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YOLO, Meme, and EMH: What's Your Investment Style?

3/11/2021

 
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​You only live once! Social media investors have banded together on unconventional platforms to drive up the prices of a handful of “meme stocks,” seemingly without traditional evaluation of investing risks and rewards. They made headlines with their “short squeeze” of GameStop (GME), and, as they garner media attention, their tactics continue. While it’s not the intended victim of the YOLO traders, will the efficient market hypothesis be a casualty of these events? The answer depends a lot on your definition of efficient markets. Perhaps long-term investors would be better served questioning the potential impact on their investment philosophy.

Fama (1970) defines the efficient market hypothesis (EMH) to be the simple statement that prices reflect all available information. The rub is that it doesn’t say how investors should use this information. EMH is silent on the “correct” ways investors should use information and prices should be set. To be testable, EMH needs a companion model: a hypothesis for how markets and investors should behave. This leaves a lot of room for interpretation. Should asset prices be set by rational investors whose only concerns are systematic risk1 and expected returns? It seems implausible to link recent meme-stock price movements to economic risks. Rather, they seem fueled by investor demand to be part of a social movement, hopes to strike it rich with a lucky stock pick, or plain old schadenfreude.

There is a vast ecosystem of investors, from individuals investing in their own accounts to governments and corporations who invest on behalf of thousands. Ask investors why they invest the way they do, and you’ll likely get a range of goals and approaches just as diverse. It’s this complex system that generates the demand for stocks. Another complex system fuels the supply of stocks. Supply and demand meet at the market price. People may contend that the market is not always efficient, or rational, but the stock market is always in equilibrium. Every trade has two sides, with a seller for every buyer and a profit for every loss.

There are plenty of well-studied examples that show supply and demand at work. The huge increase in demand for stocks added to a well-tracked index often creates a run-up in the stock price. Some of this price increase can be temporary and reversed once the tremendous liquidity demands at index reconstitution2 are met. Index reconstitution is just one example; instances of liquidity-driven price movements happen all the time. It is well documented that liquidity demands can produce temporary price movements.3 Investors may wonder if temporary price dislocations motivated by users of r/WallStreetBets differ from those caused by changes to an index. Lots of buying puts temporary upward pressure on prices, which later fall back to “fundamental value”–it sounds familiar. The more relevant observation may be that markets are complex systems well adapted to facilitate the supply and demand of numerous market participants.

There are numerous reasons people may be willing to hold different stocks at different expected returns. Can all those differences be explained by risks? Doubtful. To quote Professor Fama, “The point is not that markets are efficient. They’re not. It’s just a model.”4  EMH can be a very useful model to inform how investors should behave. We believe investing as if markets are efficient is a good philosophy for building long-term wealth. Trying to outguess markets might be a quick way to destroy wealth.

It’s true, you only live once. The good news is that investors can look to market prices, not internet fads, to pursue higher expected returns. Theoretical and empirical research indicate higher expected returns come from lower relative prices and higher future cash flows to investors. Long-run investors can be better served by using markets, rather than chatrooms, for information on expected returns.
Appendix 
YOLO, Meme, and EMH: What's Your Investment Style?
1. Systematic risk is the possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets in which he or she is involved.
2. Reconstitution involves the re-evaluation of a market index. The process involves sorting, adding, and removing stocks to ensure that the index reflects up-to-date market capitalization and style.
3. For example, see "Tesla’s Charge Reveals Weak Points of Indexing" (Dimensional, 2021)
4. "Are markets efficient?" – Interview between Eugene Fama and Richard Thaler (June 30, 2016)

The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or, representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by the Issuing Entity to be reliable and the Issuing Entity has reasonable grounds to believe that all factual information herein is true as at the date of this document. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorised reproduction or transmitting of this material is strictly prohibited. The Issuing Entity does not accept responsibility for loss arising from the use of the information contained herein. 

Looking Back on an Unprecedented Year

1/16/2021

 
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The year 2020 proved to be one of the most tumultuous in modern history, marked by a number of developments that were historically unprecedented. But the year also demonstrated the resilience of people, institutions, and financial markets.

The novel coronavirus was already in the news early in the year, and concerns grew as more countries began reporting their first cases of COVID-19. Infections multiplied around the world through February, and by early March, when the outbreak was labeled a pandemic, it was clear that the crisis would affect nearly every area of our lives. The spring would see a spike in cases and a global economic contraction as people stayed closer to home, and another surge of infections would come during the summer. Governments and central banks worked to cushion the blow, providing financial support for individuals and businesses and adjusting lending rates.

On top of the health crisis, there was widespread civil unrest over the summer in the US tied to policing and racial justice. In August, Americans increasingly focused on the US presidential race in this unusual year. Politicians, supporters, and voting officials wrestled with the challenges of a campaign that at times was conducted virtually and with an election in the fall that would include a heightened level of mail-in and early voting. In the end, the results of the election would be disputed well into December. As autumn turned to winter, 2020 would end with both troubling and hopeful news: yet another spike in COVID-19 cases, along with the first deliveries of vaccines in the US and elsewhere.

For investors, the year was characterized by sharp swings for stocks. March saw a 33.79% drop in the S&P 500 Index1 as the pandemic worsened. This was followed by a rally in April, and stocks reached their previous highs by August. Ultimately, despite a sequence of epic events and continued concerns over the pandemic, global stock market returns in 2020 were above their historical norm. The US market finished the year in record territory and with an 18.40% annual return for the S&P 500 Index. Non-US developed markets, as measured by the MSCI World ex USA Index,2 returned 7.59%. Emerging markets, as measured by the MSCI Emerging Markets Index, returned 18.31% for the year.


Exhibit 1: Highs and Lows
MSCI All Country World Index with selected headlines from 2020
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Fixed income markets mirrored the extremity of equity behavior, with nearly unprecedented dispersion in returns during the first half of 2020. For example, in the first quarter, US corporate bonds underperformed US Treasuries by more than 11%, the most negative quarterly return difference in data going back a half century. But they soon swapped places: the second quarter was the second-most positive one on record for corporates over Treasuries, with a 7.74% advantage.3 Large return deviations were also observed between US and non-US fixed income as well as between inflation-protected and nominal bonds.

Global yield curves finished the year generally lower than at the start. US Treasury yields, for example, fell across the board, with drops of more than 1% on the short and intermediate portions of the curve.4 The US Treasury curve ended relatively flat in the short-term segment but upwardly sloped from the intermediate- to long-term segment. For 2020, the Bloomberg Barclays Global Aggregate Bond Index5 returned 5.58%.


Exhibit 2: Sharp Shifts
US Credit minus US Treasury: Quarterly Returns, March 1973– December 2020
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Uncertainty remains about the pandemic and the broad impact of the new vaccines, continued lockdowns, and social distancing. But the events of 2020 provided investors with many lessons, affirming that following a disciplined and broadly diversified investment approach is a reliable way to pursue long-term investment goals.

MARKET PRICES QUICKLY REFLECT NEW INFORMATION ABOUT THE FUTURE
The fluctuating markets in the spring and summer were also a lesson in how markets incorporate new information and changes in expectations. From its peak on February 19, 2020, the S&P 500 Index fell 33.79% in less than five weeks as the news headlines suggested more extreme outcomes from the pandemic. But the recovery would be swift as well. Market participants were watching for news that would provide insights into the pandemic and the economy, such as daily infection and mortality rates, effective therapeutic treatments, and the potential for vaccine development. As more information became available, the S&P 500 Index jumped 17.57% from its March 23 low in just three trading sessions, one of the fastest snapbacks on record. This period highlighted the vital role of data in setting market expectations and underscored how quickly prices adjust to new information.

One major theme of the year was the perceived disconnect between markets and the economy. How could the equity markets recover and reach new highs when the economic news remained so bleak? The market’s behavior suggests investors were looking past the short-term impact of the pandemic to assess the expected rebound of business activity and an eventual return to more-normal conditions. Seen through that lens, the rebound in share prices reflected a market that is always looking ahead, incorporating both current news and expectations of the future into stock prices.

OWNING THE WINNERS AND LOSERS
The 2020 economy and market also underscored the importance of staying broadly diversified across companies and industries. The downturn in stocks impacted some segments of the market more than others in ways that were consistent with the impact of the COVID-19 pandemic on certain types of businesses or industries. For example, airline, hospitality, and retail industries tended to suffer disproportionately with people around the world staying at home, whereas companies in communications, online shopping, and technology emerged as relative winners during the crisis. However, predicting at the beginning of 2020 exactly how this might play out would likely have proved challenging.

In the end, the economic turmoil inflicted great hardship on some firms while creating economic and social conditions that provided growth opportunities for other companies. In any market, there will be winners and losers-and investors have historically been well served by owning a broad range of companies rather than trying to pick winners and losers.

STICKING WITH YOUR PLAN
Many news reports rightly emphasized the unprecedented nature of the health crisis, the emergency financial actions, and other extraordinary events during 2020. The year saw many “firsts”—and subsequent years will doubtless usher in many more. Yet 2020’s outcomes remind us that a consistent investment approach is a reliable path regardless of the market events we encounter. Investors who made moves by reacting to the moment may have missed opportunities. In March, spooked investors fled the stock and bond markets, as money-market funds experienced net flows for the month totaling $684 billion. Then, over the six-month period from April 1 to September 30, global equities and fixed income returned 29.54% and 3.16%, respectively. A move to cash in March may have been a costly decision for anxious investors.

Exhibit 3: Cash Concerns in 2020
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It was important for investors to avoid reacting to the dispersion in performance between asset classes, too, lest they miss out on turnarounds from early in the year to later. For example, small cap stocks on the whole fared better in the second half of the year than the first. The stark difference in performance between the first and second quarters across bond classes also drives home this point.

A WELCOME TURN OF THE CALENDAR
Moving into 2021, many questions remain about the pandemic, new vaccines, business activity, changes in how people work and socialize, and the direction of global markets. Yet 2020’s economic and market tumult demonstrated that markets continue to function and that people can adapt to difficult circumstances. The year’s positive equity and fixed income returns remind that, with a solid investment approach and a commitment to staying the course, investors can focus on building long-term wealth, even in challenging times.
All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Appendix 
Looking Back on an Unprecedented Year
Past performance is no guarantee of future results. Exhibit 1: In US dollars, net dividends. MSCI data © MSCI 2021, all rights reserved. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Exhibit 2: In US dollars. US credit represented by the Bloomberg Barclays US Credit Bond Index. US Treasuries represented by the Bloomberg Barclays US Treasury Bond Index. Bloomberg Barclays data provided by Bloomberg. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Exhibit 3: In US dollars. Global equity returns is the MSCI All Country World IMI Index (net div.). MSCI data © MSCI 2021, all rights reserved. Money market fund flows provided by Morningstar. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment.

1. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment.
2. MSCI data © MSCI 2021, all rights reserved. Indices are not available for direct investment.
3. US corporate bonds represented by the Bloomberg Barclays US Credit Bond Index. US Treasuries represented by the Bloomberg Barclays US Treasury Bond Index. Bloomberg Barclays data provided by Bloomberg. Indices are not available for direct investment.
4. ICE BofA government yield. ICE BofA index data © 2021 ICE Data Indices, LLC.
5. Bloomberg Barclays data provided by Bloomberg. All rights reserved. Indices are not available for direct investment.

The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or, representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by the Issuing Entity to be reliable and the Issuing Entity has reasonable grounds to believe that all factual information herein is true as at the date of this document. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorised reproduction or transmitting of this material is strictly prohibited. The Issuing Entity does not accept responsibility for loss arising from the use of the information contained herein. 

Dividends in the Time of COVID-19

12/3/2020

 
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Many investors view dividend payouts as a reliable source of income. However, those expecting to receive consistent dividend income may have been surprised to see lower- than-expected dividend payouts following the onset of the coronavirus pandemic, when both market volatility and market declines were extraordinary. In reality, recent and historical data show that changes in dividend policy are common, especially during times of higher uncertainty.

Aggregate dividend payouts fell meaningfully in the first three quarters of 2020 compared to the same period in 2019. Exhibit 1 shows the dividends earned from a hypothetical $1 million investment in US, developed ex US, and emerging markets in both periods. Developed ex US markets showed the most drastic change with a 41% decrease. Dividend payments in emerging markets decreased by 29% and in US markets by 22%.

Exhibit 1 Drop Zone
Dividends from a Hypothetical $1 Million Investment
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Globally, large firms have historically had the highest propensity to offer dividend payouts,1 but even successful, established firms were not immune to the economic consequences of a global pandemic. A few examples help illustrate this point. Harley Davidson (HOG) has been paying dividends to shareholders since the 1990s. In April 2020, the motorcycle manufacturer slashed its dividend from $0.38 per share to just $0.02, a 95% decrease.2 Gap Inc. (GPS) suspended its dividend payments until at least April 20213 after the economic downturn left the clothing brand with particularly poor revenues.

Harley Davidson and Gap were not the only firms to change their dividend policies. As shown in Exhibit 2, 38% of firms in global markets (2,584 companies) that were expected to pay dividends, consistent with their payout history, instead decreased, omitted, or eliminated their dividend payments in the second quarter, more than doubling the 1,248 firms that made similar changes to their dividend policy in the first quarter of the year. The trend continued into the third quarter: 2,699 firms made such changes.

