What is our investment philosophy?
Investments are very simple. When asked what is the perfect investment portfolio for an average investor, Nobel Laureates have a highly consistent answer. They do so because the best data and models are overwhelmingly in favor of certain types of investments. At Moraya Consulting, we are believers in the data and we strongly reject conventional wisdom if it is not backed up by science. Thus, in a nutshell, we recommend:
1. Wide diversification between stocks and bonds denominated in multiple currencies (especially US dollar)
2. Wide diversification between countries, including investments in emerging markets
3. A passive investment strategy, i.e. buy and hold through total market low-cost index funds or ETFs
4. Mostly stocks for long-term investment
5. Mostly bonds for short-term investment
And we rarely recommend:
6. Mutual funds
7. Real Estate investments, even if the mortgage rates are extremely low
8. Bitcoin or other types of cryptocurrencies
10. Trying to buy stocks at a "low" price and sell at a "high price"
11. Trying to time the market
12. Trying to find the best performing fund
First and foremost, we strongly encourage wide diversification in currencies, bonds, and stocks. As we already saw in "Investing Abroad", "Emerging Markets", and "Risk Can Equal Safety," diversification can increase the financial returns and decrease the risks of a portfolio simultaneously. As William Sharpe, 1990 Nobel Prize Winner in Economics, said, the three golden rules of investing are: "diversify, diversify, diversify."
Second, the best performing asset class in the long term are stocks (see "Stocks vs Real Estate Investment" and "Stocks vs. Bonds"). On average, for every 100 thousand that you invest in real estate, you lose 300 thousand in 30 years compared to a simple total market ETF. Most middle-class individuals still invest heavily in real estate due to various scientifically demonstrated reasons such as lack of information, herd behavior, overconfidence, and loss aversion.
We are also fans of buy and hold strategies, ETFs, and low-cost index funds. Buy and hold is a passive investment strategy for which an investor buys stocks and holds them for a long period regardless of fluctuations in the market. An investor who uses a buy-and-hold strategy has no concern for short-term price movements and technical indicators. Why do we like a passive, buy and hold, strategy?
Passive strategies tend to far outperform active strategies. According to Princeton Professor Burton Malkiel, 2/3 of the active managers are outperformed by market index (e.g. S&P 500) in a given year and the 1/3 who outperformed in year 1 are the not same as the ones who do it the next year. Standard & Poor's also did a report (SPIVA = S&P Indices vs. Active) using 15-year periods, which shows not that 2/3 but 90% of the active managers are outperformed by the market. The theory behind why passive strategies tend to far outperform active strategies is the Efficient Market Hypothesis (EMH). According to the EMH theory, stock prices adjust to reflect all information available without delay. Therefore, it is impossible even for professionals to constantly “beat the market,” i.e. to have better returns than the market average. Stock market fluctuations in the short term are random. Although there is still strong debate among academics in the topic, along with remarkable contributions of several individuals such as Nobel Laureates Robert Shiller and Daniel Kahneman, it remains quite unanimous that the EMH remains the fundamental idea for investors trying to persistently generate financial gains out of investments. Even strong critics of the Efficient Market Hypothesis agree that buying and holding index funds is the optimal strategy for amateur investors. As 2017 Nobel Winner Richard Thaler has said, "just investing based on fees is not a dumb thing to do." Moreover, different than most funds and advisors who charge clients on 20% of their gains and 2% of their total investment, at Moraya Consulting we charge 0% of their gains and 0% of their total assets.
Outperforming the Market
Diversifying (across countries, currencies, asset types) and investing passively through low-cost index funds are the only ways in which you can increase your returns and decrease your risks, simultaneously. Outside of diversification and passive investing, there is no "free lunch" in finance. That is if you want to have higher returns than the market you will need to accept higher risks. Moreover, very few extra risks will lead to higher returns in the long term. For example, investing all your money in bitcoin will increase your risks but is unlikely to increase your long term returns.
Basically, only three types of investable assets outperform the market in the long term: emerging markets, small stocks, and value stocks. As indicated in the Fama-French Three-Factor Model (1992), small capitalization and value stocks tend to outperform large capitalization and growth stocks, respectively. As evidence of that, a blindfolded monkey throwing darts at the stock pages in a newspaper outperform Wall Street professionals AND the market itself (Arnott et al, 2013). However, this is due to higher risks intrinsically related to small and value stocks. In the US and Europe, it is possible to tilt investment portfolios toward these higher return stocks with relative ease if the clients want. On the other hand, in less developed stock markets, to do so will require active management, i.e. high fees, which will lead to smaller overall returns than the simple market growth. At Moraya Consulting, we help clients to open brokerage accounts in developed markets so they can invest in small-capitalization and value stocks without having to waste their extra gains in fees. An idea of a "perfect" investment portfolio for an average investor can be found in "The "Perfect" Portfolio".
Sticking with the Strategy
The hardest part for many people, however, is not to set up the best strategy but to stick with it. Psychological studies have repeatedly observed that individuals are far more distressed by losses than they are delighted by gains (e.g. Kahneman et al, 1991). This leads people to discard their winners if they need cash. Regardless of the investment strategy you choose, it is unlikely to work if you do not stick with the plan.
Interviewer: Some observe that is not so much about the [investment] strategy, the key is to have the discipline to stick with it, which most people don't. Do you agree with that?
Dr. Siegel: Oh, absolutely!
- Jeremy Siegel, Professor at the Wharton School of the University of Pennsylvania
Interviewer: How can individuals avoid bubbles?
Dr. Shiller: What I often say is: get a financial advisor.
- Robert Shiller, The Man Who Predicted the 2008 Bubble, the 2013 Nobel Winner
- Arnott, Robert, Jason Hsu, Vitali Kalesnik, and Phil Tindall (2013). "The Surprising 'Alpha' from Malkiel's Monkey and Upside-Down Strategies." Journal of Portfolio Management, 39 (4): 91–105.
- Fama, Eugene (1970). "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417.
- Fama, Eugene & French, Kenneth R, (1992). "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465.
- Jensen, Michael C. (1968). "The Performance Of Mutual Funds In The Period 1945–1964," Journal of Finance, American Finance Association, vol. 23(2), pages 389-416.
- Kahneman, Daniel, Jack L. Knetsch, and Richard H. Thaler (1991). “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias.” Journal of Economic Perspectives 5, no. 1: 193–206.
- Malkiel, Burton Gordon (1973). A Random Walk down Wall Street: The Time-Tested Strategy for Successful Investing. New York: W.W. Norton.
- Shiller, Robert (2000). Irrational Exuberance. Princeton, N.J. :Princeton University Press.
- Siegel, Jeremy (1994). Stocks for the long run: the definitive guide to financial market returns and long-term investment strategies. New York: McGraw-Hill.