going with the market
The key thing to remember is whenever you buy something somebody else needs to sell it to you. The bulk of the guys doing the selling are professionals who know a lot more than the average investor. Unless you know something most people don’t it is unlikely that you are going to get the better of the professionals.
The bottom line is, most investors are better off simply going with the market.