Exhibit 2 Changing Tune
Dividend Policy Changes in Global Markets (% of Dividend- Paying Firms), 2020
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While these dividend cuts may come as a surprise to some investors, history buffs may recall that, in 2009, Harley Davidson announced it was cutting dividend payouts from $0.33 per share to $0.10, a 70% decrease.4 In fact, during the Great Recession, significant changes to firms’ dividend policies spiked throughout global markets. Exhibit 3 displays Fama/French global market returns for 1991–2019 with a one-year lag and the proportion of dividend-paying firms that eliminated or decreased their dividend payouts. In 2008, for example, the global market was down more than 40%, and, the following year, many firms made changes to their dividend policies. The historical correlation between global market returns and dividends that are eliminated or decreased may suggest that firms are more likely to alter their dividend payouts during times of market instability.

Exhibit 3 In Step
Global Market Returns and Dividend Changes
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The first three quarters of 2020 remind us that dividend payouts can be inconsistent, particularly in volatile markets. Hence, investment strategies that focus on income derived from dividends may not serve investors who need a steady income stream and, moreover, might not be the most effective way to pursue long-term wealth growth. A more reliable approach is to structure equity asset allocation around the characteristics that research demonstrates drive long-term higher expected returns, namely size, relative price, and profitability, while maintaining broad diversification across names, sectors, and countries.
All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

Dividends in the Time of COVID-19
FOOTNOTES

1Stanley Black, “Global Dividend-Paying Stocks: A Recent History” (white paper, Dimensional Fund Advisors, March 2013).
2Harley-Davidson, Inc., “Dividends & Stock Splits,” investor.harley-davidson.com/stock-info/dividends-and-stock-split.
3Gap Inc., “Gap Inc. Provides Update In Response To Covid-19 Outbreak,” news release, March 26, 2020, investors.gapinc.com/press-releases/news-details/2020/GAP-INC-PROVIDES-UPDATE-IN-RESPONSE-TO-COVID-19-OUTBREAK/default.aspx
4Harley-Davidson, Inc., “Dividends & Stock Splits.”
Exhibit 1 Source: Calculated by Dimensional from Bloomberg data. In USD. Each hypothetical investment includes all securities in the investable equity universe in the applicable region at free-float market cap weight as determined at the beginning of each year. To be included in the investable equity universe, securities must meet certain minimum capitalization and liquidity requirements. Investment companies are excluded. Exhibit 2 Source: Calculated by Dimensional from Bloomberg data. Dividend-paying firms include all firms that have paid a dividend in the preceding 12 months and were expected to pay a dividend in the current quarter. Exhibit 3 Note: Global Market return is free-float market cap weighted average of Fama/French Developed Markets and Emerging Markets Indexes. See Index Descriptions in the disclosures for descriptions of Fama/French index data. Source: Calculated by Dimensional from Bloomberg data. Past performance is no guarantee of future results. Dividend- paying firms include all firms that paid a dividend in the prior calendar year.

The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or, representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by the Issuing Entity to be reliable and the Issuing Entity has reasonable grounds to believe that all factual information herein is true as at the date of this document. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorised reproduction or transmitting of this material is strictly prohibited. The Issuing Entity does not accept responsibility for loss arising from the use of the information contained herein. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, DFAL and DIL.

In USD. Index DescriptionsFama/French Developed Markets Index: July 1990–present: Courtesy of Fama/French from Bloomberg securities data. Companies weighted by market cap; rebalanced annually in June. 
Fama/French Emerging Markets Index: July 1989–present: Courtesy of Fama/French from Bloomberg and IFC securities data. Companies weighted by float-adjusted market cap; rebalanced annually in June.

What History Tells Us About Elections and the Market

10/12/2020

 
It’s natural for investors to look for a connection between who wins the White House and which way stocks will go. But as nearly a century of returns shows, stocks have trended upward across administrations from both parties.

GROWTH OF $100
Fama/French Total US Market Research Index: March 4, 1929 - June 30, 2020
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  • Shareholders are investing in companies, not a political party. And companies focus on serving their customers and growing their businesses, regardless of who is in the White House.
  • US presidents may have an impact on market returns, but so do hundreds, if not thousands, of other factors - the actions of foreign leaders, a global pandemic, interest rate changes, rising and falling oil prices, and technological advances, just to name a few.

Stocks have rewarded disciplined investors for decades, through Democratic and Republican presidencies. It’s an important lesson on the benefits of a long-term investment approach.
​
What History Tells Us About Elections and the Market: In US dollars. Growth of wealth shows the growth of a hypothetical investment of $100 in the securities in the Fama/French US Total Market Research Index. The chart begins with the start of the first full presidential term (March 4, 1929) for which Fama/French Total US Market Research Index data is available and ends on June 30, 2020. Data presented in the growth of wealth chart is hypothetical and assumes reinvestment of income and no transaction costs or taxes. The chart is for illustrative purposes only and is not indicative of any investment.
Fama/French Total US Market Research Index: The value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American Depositary Receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.


When It's Value vs. Growth, History Is on Value's Side

9/7/2020

 
Logic and data provide the basis for a positive expected value premium, offering a guide for investors targeting higher potential returns.

There is pervasive historical evidence of value stocks outperforming growth stocks. Data covering nearly a century in the US, and nearly five decades of market data outside the US, support the notion that value stocks— those with lower relative prices—have higher expected returns.

Recently, growth stocks have enjoyed a run of outperformance vs. their value counterparts. But while disappointing periods emerge from time to time, the principle that lower relative prices lead to higher expected returns remains the same. On average, value stocks have outperformed growth stocks by 4.54% annually in the US since 1928, as Exhibit 1 shows.

Some historical context is helpful in providing perspective for growth stocks’ recent outperformance. As Exhibit 1 demonstrates, realized premiums are highly volatile. While periods of underperformance are disappointing, they are also within the range of possible outcomes.

We believe investors are best served by making decisions based on sound economic principles supported by a preponderance of evidence. Value investing is based on the premise that paying less for a set of future cash flows is associated with a higher expected return. That’s one of the most fundamental tenets of investing. Combined with the long series of empirical data on the value premium, our research shows that value investing continues to be a reliable way for investors to increase expected returns going forward. 

Exhibit 1
Value Add
Yearly observations of premiums: value minus growth in US markets, 1928-2019
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Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. In US dollars. Yearly premiums are calculated as the difference in one-year returns between the two indices described. Value minus growth: Fama/French US Value Research Index minus the Fama/French US Growth Research Index. Fama/French US Value Research Index: Provided by Fama/French from CRSP securities data. Includes the lower 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973). Fama/French US Growth Research Index: Provided by Fama/French from CRSP securities data. Includes the higher 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973). 

Giant Firms atop the Market Is Nothing New

6/24/2020

 
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A top-heavy stock market with the largest 10 stocks accounting for over 20% of market capitalization and a marquee technology firm perched at No. 1? This sounds like a description of the current US stock market, dominated by Apple and the other FAANG stocks,1 but it is actually a reference to 1967, when IBM represented a larger portion of the market than Apple at the end of 2019 (5.8% vs. 4.1%).

As we see in Exhibit 1
, it is not particularly unusual for the market to be concentrated in a handful of stocks. The combined market capitalization weight of the 10 largest stocks, just over 20% at the end of last year, has been higher in the past.

​
Exhibit 1 Same Old Story 
Weight of largest stocks by market capitalization in US stock market, 1927–2019
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A breakdown of the largest US stocks by decade in Exhibit 2 shows some companies have stayed on top for a long time. AT&T was among the largest two for six straight decades beginning in 1930. General Motors and General Electric ranked in the top 10 at the start of multiple decades. IBM and Exxon were also mainstays in the second half of the 20th century. Hence, concentration of the stock market in a few large companies such as the FAANG stocks in recent years is not a new normal; it is old normal. 

Exhibit 2 Big Board
Largest 10 US stocks at the start of each decade
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Moreover, while the definition of “high-tech” is constantly evolving, firms dominating the market have often been on the cutting edge of technology. AT&T offered the first mobile telephone service in 1946. General Motors pioneered such innovations as the electric car starter, airbags, and the automatic transmission. General Electric built upon the original Edison light bulb invention, contributing to further breakthroughs in lighting technology, such as the fluorescent bulb, halogen bulb, and the LED. So technological innovation dominating the stock market is not a new normal; it is an old normal too.

Another trend attributed to a new normal is the extraordinary performance of FAANG stocks over the past decade, leading some to wonder if we should expect these stocks to continue such strong performance going forward. Investors should remember that any expectations about the future operational performance of a firm are already reflected in its current price. While positive developments for the company that exceed current expectations may lead to further appreciation of its stock price, those unexpected changes are not predictable.

To this point, charting the performance of stocks following the year they joined the list of the 10 largest firms shows decidedly less stratospheric results. On average, these stocks outperformed the market by an annualized 0.7% in the subsequent three-year period. Over five- and 10-year periods, these stocks underperformed the market on average. 


Exhibit 3 Power Down
Annualized return in excess of market for stocks after joining list of 10 largest US stocks, 1927–2019
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The only constant is change, and the more things change the more they stay the same. This seems an apt description of the dominant stocks atop the market. While the types of businesses most prominent in the market vary through time, the fact that a small subset of companies’ stocks account for an outsized portion of the stock market is not new. And it remains impossible to systematically predict which large companies will outperform the stock market and which will underperform it. This underscores the importance of having a broadly diversified equity portfolio that provides exposure to a vast array of companies and sectors.
GLOSSARY
1. Facebook, Amazon, Apple, Netflix, and Google (a subsidiary of Alphabet) are often referred to as the FAANG stocks.
Fama/French Total US Market Research Index: The value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.


The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein. “Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd, Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Same Old Story, Big Board, Power Down Charts Source: Dimensional, using data from CRSP and Compustat. Includes all US common stocks. Largest stocks identified at the end of each calendar year by sorting stocks on market capitalization. CRSP and Compustat data provided by the Center for Research in Security Prices, University of Chicago. Market is represented by the Fama/French Total US Market Research Index. Excess return for each stock is the difference in annualized compound returns between the stock and the market, computed from the first month following initial classification in the top 10. Stocks in the sample are required to have at least 36 months of returns data following classification in the top 10.

When Stocks and the Economy Diverge

6/3/2020

 
Do you find it puzzling when a bleak economic report emerges from the press, only to be accompanied by a positive surge in the stock market? You’re not alone. The last few weeks have produced many examples of a stark contrast between stock market performance and economic indicators. So why the apparent disconnect?

Markets are forward-looking, meaning current asset prices reflect market participants’ aggregate expectations. Those expectations include whatever future economic developments are anticipated and their potential impact on cash flows, which are key to a stock’s value. For example, if the market expects the economic environment to weaken company cash flows, stock markets may react well in advance of when we observe the impact on cash flows, as expectations are embedded in prices. And the eventual direction of the stock market will depend on how the economic outcome compares to expectations. If things aren’t as bad as expected, poor economic news can be greeted with a positive stock reaction.

Looking Ahead
We can see this anticipatory nature of markets in action by looking at the relation between US gross domestic product (GDP) growth and equity premiums, or stock market returns in excess of one-month US Treasury bills. When annual US equity premiums are plotted against GDP growth for the same year (top panel of Exhibit 1), there is no discernable relation between the two. Changes in GDP have not been strongly related to simultaneous stock market returns.

It’s important to note that this result does not imply financial markets ignore macroeconomic data. After all, GDP encompasses several measures of the economy, not just corporate profits. However, while GDP may be an imprecise representation of the activities that ultimately drive stock prices, further analysis shows that is not the sole cause for the lack of relation between GDP growth and simultaneous equity premiums.

Plotting GDP growth against the previous year’s equity premium (bottom panel of Exhibit 1) reveals a noticeable relation. The positive trend in the data suggests market prices have in fact reacted to changes in GDP but have done so in advance of these economic developments coming to fruition. This result is consistent with markets pricing in their expectation of economic growth.


Exhibit 1 - Plot Development
US equity premium vs. GDP growth, 1930-2019
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​That brings us to the latest news headline worrying some investors: the eventual fallout from increasingly large US government expenditures designed to ease the economic burden of the COVID-19 pandemic. Will these efforts ultimately create a financial burden for the US government that affects future stock returns?

The results in Exhibit 2 should help allay concerns over the debt level impacting equity market performance. When we sort countries each year on their debt-to-GDP for the prior year (top panel), average annual equity premiums have been slightly higher for high-debt countries than low-debt countries in both developed and emerging markets. However, the return differences’ small t-statistics—a measure of the precision of a value’s estimate – suggest these averages are not reliably different from one another.1

The top panel uses prior year debt-to-GDP data to sort countries into the high/low groups. But investors may be more focused on where they expect the debt to end up, rather than on where it’s been. In the bottom panel of Exhibit 2, we rank countries on debt-to-GDP at the end of the current year, assuming perfect foresight of end-of-year debt levels. Again, average equity premiums have been similar for high- and low-debt countries. Like the results for GDP growth, these results imply that markets have generally priced in expectations for future government debt.


Exhibit 2 - Debt Defying
Average equity premiums for countries sorted on debt
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​MARKETS AT WORK
Macroeconomic variables and investment decisions are like frozen turkeys and deep fryers—caution should be exercised when combining the two. The results presented here are consistent with markets aggregating and processing vast sets of macroeconomic indicators and expectations for those indicators. By incorporating this information into market prices, we believe public capital markets effectively become the best available leading macroeconomic indicator.
​
All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Appendix
When Stocks and the Economy Diverge
Past performance is not a guarantee of future results.
Annual GDP growth rates obtained from the US Bureau of Economic Analysis. GDP growth numbers are adjusted to 2012 USD terms to remove the effects of inflation. Annual US equity premium is return difference between the Fama/French Total US Market Research Index and One-Month US Treasury Bill. Equity premium data provided by Ken French, available at mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. “One-Month Treasury Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct.


All returns in USD. Countries are sorted at the beginning of each year. High-Debt and Low-Debt refer to countries above and below the median debt, respectively. Debt is general government debt and central government debt. Source: The International Monetary Fund. Equity market returns represented by MSCI country indices. Dimensional calculations from Bloomberg and MSCI data. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
1. Researchers often cite a t-statistic value of 2.0 as the threshold for statistical reliability.
GLOSSARY
Macroeconomic data: Data used to measure the output of an economy, such as employment or production.
Gross domestic product: The total value of goods and services produced by, for example, a country over a set period of time.
Debt-to-GDP: The ratio of a company’s debt to its gross domestic product.
Fama/French Total US Market Research Index: The value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.
The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd, Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Long-Term Investors, Don't Let a Recession Faze You

4/17/2020

 
With activity in many industries sharply curtailed in an effort to reduce the chances of spreading the coronavirus, some economists say a recession is inevitable, if one hasn’t already begun.1 From a markets perspective, we have already experienced a drop in stocks, as prices have likely incorporated the growing chance of recession. Investors may be tempted to abandon equities and go to cash because of perceptions of recessions and their impact. But across the two years that follow a recession’s onset, equities have a history of positive performance.
​
Data covering the past century’s 15 US recessions show that investors tended to be rewarded for sticking with stocks. Exhibit 1 shows that in 11 of the 15 instances, or 73% of the time, returns on stocks were positive two years after a recession began. The annualized market return for the two years following a recession’s start averaged 7.8%.

​Downturns, Then Upturns
Growth of wealth for the Fama/French Total US Market Research Index
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​Recessions understandably trigger worries over how markets might perform. But history can be a comfort for investors wondering whether now may be the time to move out of stocks.
GLOSSARY
Fama/French Total US Market Research Index: The value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American Depositary Receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.

FOOTNOTES
1Nelson D. Schwartz, “Coronavirus Recession Looms, Its Course ‘Unrecognizable,’” New York Times, March 21, 2020; Peter Coy, “The U.S. May Already Be in a Recession,” Bloomberg Businessweek, March 6, 2020.


DISCLOSURES
The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein. 
Past performance, including hypothetical performance, is not a guarantee of future results.

Coronaviruses, Market Volatility & Perspective

3/21/2020

 
Over the past few weeks we've witnessed the global market reaction to uncertainty surrounding the coronavirus. The environment remains fluid with strongly positive and negative movements based on the latest developments. The situation can be unsettling both on a human level and from the perspective of how markets respond. The question is, what historical evidence do we have to provide rational guidance during times like these?

At WealthShape, it is a fundamental principle that markets are designed to handle uncertainty, processing information in real-time as it becomes available. We see this happening when markets decline sharply, as they have recently, as well as when they rise. Such declines can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.

Market declines can occur when investors are forced to reassess expectations for the future. The expansion of the outbreak is causing worry among governments, companies, and individuals about the impact on the global economy. Apple announced earlier this month that it expected revenue to take a hit from problems making and selling products in China1. Australia’s prime minister has said the virus will likely become a global pandemic2, and other officials there warned of a serious blow to the country’s economy3. Airlines are preparing for the toll it will take on travel4. And these are just a few examples of how the impact of the coronavirus is being assessed.

Growth of $1 During Outbreaks
S&P 500 Composite Index
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Sources: Robert Shiller Data Collection at Yale University and Centers for Disease Control and Prevention. S&P 500® Composite Index does not include reinvested dividends.
We plot the growth of $1 for the S&P 500® Composite Index in the months following the first reported cases of several outbreaks throughout history and show the ending value when the outbreak subsided. There is much uncertainty associated in determining the measurement periods and precise length of each outbreak. It’s impossible to disentangle the market effects of the outbreak itself from other economic forces. The sell-off across stock markets in recent days was attributed to fears surrounding the impact of the coronavirus but happens to coincide with valuation ratios on the high side relative to historical averages for equities. 

The market is clearly responding to new information as it becomes known, but the market is pricing in unknowns, too. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower.

We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been a lesson of past health crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008–2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire.

The Market’s Response to Crisis
Performance of a Balanced Strategy: 60% Stocks, 40% Bonds
Cumulative Total Return

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This shows the performance of a balanced investment strategy following a few historical crises. Each crisis is labeled with the month and year that it occurred or peaked. The subsequent one-, three-, and five-year annualized returns start from the first day of the month following each crisis. Although a global investment strategy would have suffered losses immediately following most of these events, the financial markets recovered over time, as indicated by the positive five-year cumulative returns. Negative events such as these may tempt investors to flee the financial markets. But diversification and a long-term perspective can help investors apply discipline to ride out the storm.

Conclusion
In the mind of some investors, there is always a “crisis of the day” or potential major event looming that could mean the beginning of the next drop in markets. As we know, predicting future events correctly, or how the market will react to future events, is a difficult exercise. It is important to understand, however, that market volatility is a part of investing. To enjoy the benefit of higher potential returns, investors must be willing to accept increased uncertainty. A key part of a good long-term investment experience is being able to stay with your investment philosophy, even during tough times.

Financial planning combined with a well‑thought‑out, transparent investment approach can help people be better prepared to face uncertainty and improve their ability to stick with their plan and ultimately capture the long-term returns of capital markets. Amid the anxiety that accompanies developments surrounding the coronavirus, decades of financial science and long-term investing principles remain a strong guide.
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Appendix
The Markets Response to Crisis

In US dollars. Represents cumulative total returns of a balanced strategy invested on the first day of the following calendar month of the event noted. Balanced Strategy: 12% S&P 500 Index, 12% Dimensional US Large Cap Value Index, 6% Dow Jones US Select REIT Index, 6% Dimensional International Value Index, 6% Dimensional US Small Cap Index, 6% Dimensional US Small Cap Value Index, 3% Dimensional International Small Cap Index, 3% Dimensional International Small Cap Value Index, 2.4% Dimensional Emerging Markets Small Index, 1.8% Dimensional Emerging Markets Value Index, 1.8% Dimensional Emerging Markets Index, 10% Bloomberg Barclays Treasury Bond Index 1-5 Years, 10% FTSE World Government Bond Index 1-5 Years (hedged), 10% FTSE World Government Bond Index 1-3 Years (hedged), 10% ICE BofAML 1-Year US Treasury Note Index. Assumes monthly rebalancing. For illustrative purposes only. S&P and Dow Jones data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. ICE BofAML index data © 2019 ICE Data Indices, LLC. FTSE fixed income indices © 2019 FTSE Fixed Income LLC. All rights reserved. Bloomberg Barclays data provided by Bloomberg. Dimensional indices use CRSP and Compustat data. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance. See “Balanced Strategy Disclosure and Index Descriptions” pages in the Appendix for additional information.

1Apple, February 17 press release https://www.apple.com/newsroom/2020/02/investor-update-on-quarterly-guidance/
2Ben Doherty and Katharine Murphy, “Australia Declares Coronavirus Will Become a Pandemic as It Extends China Travel Ban,” The Guardian, February 27, 2020. https://www.theguardian.com/world/2020/feb/27/australia-declares-coronavirus-will-become-a-pandemic-as-it-extends-china-travel-ban
3Ben Butler, “Coronavirus Threatens Australian Economy Reeling from Drought and Fires,” The Guardian, February 5, 2020. https://www.theguardian.com/business/2020/feb/05/coronavirus-threatens-australian-economy-reeling-from-drought-and-fires; Ed Johnson, “Australia Says Economy to Take ‘Significant’ Hit from Virus,” https://www.bloomberg.com/news/articles/2020-02-05/australia-says-economy-to-take-significant-hit-from-virus
4Alistair MacDonald and William Boston, “Global Airlines Brace for Coronavirus Impact,” The Wall Street Journal, February 26, 2020.https://www.wsj.com/articles/germanys-lufthansa-makes-cuts-as-it-braces-for-coronavirus-impact-11582712819

Yield of Dreams: A Closer Look at Dividends

2/18/2020

 
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Investors often see dividends as a way to generate income. But dividend strategies are not the only way to produce cash, and investors should be aware of the potential tradeoffs that accompany a focus on dividends.
​
For stockholders who own dividend-paying shares, those payments arrive on a schedule (quarterly, in many cases). The cash to fund a dividend must come from somewhere, however. We know the price of a stock is potentially influenced by all expected future cash flows to shareholders. If cash is paid today in the form of a dividend, the stock price—and total market capitalization—of the issuing company may therefore fall, as the hypothetical Portfolio A in Exhibit 1 shows. That means, all else being equal, an investor who receives a dividend may also be left with a less valuable equity holding.
​
Exhibit 1: Pay, Your Way
Comparing methods of income generation
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Cash Considerations
An alternative method of raising cash is to simply sell shares. Exhibit 1 compares the two methods of generating income by contrasting Portfolio A with the similarly valued hypothetical Portfolio B. While Portfolio A receives income through a dividend payout, Portfolio B generates it through a stock sale.
The investor in Portfolio A, in which a dividend is issued, ends up holding the same number of shares as were held prior to the dividend payout, but we assume that those shares have declined in value. The investor in Portfolio B holds a reduced number of shares that haven’t seen their value decrease as a result of a dividend payout. The two approaches arrive at the same place—both investors end up with $100 in cash and $1,900 in stock, notwithstanding potential trading costs or tax implications. But there are potential downsides to the dividend approach when contrasted with the stock-sale approach.
​
First, the average proportion of firms paying dividends in the US was about 52% from 1963 through 2019, meaning an investor focusing only on those stocks is missing out on nearly half of investible US companies. A second consideration is that a dividend’s value, while not subject to the same degree of fluctuation as a stock price, isn’t guaranteed. Just 10 years ago, more than half of dividend-paying firms cut or eliminated those payouts following the financial crisis. More recently, a company that had consistently paid dividends for more than a century, General Electric, slashed its payout to just one cent a share, and the UK’s Vodafone Group cut its full‑year dividend for the first time in two decades. Thirdly, investors may give up flexibility in terms of the timing and the size of the payout when they rely on company-issued dividends. With stock sales, an investor determines the amount and schedule of the income.

Total Return
When considering an investment, it is also important to assess total return, which accounts for capital appreciation (or loss) alongside dividend income. High dividend yields may not lead to high total returns. Exhibit 2 plots the trailing 12-month returns of S&P 500 Index constituents as of December 31, 2019, with each dot representing a company. It’s clear that companies with greater dividend yields, the dots located higher up the vertical axis, weren’t consistently those with a higher total return over that period.

Exhibit 2: Income Facts
Dividend yields and 12-month returns for S&P 500 firms as of December 31, 2019
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Note: Plotted yield of 18.38% reflects a stock that paid special dividends.
​Income generation may be a priority for some investors, but other important investment considerations, such as diversification and flexibility, needn’t fall victim to that aim. While the use of stock sales instead of dividends to create cash flow may involve trading costs and tax considerations, those concerns may be offset by the benefits of investing in companies that don’t currently pay dividends. An approach focused on income derived through dividends may not be the most desirable choice when weighing broader investment goals.
All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

Appendix
Yield of Dreams: A Closer Look at Dividends

Exhibit 2: Source: Dimensional calculations using Bloomberg data. For constituents with reported returns of less than one year, returns shown since earliest date available. S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Dividend yield is calculated as the sum of dividends paid in calendar year t divided by end of year t-1 price. Note: Plotted yield of 18.38% reflects a stock that paid special dividends.
FOOTNOTES
1Source: Dimensional, using data from CRSP. Stocks are sorted at the end of each June based on whether a dividend was issued in the preceding 12 months. 2Stanley Black, “Global Dividend-Paying Stocks: A Recent History” (white paper, Dimensional Fund Advisors, March 2013). 3Janet Babin, “GE cuts dividend to a penny per share. Why bother keeping it at all?” Marketplace, American Public Media, October 30, 2018. 4Adrià Calatayud, “Vodafone cuts dividend after swinging to 2019 loss.” MarketWatch, May 14, 2019.

DISCLOSURES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Investing risks include loss of principal and fluctuating value. All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

The 2010's: A Decade in Review

1/16/2020

 
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Imagine it is early January 2010 and you are reading a review of the financial markets. Investors have been on a roller coaster over the past three years, living through the stress of the global financial crisis and market downturn of 2008–2009, then experiencing the recovery that began in March 2009 and is still going strong.

Investors who rode out the market’s slide are beginning to be rewarded. But the rebound is 10 months old, and markets have a long way to go to reach their previous highs. Opinions are mixed about what might unfold in the coming year. A December 2009 headline in the Wall Street Journal underscored the uncertainty: “Bull Market Shows Signs of Aging.”1 The publication pointed out that, although stocks have rallied and indices are on the rise, worries are mounting in some quarters that the market is running out of steam.

From the vantage point of early 2010, you may be wondering whether to stick with your investment plan or move into cash and wait for more evidence that the markets have recovered. Now, fast forward to today and consider what the global equity markets delivered to investors who stayed the course.

On a total return basis, global stocks more than doubled in value from 2010–2019, as Exhibit 1 shows. The MSCI All Country World IMI Index, which includes large and small cap stocks in developed and emerging markets, had a 10-year annualized return of 8.91%. From a growth-of-wealth standpoint, $10,000 invested in the stocks in the index at the beginning of 2010 would have grown to $23,473 by year-end 2019.

Exhibit 1: Growth of Wealth
MSCI All Country World IMI Index, January 2010–December 2019 
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Despite positive annual market returns during most of the decade, investors had to process ever-present uncertainty arising from a host of events, including an unprecedented US credit rating downgrade, sovereign debt problems in Europe, negative interest rates, flattening yield curves, the Brexit vote, the 2016 US presidential election, recessions in Europe and Japan, slowing growth in China, trade wars, and geopolitical turmoil in the Middle East, to name a few.

The decade also brought technological advances in electronic commerce and cloud computing, the global embrace of the smartphone and social media, increased automation and enhanced artificial intelligence, and new products like electric cars and early iterations of self-driving ones.

Looking back, you could conclude that the decade had its share of uncertainty—just like the decades before. But overall, the US equity market experienced moderate volatility compared with previous decades. Exhibit 2 displays this by looking at returns and standard deviation, where a higher standard deviation reflects wider market swings during that decade.

BENEFITS OF DIVERSIFICATION
Exhibit 2: Volatility in Perspective
S&P 500 Index annualized returns grouped by decade (1930–2019) 
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Investors who committed to global diversification and to areas of the market associated with higher returns—small cap stocks and value stocks (i.e., stocks trading at low relative prices)—were challenged over the past decade. As shown in Exhibit 3, during the 2000s, investors were generally rewarded for holding emerging markets stocks and developed ex US stocks. During the 2010s, the US market outperformed developed ex US and emerging markets.

​The performance of value stocks vs. growth stocks (i.e., stocks trading at high relative prices), and small vs. large cap stocks, also varied between decades.

Exhibit 3: The Past Two Decades—2000s vs. 2010s
Annualized returns (%)
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Exhibit 4: The Longer View
2000–2019: Annualized returns (%) 
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Small cap and value stocks outperformed large cap and growth stocks in the 2000s, while the 2010s produced mixed outcomes. Small caps underperformed large caps in the US and emerging markets but outperformed in the developed ex US market. Value underperformed growth in all three market regions. Despite underperforming large cap and growth in the US, small cap and value delivered 11.83% and 11.71%, respectively, for the decade.

Exhibit 4 shows the cumulative investment experience over both decades, with small cap and value stocks outperforming large cap and growth stocks, respectively, across the US, developed ex US, and emerging markets. The annualized 20-year returns illustrate how diversification can help investors ride out the extremes to pursue a positive longer-term outcome.

Over the past decade, global fixed income also posted returns that may have surprised some investors. In 2010, investors looking at historically low interest rates may have expected rising rates as financial markets and economies recovered from the crisis. But over the decade, short-term rates increased while long-term rates decreased. Realized term premiums were positive, as long-term bonds generally outperformed shorter-term bonds. Realized credit premiums were also positive, as lower-quality bonds generally outperformed higher-quality bonds.2

ENDURING PRINCIPLES
That brings us to now—January 2020. Stocks and bonds in the US, and in many other developed markets and emerging markets, logged strong returns last year. The US bull market is 10 years old, and current headlines can give investors other reasons to worry about the future—for example, a pushback on globalization, the effects of climate change, the limits of monetary policy, the fate of Brexit, and the vagaries of the 2020 US presidential race. And those are merely the known unknowns. Looking ahead, who can say what the next 10 years will bring? The only certainty is the decade will have its own set of surprises.

Here’s what we can learn from the past decade (and the ones that came before it): Despite all the change and uncertainty, the fundamentals of successful investing endured. Diversify across markets and asset groups to manage risks and pursue higher expected returns. Stay disciplined and maintain a long-term perspective. Take the daily news with a grain of salt and avoid reactive investment decisions based on fear or anxiety. Don’t try to predict future performance or time the markets. Instead, develop a sensible investment plan based on a strong philosophy—and stick with it.
​
Investors who follow these principles can have a better financial journey in any decade.
All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Appendix
Exhibits 1,2 3,4 Past performance is not a guarantee of future results. Source: MSCI. In US dollars, net dividends. MSCI data © MSCI 2020, all rights reserved. Index is not available for direct investment. Performance does not reflect the expenses associated with management of an actual portfolio. S&P 500 Index data provided by Standard & Poor’s Index Services Group. Standard deviation is a statistical measurement of historical volatility. Market segment (index representation) as follows: US Stocks—Large Cap (Russell 1000 Index), Small Cap (Russell 2000 Index), Growth (Russell 3000 Growth Index), Value (Russell 3000 Value Index); Developed ex-US Stocks—Large Cap (MSCI World ex USA Index), Small Cap (MSCI World ex USA Small Cap Index), Value (MSCI World ex USA Value Index), Growth (MSCI World ex USA Growth Index); Emerging Markets Stocks—Large Cap (MSCI Emerging Markets Index), Small Cap (MSCI Emerging Markets Small Cap Index), Value (MSCI Emerging Markets Value Index), Growth (MSCI Emerging Markets Growth Index). Index returns are in US dollars, net of withholding tax on dividends. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2020, all rights reserved. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio.

1. “Bull Market Shows Signs of Aging,” The Wall Street Journal, December 7, 2009. 2. Bloomberg Barclays Indices In USD. Growth stocks trade at a high price relative to a measure of fundamental value, such as book value or earnings. Value stocks trade at a low price relative to a measure of economic value, such as book value or earnings. The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein. “Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.

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RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful. Diversification neither assures a profit nor guarantees against loss in a declining market.

December 12th, 2019

12/12/2019

 
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The year 2019 served up many examples of the unpredictability of markets.

Interest rates that US policy makers expected to rise fell instead. American consumers’ confidence weakened as the year began, and news headlines broadcast fears of an economic slowdown. But investors who moved onto the sidelines may have missed the gains in the US stock market. As of the end of October, the S&P 500 was up more than 20% for the year on a total-return basis. That puts it on course for the best showing since 2013 should that gain hold through December.

The Greek stock market swung from a 37% decline last year to a 37% advance this year.

Outside the US, Greece—the site of an economic crisis so dire some expected the country to abandon the euro earlier this decade, and a country whose equity market lost more than a third of its value last year—has had one of the most robust stock market performances among emerging economies in 2019. On top of that, Greece issued bonds at a negative nominal yield, which means investors paid for the privilege of lending the government cash.

Taken as a whole, it’s a reminder that the prediction game can be a losing one for investors.

Exhibit 1: Shifting Curves
Yields on US Treasuries of various maturities since the end of 2018
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UP OR DOWN?
A closer look at interest rates and the bond market shows just how unpredictable asset performance can be. Going into 2019, Federal Reserve officials expected economic conditions to support raising a key interest rate benchmark twice. Instead, policy makers lowered it three times.

In the market for US Treasuries—where market participants set interest rates—the yield curve that tracks Treasuries inverted for the first time in more than 10 years, as seen in Exhibit 1. Some long-term yields fell below some short-term yields over the summer. What’s more, yields on medium- and long-term bonds were at historically low levels at the start of the year, but they fell even lower by the end of October. Investors who made moves based on the expectation yields would rise in 2019 may have been disappointed in how events ultimately transpired.

​Exhibit 2: Changes in the Ranks
Performance of equity markets in 23 developed and 24 emerging economies
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TRADING PLACES
Events weren’t any easier to anticipate in the global equity markets, where no evident link appears between markets that performed well last year and those that have excelled this year, as Exhibit 2 shows.

Among the 23 developed market countries, only one country was a Top 5 performer for 2018 and 2019: the US. Last year’s strongest performing market— Finland—ranked 22nd this year through the end of October. Among emerging markets, Greece swung from a 37% decline last year to a 37% advance this year through the end of October.

PERENNIAL WISDOM
History has shown there’s no compelling or dependable way to forecast stock and bond movements, and 2019 was a case in point. Neither the mainstream prognostications nor the hindsight of recent strong performance predicted outcomes in 2019.
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Rather than basing investment decisions on predictions of which way debt or equity markets are headed, a wiser strategy may be to hold a range of investments that focus on systematic and robust drivers of potential returns. Investors who were broadly diversified across asset classes and around the globe were in a position to potentially enjoy the returns that the markets delivered thus far in 2019. Last year, this year, next year—that approach is a timeless one.
All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
​

Appendix
Foresight Isn't 20/20
Shifting Yield Curves: Source: ICE BofAML fair value government spot yield. ICE BofAML index data © 2019 ICE Data Indices, LLC.
Changes in the Ranks: Source: MSCI country indices (net dividends) in USD for each country listed. MSCI data © MSCI 2019, all rights reserved. 2019 YTD as of 10/31/19. Note: Emerging economies do not include Argentina and Saudi Arabia, which MSCI classified as frontier and standalone, respectively, prior to May 2019.
1. Based on readings from the Conference Board Consumer Confidence Survey and the University of Michigan Index of Consumer Sentiment.
2. Markets designated as developed or emerging by MSCI.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

How Markets Work and the FAANG Mentality

11/5/2019

 
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The stocks commonly referred to by the FAANG moniker— Facebook, Amazon, Apple, Netflix, and Google (now trading as Alphabet)—have posted impressive gains through the years, with all now worth many times their initial-public-offering prices. The notion of FAANG stocks as a powerful group holding sway over the markets has sunk its teeth into some investors. But how much of the market’s recent returns are attributable to FAANG stocks? And does their performance point to a change in the markets?

Exhibit 1: A Little Help from the FAANGs
Annualized US market compound returns with and without Facebook, Amazon, Apple, Netflix, and Alphabet (Google), 2009–2018
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​Research has shown no reliable way to predict the top‐performing stocks, arguing for diversification instead.
Over the 10 years through December 31, 2018, the US broad market returned an annualized 13.4%, as shown in Exhibit 1. Excluding FAANG stocks, the market returned 12.6%. The 0.8-percentage-point bump resulted from the FAANGs collectively averaging a 30.4% yearly return over the decade.
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Investors may be surprised to learn that it is actually common for a subset of stocks to drive a sizable portion of the overall market return. Exhibit 2 shows that excluding the top 10% of performers each year from 1994 to 2018 would have reduced global market performance from 7.2% to 2.9%. Further excluding the best 25% of performers would have turned a positive return into a relatively large negative return.

This lesson also applies to capturing the premiums associated with a company’s size and its price-to-book ratio. Research by Eugene Fama and Kenneth French (”Migration,” 2006) provides evidence that these premiums are driven in large part by a subset of stocks migrating across the market.

Exhibit 2: Weighing the Impact
Global stock market performance excluding top performers, 1994–2018
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​Research has shown no reliable way to predict the top-performing stocks. Looking at the top 10% of stocks by performance each year since 1994, on average less than a fifth of that group has ranked in the top 10% the following year.

The tendency for strong market performance to be concentrated in a subset of stocks is therefore also a cautionary tale about the importance of diversification— investors with concentrated portfolios may actually miss out on the very stocks that deliver the best of what the market has to offer. An investment approach built around broad diversification can help achieve a more reliable outcome for investors over the long term—sharp acronym or not.
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All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Appendix
How Markets Work and the FAANG Mentality
Exhibit 1: Source: Dimensional using data from the Center for Research in Security Prices (CRSP) covering the 10 calendar years since the financial crisis. With FAANGs portfolio formed each month including common stocks listed on NYSE, NYSE MKT, and NASDAQ. Stocks are weighted by market capitalization. Without FAANGs formed similarly but excluding Facebook, Apple, Amazon, Netflix, and Alphabet (Google). Past performance is no guarantee of future results.

Exhibit 2: “All stocks” includes all eligible stocks in all eligible developed and emerging markets at their market cap weights. Eligible stocks are required to meet a minimum market capitalization requirement. REITs and investment companies are excluded. Compound average annual returns are computed as the compound returns of the value-weighted averages of the annual returns of the included securities. “Excluding the top 10%” and “Excluding the top 25%” are constructed similarly but exclude the respective percentages of stocks with the highest annual returns by security count each year. Individual security data are obtained from Bloomberg, London Share Price Database, and Centre for Research in Finance. The eligible countries are: Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Czech Republic, Denmark, Egypt, Finland, France, Germany, Greece, Hong Kong, Hungary, India, Indonesia, Ireland, Israel, Italy, Japan, Republic of Korea, Malaysia, Mexico, Netherlands, New Zealand, Norway, Peru, Philippines, Poland, Portugal, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, the UK, and US. Diversification does not eliminate the risk of market loss. Past performance is no guarantee of future results.
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1. With-FAANGs portfolio formed each month including common stocks listed on NYSE, NYSE MKT, and NASDAQ. Stocks are weighted by market capitalization. Without-FAANGs formed similarly but excluding Facebook, Apple, Amazon, Netflix, and Alphabet (Google). Source: Dimensional using data from CRSP.
2. The onset of broad coverage of all-cap stock data across developed and emerging markets.
3. All eligible common stocks in all eligible developed and emerging markets, ranked by total return. Source: Dimensional, using data from Bloomberg LP.


Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

A Tale of Two Decades: Lessons for Long-Term Investors

9/10/2019

 
The first decade of the 21st century, and the second one that’s drawing to a close, have reinforced for investors some timeless market lessons: Returns can vary sharply from one period to another. Holding a broadly diversified portfolio can help smooth out the swings. And focusing on known drivers of higher expected returns can increase the potential for long‐term success. Having a sound strategy built on those principles - and sticking to it through good times and bad - can be a rewarding investment approach.
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“THE LOST DECADE”?
Looking at a broad measure of the US stock market, such as the S&P 500, over the past 20 years, you could be forgiven for thinking of Charles Dickens: It was the best of times and the worst of times (see Exhibit 1). For US large cap stocks, the worst came first. The “lost decade” from January 2000 through December 2009 resulted in disappointing returns for many who were invested in the securities in the S&P 500. An index that had averaged more than 10% annualized returns before 2000 instead delivered less‐than‐average returns from the start of the decade to the end. Annualized returns for the S&P 500 during that market period were −0.95%. ​
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Yet it was a good decade for investors who diversified their holdings globally beyond US large cap stocks and included other parts of the market with higher expected returns—companies with small market capitalizations or low relative price (value stocks). As Exhibit 2 shows, a range of indices across many other parts of the global market outperformed the S&P 500 during that time span.

​FLIPPING THE SCRIPT
The next period of nine‐plus years reveals quite a different story. It has looked more like best of times for the S&P 500, as the index, when viewed by total return, has more than tripled since the start of the decade in the bounce‐back from the global financial crisis. US large cap growth stocks have been some of the brightest stars during this span. Accordingly, from 2010 through the first half of 2019, many parts of the market that performed well during the previous decade haven’t been able to outperform the S&P 500, as Exhibit 3 displays. Since many of these asset classes haven’t kept pace with the S&P, these returns might cause some to question their allocation to the asset classes that drove positive returns during the 2000s. ​
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THE CASE FOR GREAT EXPECTATIONS
It’s been stated many times that investors may want to take a long‐term perspective toward investing, and the performance of stock markets since 2000 supports this point of view. Over the past 19 1⁄2 years (see Exhibit 4), investing outside the US presented investors with opportunities to capture annualized returns that surpassed the S&P 500’s 5.65%, despite periods of underperformance, including the most recent nine‐plus years. Cumulative performance from 2000 through June 2019 also reflects the benefits of having a diversified portfolio that targets areas of the market with higher expected returns, such as small and value stocks. And it underscores the principle that longer time frames increase the likelihood of having a good investment experience.

​No one knows what the next 10 months will bring, much less the next 10 years. But maintaining patience and discipline, through the bad times and the good, puts investors in position to increase the likelihood of long‐term success. 
APPENDIX: Index Descriptions
Dimensional US Large Cap Value Index is compiled by Dimensional from CRSP and Compustat data. Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market with market capitalizations above the 1,000th-largest company whose relative price is in the bottom 30% of the Dimensional US Large Cap Index after the exclusion of utilities, companies lacking financial data, and companies with negative relative price.
The index emphasizes securities with higher profitability, lower relative price, and lower market capitalization. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: non-US companies, REITs, UITs, and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to March 2007. The calculation methodology for the Dimensional US Large Cap Value Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index. Prior to January 1975: Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market with market capitalizations above the 1,000th-largest company whose relative price is in the bottom 20% of the Dimensional US Large Cap Index after the exclusion of utilities, companies lacking financial data, and companies with negative relative price.

Dimensional US Small Cap Index is compiled by Dimensional from CRSP and Compustat data. Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market whose market capitalization falls in the lowest 8% of the total market capitalization of the eligible market. The index emphasizes companies with higher profitability. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: non-US companies, REITs, UITs, and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to March 2007. The calculation methodology for the Dimensional US Small Cap Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index. Prior to January 1975: Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market whose market capitalization falls in the lowest 8% of the total market capitalization of the eligible market.

Dimensional International Marketwide Value Index is compiled by Dimensional from Bloomberg securities data. The index consists of companies whose relative price is in the bottom 33% of their country’s companies after the exclusion of utilities and companies with either negative or missing relative price data. The index emphasizes companies with smaller capitalization, lower relative price, and higher profitability. The index also excludes those companies with the lowest profitability and highest relative price within their country’s value universe. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to April 2008. The calculation methodology for the Dimensional International Marketwide Value Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index.

Dimensional International Small Cap Value Index is defined as companies whose relative price is in the bottom 35% of their country’s respective constituents in the Dimensional International Small Cap Index after the exclusion of utilities and companies with either negative or missing relative price data. The index also excludes those companies with the lowest profitability within their country’s small value universe. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to April 2008. The calculation methodology for the Dimensional International Small Cap Value Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index. Prior to January 1990: Created by Dimensional, the index includes securities of MSCI EAFE countries in the top 30% of book-to-market by market capitalization conditional on the securities being in the bottom 10% of market capitalization, excluding the bottom 1%. All securities are market capitalization weighted. Each country is capped at 50%; rebalanced semiannually.
Dimensional Emerging Markets Index is compiled by Dimensional from Bloomberg securities data. Market capitalization-weighted index of all securities in the eligible markets. The index has been retroactively calculated by Dimensional and did not exist prior to April 2008. Exclusions: REITs and investment companies.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

Timing Isn't Everything

7/9/2019

 
Over the course of a summer, it’s not unusual for the stock market to be a topic of conversation at barbecues or other social gatherings. A neighbor or relative might ask about which investments are good at the moment. The lure of getting in at the right time or avoiding the next downturn may tempt even disciplined, long-term investors. The reality of successfully timing markets, however, isn’t as straightforward as it sounds.

OUTGUESSING THE MARKET IS DIFFICULT
Attempting to buy individual stocks or make tactical asset allocation changes at exactly the “right” time presents investors with substantial challenges. First and foremost, markets are fiercely competitive and adept at processing information. During 2018, a daily average of $462.8 billion in equity trading took place around the world.1 The combined effect of all this buying and selling is that available information, from economic data to investor preferences and so on, is quickly incorporated into market prices. Trying to time the market based on an article from this morning’s newspaper or a segment from financial television? It’s likely that information is already reflected in prices by the time an investor can react to it.

Dimensional recently studied the performance of actively managed mutual funds and found that even professional investors have difficulty beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs.2
Attempting to buy individual stocks or make tactical asset allocation changes at exactly the
“right” time presents investors with substantial challenges.
Further complicating matters, for investors to have a shot at successfully timing the market, they must make the call to buy or sell stocks correctly not just once, but twice. Professor Robert Merton, a Nobel laureate, said it well in a recent interview with Dimensional: 

“Timing markets is the dream of everybody. Suppose I could verify that I’m a .700 hitter in calling market turns. That’s pretty good; you’d hire me right away. But to be a good market timer, you’ve got to do it twice. What if the chances of me getting it right were independent each time? They’re not. But if they were, that’s 0.7 times 0.7. That’s less than 50-50. So, market timing is horribly difficult to do.” 

Exhibit 1: Average Annualized Returns After New Market Highs
S&P 500, January 1926–December 2018 ​
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TIME AND THE MARKET
The S&P 500 Index has logged an incredible decade. Should this result impact investors’ allocations to equities? Exhibit 1 suggests that new market highs have not been a harbinger of negative returns to come. The S&P 500 went on to provide positive average annualized returns over one, three, and five years following new market highs.
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CONCLUSION
Outguessing markets is more difficult than many investors might think. While favorable timing is theoretically possible, there isn’t much evidence that it can be done reliably, even by professional investors. The positive news is that investors don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise. By focusing on the things they can control (like having an appropriate asset allocation, diversification, and managing expenses, turnover, and taxes) investors can better position themselves to make the most of what capital markets have to offer. 
Appendix
Average Annualized Returns After New Market Highs: In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926– December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation YearbookTM, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money. 
1. In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.
2. Mutual Fund Landscape 2019.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit. All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Robert Merton provides consulting services to Dimensional Fund Advisors LP. 

In 20/20 Hindsight Markets Are Always Wrong

6/6/2019

 
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​“I knew the market was going to crash.” It’s a common investment expression that you’ve likely heard plenty of times. However, is there any reason to take such statements seriously? Hindsight bias has been deceiving investors for years. Once we’ve had time to digest information, it can often seem like yesterday’s news should have been more predictable. Perhaps the best way to avoid behavioral hazards is to first acknowledge that they exist. Recognizing what we really know versus what’s unknowable may be the single most important investment decision we ever make.
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The history of stock markets is filled with ups and downs which after the fact appear to be easily identified. The huge leverage risk-taking by banking/investment and insurance firms leading up to the 2008 financial crisis is blatantly visible today. We’ve had the benefit of 10 years to reflect. Nobel prize-winning psychologist, Daniel Kahneman would say, it’s during this time of careful observation that hindsight creates an illusion of understanding. Essentially our brains screw up the timeline. Signs of danger appear more obvious after the fact than they were in real time.  

In 2008, a variety of dominoes had to fall on the way to peak awareness. When it became evident that the housing market was bolstered by bad loans with roots extending across the financial spectrum, markets reacted exactly as they should. They priced in the new information and the results were painful.

Investing in 20/20 hindsight can lead to an even more detrimental exercise in creating a misconception that future events are coming based on information that is wholly unknowable. This is evidenced by an unending flow of soothsaying from financial media outlets. A few examples:
October 20th 1987
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​One Day later: October 21st 1987
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​​One of the single best days in market history was October 21, 1987, only two days after the Black Monday market crash. The S&P 500 was up 9.10%
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​Money Magazine – Aug. 1997

Annualized returns of the S&P 500 from August 1997:
6 months             3.56%
12 months          19.28%
3 years                16.04%

So much time and energy focuses on things that are unknowable in the moment. News by definition is unpredictable. Therefore, any action taken as an investor must answer the following: “What are the chances that I know something that everyone else doesn’t? Furthermore, even if I do know something, how long will I be the only one? And finally, what are the chances that my information has already been incorporated into current market values?”
 
Today we carry more computing power in our pockets than all of NASA did when it put the first men on the moon in 1969. Needless to say, news travels at an incredible speed. By the time it reaches you and me, it’s almost a certainty that markets have already incorporated the latest news into prices. This simple fact demonstrates the value or lack thereof for opinions based on past events. Investors should remain conscious of the brain’s tendency to value “known information” as if it were “unknown.” By doing so, we can better combat the impacts of hindsight decision making.

What’s an investor to do?
It’s folly to suggest in retrospect that market prices were wrong because they were never perfect in the first place. Their primary role is to provide the best representation of all available information at the moment. It’s a far better exercise to follow the preponderance of evidence we know exists. Markets tend to be resilient to crisis over the long term and investors have historically been rewarded for maintaining behavioral discipline. Therefore, an accurate forecast of future events isn't a prerequisite for success.
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​
The Market’s Response to Crisis
Performance of a Balanced Strategy: 60% Stocks, 40% Bonds (Cumulative Total Return)
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In US dollars. Represents cumulative total returns of a balanced strategy invested on the first day of the following calendar month of the event noted. Balanced Strategy: 12% S&P 500 Index,12% Dimensional US Large Cap Value Index, 6% Dow Jones US Select REIT Index, 6% Dimensional International Marketwide Value Index, 6% Dimensional US Small Cap Index, 6% Dimensional US Small Cap Value Index, 3% Dimensional International Small Cap Index, 3% Dimensional International Small Cap Value Index, 2.4% Dimensional Emerging Markets Small Index, 1.8% Dimensional Emerging Markets Value Index, 1.8% Dimensional Emerging Markets Index, 10% Bloomberg Barclays Treasury Bond Index 1-5 Years, 10% Citigroup World Government Bond Index 1-5 Years (hedged), 10% Citigroup World Government Bond Index 1-3 Years (hedged), 10% BofA Merrill Lynch 1-Year US Treasury Note Index. The S&P data are provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2017 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Citigroup Indices used with permission, © 2017 by Citigroup. Bloomberg Barclays data provided by Bloomberg. For illustrative purposes only. Dimensional indices use CRSP and Compustat data. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Rebalanced monthly. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance.
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All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
The Market Response to Crisis
Source: Dimensional Fund Advisors LP. Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Investing involves risks including possible loss of principal. Diversification does not eliminate the risk of market loss. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.

The Index Boogyman

5/8/2019

 
Over the last several years, index funds have received increased attention from investors and the financial media.

Some have even made claims that the increased usage of index funds may be distorting market prices. For many, this argument hinges on the premise that indexing reduces the efficacy of price discovery. If index funds are becoming increasingly popular and investors are “blindly” buying an index’s underlying holdings, sufficient price discovery may not be happening in the market. But should the rise of index funds be a cause of concern for investors? Using data and reasoning, we can examine this assertion and help investors understand that markets continue to work, and investors can still rely on market prices despite the increased prevalence of indexing.

Many buyers and sellers
While the popularity of indexing has been increasing over time, index fund investors still make up a relatively small percentage of overall investors. For example, data from the Investment Company Institute shows that as of December 2017, 35% of total net assets in US mutual funds and ETFs were held by index funds, compared to 15% in December of 2007. Nevertheless, the majority of total fund assets (65%) were still managed by active mutual funds in 2017. As a percentage of total market value, index-based mutual funds and ETFs also remain relatively small. As shown in Exhibit 1, domestic index mutual funds and ETFs comprised only 13% of total US stock market capitalization in 2017.

Exhibit 1.    Investor Breakdown in the US Stock Market as a Percentage of Total US Stock Market Capitalization
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All totals may not equal 100% due to rounding. Sourced from the 2018 ICI Fact Book: ici.org/pdf/2018_factbook.pdf

​In this context, it should also be noted that many investors use nominally passive vehicles, such as ETFs, to engage in traditionally active trading. For example, while both a value index ETF and growth index ETF may be classified as index investments, investors may actively trade between these funds based on short-term expectations, needs, circumstances, or for other reasons. In fact, several index ETFs regularly rank among the most actively traded securities in the market.

Beyond mutual funds, there are many other participants in financial markets, including individual security buyers and sellers, such as actively managed pension funds, hedge funds, and insurance companies, just to name a few. Security prices reflect the viewpoints of all these investors, not just the population of mutual funds.

As Professors Eugene Fama and Kenneth French point out in their blog post titled “Q&A: What if Everybody Indexed?”, the impact of an increase in indexed assets also depends to some extent on which market participants switch to indexing: “If misinformed and uninformed active investors (who make prices less efficient) turn passive, the efficiency of prices improves. If some informed active investors turn passive, prices tend to become less efficient. But the effect can be small if there is sufficient competition among remaining informed active investors. The answer also depends on the costs of uncovering and evaluating relevant knowable information. If the costs are low, then not much active investing is needed to get efficient prices.”
 
What’s the volume?
Trade volume data are another place to look for evidence of well-functioning markets. Exhibit 2 shows that despite the increased prevalence of index funds, annual equity market trading volumes have remained at similar levels over the past 10 years. This indicates that markets continue to facilitate price discovery at a large scale.

Exhibit 2.      Annual Global Equity Market Trading Volume, 2007–2018
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In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded.

​Besides secondary market trading, there are also other paths to price discovery through which new information can get incorporated into market prices. For example, companies themselves can impact prices by issuing stock and repurchasing shares. In 2018 alone, there were 1,633 initial public offerings, 3,492 seasoned equity offerings, and 4,148 buybacks around the world.3 The derivatives markets also help incorporate new information into market prices as the prices of those financial instruments are linked to the prices of underlying equities and bonds. On an average day in 2018, market participants traded over 1.5 million options contracts and $225 billion worth of equity futures.

Hypothesis in practice

Even though the historical empirical evidence suggests that the rise of indexing is unlikely to distort market prices, let’s consider the counterargument that the rise of indexing does distort markets and in turn causes prices to become less reliable. In this scenario, wouldn’t one expect stock-picking managers attempting to capture mispricing to have an increased rate of success over time?

Exhibit 3 shows little evidence that this has been the case. This chart shows the percentage of active managers that survive and beat their benchmarks over rolling three-year periods. These data show that there is no strong evidence of a link between the percentage of equity mutual fund assets in index funds and the percentage of active funds outperforming benchmark indices.

​Exhibit 3.      Active Manager Performance Has Not Improved
Percentage of Non-Index Equity Funds Outperforming for Three-Year Rolling Period, 2004–2018
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Lastly, in a world where index funds bias prices, we should expect to see evidence of such an impact across an index fund’s holdings. In other words, there should be more uniformity in the returns for securities within the same index as inflows drive prices up uniformly (and outflows drive prices down). Taking the S&P 500 Index as an example, however, we see that this has not been the case. The S&P 500 is a widely tracked index with over $9.9 trillion USD indexed or benchmarked to the index and with indexed assets comprising approximately $3.4 trillion USD of this total. Exhibit 4 shows that in 2008, a year of large net outflows and an index return of –37.0%, the constituent returns ranged from 39% to –97%. This exhibit also shows that in 2017, a year of large net inflows and a positive index return of 21.8%, the constituent returns ranged from 133.7% to –50.3%. We would also expect that constituents with similar weighting in traditional market cap-weighted indices would have similar returns. In 2017, Amazon and General Electric returned 56.0% and –42.9%, respectively, despite each accounting for approximately 1.5% of the S&P 500 Index.

Exhibit 4.     Range of S&P 500 Index Constituent Returns
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​Conclusion

Despite the increased popularity of index-based approaches, the data continue to support the idea that markets are working. Annual trading volume continues to be in line with prior years, indicating that market participant transactions are still driving price discovery. The majority of active mutual fund managers continue to underperform, suggesting that the rise of indexing has not made it easier to outguess market prices. Prices and returns of individual holdings within indices are not moving in lockstep with asset flows into index funds. Lastly, while naysayers will likely continue to point to indexing as a hidden danger in the market, it is important that investors keep in mind that index funds are still a small percentage of the diverse array of investor types. Investors can take comfort in knowing that markets are still functioning; willing buyers and sellers continue to meet and agree upon prices at which they desire to transact. It is also important to remember that while indexing has been a great financial innovation for many, it is only one solution in a large universe of different investment options.
All data is from sources believed to be reliable but cannot be guaranteed or warranted. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. No one should assume that any discussion or information contained in this material serves as a receipt of, or as a substitute for, personalized investment, tax or legal advice. Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

Appendix
The Index Boogyman
Derivative: A financial instrument whose value is based on an underlying asset or security.
Options Contract: An options contract is an agreement between two parties to facilitate a potential transaction on an underlying security at a preset price.
Futures: A financial contract obligating the buyer to purchase an asset or a seller to sell an asset at a predetermined future time and price.


Active Manager Performance Has Not Improved: Options, futures, and corporate action data are from Bloomberg LP. Options contact volume is the sum of the 2018 daily average put and call volume of options on the S&P 500 Index, Russell 2000 Index, MSCI EAFE Index, and MSCI Emerging Markets Index. Equity futures volume is equal to total 2018 futures volume traded divided by 252, where annual volume traded is estimated as the sum of monthly volume times month-end contract value for S&P 500 Mini futures, Russell 2000 Mini futures, MSCI EAFE Mini futures, and MSCI Emerging Markets Mini futures. IPO, seasoned equity offering, and share repurchase data are based on Bloomberg corporate actions data and include countries that are eligible for Dimensional investment.

Equity mutual fund outperformance percentages are shown for the three-year periods ending December 31 of each year, 2004–2018. Each sample includes equity funds available at the beginning of the three-year period. Outperformers are funds with return observations for every month of the three-year period whose cumulative net return over the period exceeded that of their respective Morningstar category index as of the start of the period. US-domiciled non-Dimensional mutual fund data is from Morningstar. Dimensional fund data provided by the fund accountant. Past performance is no guarantee of future results. For more methodology details, see the latest Mutual Fund Landscape brochure.

Range of S&P 500 Index Constituent Returns: Upper chart includes 2008 total returns for constituent securities in the S&P 500 Index as of December 31, 2007. Lower chart includes 2017 total returns for constituent securities in the S&P 500 Index as of December 31, 2016. Excludes securities that delisted or were acquired during the year. Source: S&P data ©2019 S&P Dow Jones Indices LLC, a division of S&P Global. For illustrative purposes only. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.


Source: Dimensional Fund Advisors LP.
Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Investing involves risks including possible loss of principal. Diversification does not eliminate the risk of market loss. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.

Getting to the Point of a Point

3/4/2019

 
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A quick online search for “Dow rallies 500 points” yields a cascade of news stories with similar titles, as does a similar search for “Dow drops 500 points.” These types of headlines may make little sense to some investors, given that a “point” for the Dow and what it means to an individual’s portfolio may be unclear. The potential for misunderstanding also exists among even experienced market participants, given that index levels have risen over time and potential emotional anchors such as a 500-point move do not have the same impact on performance as they used to. With this in mind, we examine what a point move in the Dow means and the impact it may have on an investment portfolio.

IMPACT OF INDEX CONSTRUCTION
The Dow Jones Industrial Average was first calculated in 1896 and currently consists of 30 large cap US stocks. The Dow is a price-weighted index, which is different than more common market capitalization-weighted indices.1

An example may help put this difference in weighting methodology in perspective. Consider two companies that have a total market capitalization of $1,000. Company A has 1,000 shares outstanding that trade at $1 each, and Company B has 100 shares outstanding that trade at $10 each. In a market capitalization-weighted index, both companies would have the same weight since their total market caps are the same. However, in a price-weighted index, Company B would have a larger weight due to its higher stock price. This means that changes in Company B’s stock would be more impactful to a price-weighted index than they would be to a market cap-weighted index.

The relative advantages and disadvantages of these methodologies are interesting topics themselves, but the main purpose of discussing the differences in this context is to point out that design choices can have an impact on index performance. Investors should be aware of this impact when comparing their own portfolios’ performance to that of an index.

HEADLINES VS. REALITY
Movements in the Dow are often communicated in units known as points, which signify the change in the index level. Investors should be cautious when interpreting headlines that reference point movements, as a move of, say, 500 points in either direction is less meaningful now than in the past largely because the overall index level is higher today than it was many years ago.
​
Exhibit 1 plots what a decline of this magnitude has meant in percentage terms over time. A 500-point drop in January 1985, when the Dow was near 1,300, equated to a nearly 39% loss. A 500-point drop in December 2003, when the Dow was near 10,000, meant a much smaller 5% decline in value. And a 500-point drop in early December 2018, when the Dow hovered near 25,000, resulted in a 2% loss.
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HOW DOES THE DOW RELATE TO YOUR PORTFOLIO?
While the Dow and other indices are frequently interpreted as indicators of broader stock market performance, the stocks composing these indices may not be representative of an investor’s total portfolio. For context, the MSCI All Country World Investable Market Index (MSCI ACWI IMI) covers just over 8,700 large, mid, and small cap stocks in 23 developed and 24 emerging markets countries with a combined market cap of more than $50 trillion. The S&P 500 Index includes 505 large cap US stocks with approximately $23.8 trillion in combined market cap.2 The Dow is a collection of 30 large cap US stocks with a combined market cap of approximately $6.8 trillion.3

Even though the MSCI ACWI IMI, S&P 500, and Dow are all stock market indices, each one tracks different segments of the market, so their performance can differ significantly over time, as shown in Exhibit 2. Since 1995, the Dow has outperformed the S&P 500 and MSCI ACWI IMI by an average of 0.5% and 3.3%, respectively (based on calendar year returns). However, relative performance in individual years can be much different. For example, in 1997, the Dow underperformed the S&P 500 by 8.4% but outperformed the MSCI ACWI IMI by 13.9%.
​
It is also important to note that some investors may be concerned about other asset classes besides stocks. Depending on investor needs, a diversified portfolio may include a mix of global stocks, bonds, commodities, and any number of other assets not represented in a stock index. A portfolio’s performance should always be evaluated within the context of an investor’s specific goals. Understanding how a personal portfolio compares to broadly published indices like the Dow can give investors context about how headlines apply to their own situation.
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CONCLUSION
News headlines are often written to grab attention. A headline publicizing a 500-point move in the Dow may trigger an emotional response and, depending on the direction, sound either exciting or ominous enough to warrant reading the article. However, after digging further, we can see that the insights such headlines offer may be limited, especially if investors hold portfolios designed and managed daily to meet their individual goals, needs, and preferences in a broadly diversified and cost-effective manner.
​
Appendix
1. Market capitalization is the product of price and shares outstanding. 
2. 500 companies are included in the S&P 500 Index. However, because some of these companies have multiple classes of stock that meet the requirements for inclusion, the total number of stocks tracked by the index is 505. 
3. Market cap data as of January 31, 2019.
Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered. investment advice or a solicitation to buy or sell securities. There is no guarantee an investing strategy will be successful. Investing involves risks including possible loss of principal. Diversification does not eliminate the risk of market loss. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Investment Fads Are Nothing New

2/17/2019

 
When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment opportunities. Over the years, these approaches have sought to capitalize on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short-term trends influence their investment approach may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a marketing idea every week.”

WHAT’S HOT BECOMES WHAT’S NOT
Looking back at some investment fads over recent decades can illustrate how often trendy investment themes come and go. In the early 1990s, attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan. A decade later, much was written about the emergence of the “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets. Similarly, funds targeting hot industries or trends have come into and fallen out of vogue. In the 1950s, the “Nifty Fifty” were all the rage. In the 1960s, “go‑go” stocks and funds piqued investor interest. Later in the 20th century, growing belief in the emergence of a “new economy” led to the creation of funds poised to make the most of the rising importance of information technology and telecommunication services. During the 2000s, 130/30 funds, which used leverage to sell short certain stocks while going long others, became increasingly popular. In the wake of the 2008 financial crisis, “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded. As investors reached for yield in a low interest rate environment in the following years, other funds sprang up that claimed to offer increased income generation, and new strategies like unconstrained bond funds proliferated. More recently, strategies focused on peer-to-peer lending, cryptocurrencies, and even cannabis cultivation and private space exploration have become more fashionable. In this environment, so-called “FAANG” stocks and concentrated exchange-traded funds with catchy ticker symbols have also garnered attention among investors.

THE FUND GRAVEYARD
Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess the market by constantly trading in and out of what’s hot is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world.

With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making the right call on a specific industry, region, or individual security over a specific period. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it.

It is important to remember that many investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured.

WHAT AM I REALLY GETTING?
When confronted with choices about whether to add additional types of assets or strategies to a portfolio, it may be helpful to ask the following questions:

​1. What is this strategy claiming to provide that is not already in my portfolio?

2. If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal?

3. Am I comfortable with the range of potential outcomes?

If investors are left with doubts after asking any of these questions, it may be wise to use caution before proceeding. Within equities, for example, a market portfolio offers the benefit of exposure to thousands of companies doing business around the world and broad diversification across industries, sectors, and countries. While there can be good reasons to deviate from a market portfolio, investors should understand the potential benefits and risks of doing so.
​
In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a financial advisor can help individual investors create a plan that fits their needs and risk tolerance. Pursuing a globally diversified approach; managing expenses, turnover, and taxes; and staying disciplined through market volatility can help improve investors’ chances of achieving their long-term financial goals.

CONCLUSION
Fashionable investment approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research and implementation may be the most reliable path to success in the global capital markets.
Appendix
Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. There is no guarantee an investing strategy will be successful. Diversification does not eliminate the risk of market loss.
​
Eugene Fama is a member of the Board of Directors of the general partner of, and provides consulting services to, Dimensional Fund Advisors LP. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Here's the Prescription

1/14/2019

 
As much as I value the unfettered access to information the internet provides, I recognize the potential harm that too much information can cause. Take, for example, a friend of mine, who was experiencing some troubling medical symptoms. Typing her symptoms into a search engine led to an evening of research and mounting consternation. By the end of the night, the vast quantity of unfiltered information led her to conclude that something was seriously wrong.

One of the key characteristics that distinguishes an expert is their ability to filter information and make increasingly refined distinctions about the situation at hand. For example, you might describe your troubling symptoms to a doctor simply as a pain in the chest, but a trained physician will be able to ask questions and test several hypotheses before reaching the conclusion that rather than having the cardiac arrest you suspected, you have something completely different. While many of us may have the capacity to elevate our understanding to a high level within a chosen field, reaching this point takes time, dedication, and experience.

My friend, having convinced herself that something was seriously wrong, booked an appointment with a physician. The doctor asked several pertinent questions, performed some straightforward tests, and recommended the following treatment plan: reassurance and education. Not surgery. Not drugs. But an understanding of why and how she had experienced her condition. The consultative nature of a relationship with a trusted professional—both when a situation arises and as we progress through life—is one of the key benefits that an expert can provide.

There are striking parallels with the work of a professional financial advisor. The first responsibility of the doctor or advisor is to understand the person they’re serving so that they can fully assess their situation. Once the plan is underway, the role of the professional is to monitor the person’s situation, evaluate if the course of action remains appropriate, and help to maintain the discipline required for the plan to work as intended.

Like my friend’s doctor, advisors may have experienced conversations with clients that are triggered by news reports or informed by unqualified sources. In some cases, all that is required to help put the client’s mind at ease is a reminder to focus on what is in their control as well as providing reassurance and (re)education that they have a financial plan in place that is helping them move toward their objectives. The benefits of working with the right advisor are demonstrated through the ability to both help clients pursue their financial goals and to help them have a positive experience along the way.

Trouble might arise when we confuse simple and complex conditions. Probably no harm is done when a person, recognizing the onset of a common cold, takes cold medicine, drinks plenty of fluids, and rests. But had my self-diagnosing friend not made an appointment with a specialist, and instead moved from self-diagnosis to self-medication, she may have caused herself real harm. Similarly, thinking that all aspects of your own financial situation can be handled through a basic internet search or casual conversation with a friend might result in a less than optimal financial outcome.
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Without the guidance of an advisor, the self-medicating investor might overreact to short-term market volatility by selling some of their investments. In doing so, they risk missing out on some of the best days since there is no reliable way to predict when positive returns in equity markets will occur.1 One might think that missing a few days of strong returns would not make much difference over the long term. But, as illustrated in Exhibit 1, had an investor missed the 25 single best days in the world’s biggest equity market, the US, between 1990 and the end of 2017, their annualized return would have dropped from 9.81% to 4.53%. Such an outcome can have a major impact on an investor’s financial “treatment” plan.
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Improving someone’s financial health is a lot like improving their physical health. The challenges associated with pursuing a better financial outcome include diagnosis of the current situation, development of the appropriate course of action, and sticking with the treatment plan. Many advisors are trained on the intricacies of complex financial situations and work to understand how their clients feel about money and how their clients might react to future events. By providing the prescription of reassurance and education over time, we believe the right advisor can play a vital and irreplaceable role in investors’ lives.
Article by David R. Jones EMEA and Vice President, Dimensional Fund Advisors
1. The 2018 Mutual Fund Landscape report compiled by Dimensional showed that for the 15-year period through 2017, only 14% of US equity mutual funds and 13% of US fixed income mutual funds survived and outperformed their benchmark after costs. Refer to us.dimensional.com/perspectives/mutual-fund-landscape-2018 for more information.
Dimensional makes no representation as to the suitability of any advisor, and we do not endorse, recommend, or guarantee the services of any advisor, including those in the Find an Advisor portion of our website. Investors should carefully and thoroughly evaluate any advisor whom they consider hiring or working with.
There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit. Results for other time periods, including shorter time periods, may include losses.

Why Should You Diversify?

12/17/2018

 
As 2019 approaches, and with US stocks outperforming non-US stocks in recent years, some investors have again turned their attention towards the role that global diversification plays in their portfolios. 
For the five-year period ending October 31, 2018, the S&P 500 Index had an annualized return of 11.34% while the MSCI World ex USA Index returned 1.86%, and the MSCI Emerging Markets Index returned 0.78%. As US stocks have outperformed international and emerging markets stocks over the last several years, some investors might be reconsidering the benefits of investing outside the US.

​While there are many reasons why a US-based investor may prefer a degree of home bias in their equity allocation, using return differences over a relatively short period as the sole input into this decision may result in missing opportunities that the global markets offer. While international and emerging markets stocks have delivered disappointing returns relative to the US over the last few years, it is important to remember that:

1. Non-US stocks help provide valuable diversification benefits. 2. Recent performance is not a reliable indicator of future returns. 

2. Recent performance is not a reliable indicator of future returns. 

​
There’s a World of Opportunity in Equities
The global equity market is large and represents a world of investment opportunities. As shown in Exhibit 1, nearly half of the investment opportunities in global equity markets lie outside the US. Non-US stocks, including developed and emerging markets, account for 48% of world market capitalization and represent thousands of companies in countries all over the world. A portfolio investing solely within the US would not be exposed to the performance of those markets. 

Exhibit 1. World Equity Market Capitalization 
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The Lost Decade
We can examine the potential opportunity cost associated with failing to diversify globally by reflecting on the period in global markets from 2000–2009. During this period, often called the “lost decade” by US investors, the S&P 500 Index recorded its worst ever 10­year performance with a total cumulative return of –9.1%. However, looking beyond US large cap equities, conditions were more favorable for global equity investors as most equity asset classes outside the US generated positive returns over the course of the decade. (See Exhibit 2.) Expanding beyond this period and looking at performance for each of the 11 decades starting in 1900 and ending in 2010, the US market outperformed the world market in five decades and underperformed in the other six. This further reinforces why an investor pursuing the equity premium should consider a global allocation. By holding a globally diversified portfolio, investors are positioned to capture returns wherever they occur.

Exhibit 2. Global Index Returns, January 2000–December 2009 
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Pick a Country?
Are there systematic ways to identify which countries will outperform others in advance? Exhibit 3 illustrates the randomness in country equity market rankings (from highest to lowest) for 22 different developed market countries over the past 20 years. This graphic conveys how difficult it would be to execute a strategy that relies on picking the best country and the resulting importance of diversification. 

Exhibit 3. Equity Returns of Developed Markets 
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In addition, concentrating a portfolio in any one country can expose investors to large variations in returns. The difference between the best­ and worst‐performing countries can be significant. For example, since 1998, the average return of the best‐performing developed market country was approximately 44%, while the average return of the worst­ performing country was approximately –16%. Diversification means an investor’s portfolio is unlikely to be the best or worst performing relative to any individual country, but diversification also provides a means to achieve a more consistent outcome and more importantly helps reduce and manage catastrophic losses that can be associated with investing in just a small number of stocks or a single country. 
​
A Diversified Approach
Over long periods of time, investors may benefit from consistent exposure in their portfolios to both US and non‐US equities. While both asset classes offer the potential to earn positive expected returns in the long run, they may perform quite differently over short periods. While the performance of different countries and asset classes will vary over time, there is no reliable evidence that this performance can be predicted in advance. An approach to equity investing that uses the global opportunity set available to investors can provide diversification benefits as well as potentially higher expected returns. 


Appendix
[1]. The total market value of a company’s outstanding shares computed as price times shares outstanding.
[2]. Source: Annual country index return data from the Dimson-­Marsh­-Staunton (DMS) Global Returns Data, provided by Morningstar, Inc.

World Equity Market Capitalization: As of December 31, 2017. Data provided by Bloomberg. Market cap data is free­-float adjusted and meets minimum liquidity and listing requirements. China market capitalization excludes A­-shares, which are generally only available to mainland China investors. For educational purposes; should not be used as investment advice.
Global Index Returns: S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2018, all rights reserved. Indices are not available for direct investment. Index performance does not reflect expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.
Equity Returns of Global Markets: Source: MSCI country indices (net dividends) for each country listed. Does not include Israel, which MSCI classified as an emerging market prior to May 2010. MSCI data © MSCI 2018, all rights reserved. Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. 
Source: Dimensional Fund Advisors LP. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision 

Midterm Elections: What Do They Mean for Markets?

11/5/2018

 
​It’s almost Election Day in the US once again. For those who need a brief civics refresher, every two years the full US House of Representatives and one-third of the Senate are up for reelection.

While the outcomes of the elections are uncertain, one thing we can count on is that plenty of opinions and prognostications will be floated in the days to come. In financial circles, this will almost assuredly include any potential for perceived impact on markets. But should long-term investors focus on midterm elections?

MARKETS WORK
We would caution investors against making short-term changes to a long-term plan to try to profit or avoid losses from changes in the political winds. For context, it is helpful to think of markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that incorporate the aggregate expectations of those investors. This makes outguessing market prices consistently very difficult.[1] While surprises can and do happen in elections, the surprises don’t always lead to clear-cut outcomes for investors.
The 2016 presidential election serves as a recent example of this. There were a variety of opinions about how the election would impact markets, but many articles at the time posited that stocks would fall if Trump were elected.[1] The day following President Trump’s win, however, the S&P 500 Index closed 1.1% higher. So even if an investor would have correctly predicted the election outcome (which was not apparent in pre-election polling), there is no guarantee that they would have predicted the correct directional move, especially given the narrative at the time.
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But what about congressional elections? For the upcoming midterms, market strategists and news outlets are still likely to offer opinions on who will win and what impact it will have on markets. However, data for the stock market going back to 1926 shows that returns in months when midterm elections took place did not tend to be that different from returns in any other month.
​
Exhibit 1 shows the frequency of monthly returns (expressed in 1% increments) for the S&P 500 Index from January 1926–August 2018. Each horizontal dash represents one month, and each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months where returns were between 1% and 2%). The blue and red horizontal lines represent months during which a midterm election was held, with red meaning Republicans won or maintained majorities in both chambers of Congress, and blue representing the same for Democrats. Striped boxes indicate mixed control, where one party controls the House of Representatives, and the other controls the Senate, while gray boxes represent non-election months. This graphic illustrates that election month returns were well within the typical range of returns, regardless of which party won the election. Results similarly appeared random when looking at all Congressional elections (midterm and presidential) and for annual returns (both the year of the election and the year after).

Exhibit 1. Midterm Elections and S&P 500 Index Returns, Histogram of Monthly Returns
January 1926–August 2018
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Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

​IN IT FOR THE LONG HAUL
While it can be easy to get distracted by month-to-month or even one-year returns, what really matters for long-term investors is how their wealth grows over longer periods of time. Exhibit 2 shows the hypothetical growth of wealth for an investor who put $1 in the S&P 500 Index in January 1926. Again, the chart lays out party control of Congress over time. And again, both parties have periods of significant growth and significant declines during their time of majority rule. However, there does not appear to be a pattern of stronger returns when any specific party is in control of Congress, or when there is mixed control for that matter. Markets have historically continued to provide returns over the long run irrespective of (and perhaps for those who are tired of hearing political ads, even in spite of) which party is in power at any given time.
 
Exhibit 2. Hypothetical Growth of $1 Invested in the S&P 500 Index and Party Control of Congress
January 1926–August 2018
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Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
​Equity markets can help investors grow their assets, and we believe investing is a long-term endeavor. Trying to make investment decisions based on the outcome of elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, to pursue investment returns. 
Source: Dimensional Fund Advisors LP.
Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.

There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.
All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.
​[1]. This is known as the efficient market theory, which postulates that market prices reflect the knowledge and expectations of all investors and that any new development is instantaneously priced into a security.
[2]. Examples include: “A Trump win would sink stocks. What about Clinton?” CNN Money, 10/4/16, “What do financial markets think of the 2016 election?” Brookings Institution, 10/21/16, “What Happens to the Markets if Donald Trump Wins?” New York Times, 10/31/16.

Calculating the Value of Advice

9/5/2018

 

​What do attorneys, psychiatrists, tax & financial professionals all have in common? While it may feel like a punchline is coming, what I’m referring to is what they offer. Their primary product is intellectual capital, something intangible that we can’t necessarily feel or touch. Patients/clients are tasked with quantifying the value of it. The question is: How? I could argue the following insight is applicable to lots of professions, but coming from a guy who runs a wealth management firm, I’ll keep this commentary on the financial side of the spectrum. Numerous studies have been conducted in an attempt to broadly measure the monetary benefits of working with an advisor. Here, I’ll walk through a simple critical thinking exercise, purely designed to help investors make informed decisions.

First, it’s important to point out the human element. Based on our experiences, we all have biases when it comes to interpreting value. Most of us possess situational skepticism’s thanks in part to a daily dosage of fly-by-night quick fixes, aimed at lightening our pockets. If you believe that all physiatrists are quacks, all lawyers are ambulance chasers, or all financial services professionals are salespeople, you probably have a preconception which will inevitably factor into how you value their advice.

Personal Due Diligence: A Litmus Test for Seeking Financial Advice
  1. Do I have the experience to independently handle the complexities of my complete financial situation?
  2. Do I have the time to research, apply, monitor and adjust my planning and investment portfolio?
  3. Do I have the desire to do so?
  4. Do I have the long-term discipline to independently make prudent decisions not based on emotion?
  5. Finally, do I have confidence that a contingency (someone in place of me) has the experience, time, desire and discipline?
 
Let’s break those down a bit further.
 
Experience: The question really isn’t whether or not you can do it yourself. The question that’s more applicable is can you do it “well”? The biggest challenge I commonly see with do-it-yourself investors stems from understanding how and why financial planning and investment management are related. After analyzing thousands of portfolios through the years, here are some of the most common deficiencies in no particular order.
  • A lack of relationship between asset allocation and long-term goals
  • A thorough understanding of each position in the portfolio and how it interacts with other holdings
  • True awareness of overall costs including internal expense ratios and trading fees
  • An absence of appropriate levels of diversification needed to alleviate risk

Time: Markets and investment vehicles are constantly evolving. Therefore, investment portfolios should evolve as well. We’re always learning more about expected return and where it comes from. As we do, investment providers are quick to adapt, offering solutions with incremental improvements. The problem is, there’s lots of them. At last check, there were around 7,000 mutual funds and over 2,000 ETF’s (Exchange Traded Funds) in existence.

This underscores the importance of recognizing that financial planning isn’t a one-time thing but an ongoing event that requires adjustment with life events. Investments, taxation, insurance and estate planning all need to be working in concert. Collectively, this amounts to a lot more time than many realize, which often leads to a lack of attention.

Desire: Does the on-going, in-depth examination of your financial situation interest you or not? If you don’t enjoy working on cars, you’re probably not keen on repairing your own transmission. The concept of hiring professionals in different capacities effectively allows us to spend time doing what we enjoy, or what we do best.
​
Discipline: This goes way beyond the idea of having someone there to hold your hand. Yes, psychology plays a role. However, discipline runs deeper than simply resisting reactions to every market movement. We know it applies to investing, but it must also apply to financial planning. Purchasing a home, having a child, changing jobs, marriage, college, retirement etc. are life events that require sound financial adjustments.
 
When it comes to managing your portfolio, the behavioral impact on investing is well documented. It’s easy enough to say, “disciplined investors have historically been rewarded for maintaining that discipline.” However, doing so requires not only a steady hand but also a dedicated understanding of capital markets and how a host of different scenarios affect your unique situation. We've been through around half a dozen bull and bear markets over the last 30 years. Needless to say, long-term investors are likely to experience a bunch of them over a lifetime. 
Net New Cash Flow to Equity Mutual Funds Typically Is Related to World Equity Returns
Monthly, 2002-2017
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Net new cash flow is the percentage of previous month-end equity mutual fund total net assets, plotted as a six-month moving average. The total return on equities is measured as the year-over-year percent change in the MSCI All Country World Daily Gross Total Return Index. Sources: Investment Company Institute, MSCl, and Bloomberg
The history of mutual fund cash flows through the years paints a difficult picture for investor behavior. In 2008, we saw large outflows in equity mutual funds right around the bottom of the market. Subsequently, we saw positive cash flows in the ladder part of 2009 and into 2010 long after markets went into recovery mode. Remember the age old adage about being a successful investor “Buy Low, Sell High”? Well, the opposite often happens and emotional discipline is frequently the culprit.  

Contingency: Confidence in all of the above isn’t enough to ensure a favorable outcome. Many overlook the capacity of their heirs to make sound decisions in the event that they no longer can. Death, disability or incapacity impacts everyone. Prudence dictates an analysis of capable contingencies.

Professional Due Diligence: Aptitude, Delivery, Services, Comparatives
When weighing the value of financial advice, it’s critical to understand the substantial differences between types of financial advisors. Many lack the credentials or even legal authority qualify what they offer as advice in the first place. Brokers are not advisors and Fee-Based is not the same as Fee-Only. Here, I’ll focus on Fee-Only fiduciary advice, the industry standard for placing the clients’ interests first 100% of the time.

Aptitude: This encompasses the combination of experience, education, and reputation.
Experience: In finance, there’s little substitute for the seasoned experience an advisor receives through a variety of different market cycles and with a variety of different types of clients.
Education: Undergraduate business degree’s and MBA’s demonstrate a commitment to education. Industry designations such as CFP® (Certified Financial Planner) or CFA (Chartered Financial Analyst) further indicate levels of expertise.
Reputation: Any due diligence should begin with a baseline evaluation of regulatory history (run a background check). Also, look for specific examples of expertise. Many advisors are active contributors to media outlets. Read columns or interviews to get insight into their investment philosophy or planning approach. Tip: Start with the firm’s website.

Services: Carefully understanding what’s included and what isn’t is essential because service offerings are all over the map. Does the advisor provide one-time financial planning services, ongoing investment management services, the combination of both? How much access do you have to professionals? What types of reports and online access do you receive?

Delivery: How do you want to interact with an advisor? There’s a cost to doing business. Face to face interaction is costlier than email, phone or video. Therefore, it’s reasonable to expect a premium on face to face interaction.

Comparatives: After determining what’s included and what isn’t you can then analyze the market rate for these services.  Recent study
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Conclusion
A comprehensive approach to quantifying value helps to diligently explore elements that often get overlooked. Investors should strive to understand themselves, their strengths and limitations before jumping straight into the evaluation of an advisory firm. Starting off with a basic Litmus test helps to solidify the rationale for seeking or not seeking advice. It’s about placing a timeline of personal due diligence in front of professional due diligence with the goal of making informed decisions.

The Most Dangerous Investment Phrases

8/9/2018

 
​Our daily lives are crammed with punchlines and parables. Investing has a language of sayings and catchphrases of its own. Some encourage action, others espouse knowledge. This column highlights some of the more well known. Good, bad or indifferent.

The Hazardous

We begin with what Sir John Templeton called “The four most dangerous words in investing: 'this time it's different.’” There are different interpretations of the quote but most regularly it applies to ignoring history at your own peril. When in reference to the stock market, there’s always going to be unforeseen ups and downs but overtime more ups than downs. Long term disciplined investors have historically been rewarded for maintaining that discipline despite the opinions of pundits and prognosticators.

Buy low, sell high. It’s probably the most simplistic expression, yet the most difficult in practical application. Namely, buying when things appear bleakest and selling when things look great isn’t exactly a natural human inclination. In fact, looking at equity mutual fund cash flows through the years, exactly the opposite is the tendency. The last market downturn saw massive outflows in 2008, reversing course in the ladder part of 2009 well after markets went into recovery mode.

I got in early. Usually, you see this in reference to a perceived new investment idea. The issue is, it’s almost impossible to quantify the statement thanks to the speed at which information travels and is incorporated into prices. Simply put, an investor really has no way of knowing if they got in early and should most often work under the assumption that prices reflect all available information. Similarly, “Buy the rumor, sell the news” speaks to speculation on what could happen, while failing to comprehend how much of the “rumor” has already been factored into current prices.

“I’m waiting for the pullback” suggests that prices in some way are inaccurate and an investor has the foresight to time the market perfectly in order to take advantage of a subsequent uptick. The perils of attempting to time the market are well documented. The problem is making a single accurate decision isn’t nearly good enough. To be a successful an investor would have to decide when to get in and when to get out multiple times over an investment lifetime.

The trend is your friend. That is of course until it’s not, meaning- keep buying when it appears to be going up and start selling when it goes down. One of the biggest mistakes investors make is failing to recognize that markets operate on “news” which by definition is unpredictable or else it wouldn’t be news. Essentially, there’s no way of knowing what is a trend and what isn’t.

It’s a market of stocks, not a stock market. This classic day trader proverb implies that you can always make money providing you pick the right stocks. The issue with stock speculation is the evidence of long term success isn’t remotely on the side of active traders.

Bulls make money, bears make money, pigs get slaughtered. This demonstrates an active trader’s mentality that superior skill can make money in any market, but only within the confines of their own greed. Again, we see speculation on when to get in and when to get out, a short term mentality that requires the daunting task of accurately identifying when a stock is over or underpriced.  

On the flip side: Here’s some of the wisest
I’d compare stock pickers to astrologers but I don’t want to bad mouth astrologers. Rarely at a loss for words, the father of modern finance and Nobel Prize winner Eugene Fama speaks to the difficulties in identifying stock miss pricings. Based on decades of data, studies have shown that the average actively managed dollar is far more likely to underperform the average passively managed dollar.

Warren Buffet is probably the most quoted investor of our time with gems like “When the tide goes out, you see who’s swimming naked” in reference to having a lack of diversification in your portfolio when markets pull back. In these instances, concentrated exposures in any one specific investment can spell disaster for a portfolio. Other Buffet favorites include: “The most important quality for an investor is temperament, not intellect” and “Be fearful when others are greedy. Be greedy when others are fearful" both speaking to the well-known emotional tendencies of investors. Above all, patience and levelheadedness are two attributes that investors should hold in the highest regard.

John Maynard Keynes’s famous line “Markets can stay irrational longer than you can stay solvent” has been used to describe a variety of scenarios not limited to the disposition of investors and the unpredictable nature of markets. We’ve been through five different bull and bear markets over the last 27 years, each with significant variations in how long they lasted.

Author of “The Intelligent Investor,” value investing pioneer Benjamin Graham spoke to "The investor's chief problem, even his worst enemy, is likely to be himself." Most investors have emotional attachments to hard earned money, which can lead to decisions that are detrimental to long term success. He also thought that “To be an investor you must be a believer in a better tomorrow.” It’s a basic prerequisite to believe that advancements in technology, standards of living, and ultimately profits will rise over time. Without this ideology, there would simply be no reason to invest.

Index Investing pioneer and Vanguard founder John Bogle provided some simplistic advice in reference to having all your exposure to stocks "If you have trouble imagining a 20% loss in the stock market, you shouldn't be in stocks". It’s critical to thoroughly understand your risk tolerance for market fluctuation. As your exposure to stocks increases, generally speaking, so does the level of risk in your portfolio. An investor should never take more risk than they can sleep with at night.  

Nobel laureate Paul Samuelson felt "Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas." There’s a difference between investing and speculating. The whole idea of being an investor is to grow assets over the long term. Aligning long term investment growth with short term entertainment isn’t a heck of a lot different than gambling.

Finally, a few warnings about the wisdom of Wall Street and giving too much credence to media pundits. “There seems to be an unwritten rule on Wall Street: If you don’t understand it, then put your life savings into it.” - Peter Lynch
Many of the financial products coming out of Wall Street over the years are bought and sold on the premise of being the next hot thing. As rule of thumb, you should always know how your money is invested, complete with a thorough understanding of the potential risk, fee’s and liquidity associated with any investment vehicle.

And Ex-Daily show host John Stewart on the 2008 market downturn: “If I’d only followed CNBC’s advice, I’d have a million dollars today. Provided I’d started with a hundred million dollars.” Don’t’ put too much stock in the daily commentary from talking heads whose job is to keep you reading, listening or watching. Instead, focus on your unique situation and look for help from qualified professionals who have your best interest in mind.

It’s certainly not a comprehensive list but I hope you enjoyed it. The next time you hear one of these phrases remember to keep it in the proper context.

The Impact of Inflation

6/4/2018

 
​When the prices of goods and services increase over time, consumers can buy fewer of them with every dollar they have saved.
​This erosion of the real purchasing power of wealth is called inflation. Inflation is an important element of investing. In many cases, the reason for saving today is to support future spending. Therefore, keeping pace with inflation is a crucial goal for many investors. To help understand inflation’s impact on purchasing power, consider the following illustration of the effects of inflation over time. In 1916, nine cents would buy a quart of milk. Fifty years later, nine cents would only buy a small glass of milk. And more than 100 years later, nine cents would only buy about seven tablespoons of milk. How can investors potentially prevent this loss of purchasing power from inflation over time?
Exhibit 1. Your Money Today Will Likely Buy Less Tomorrow
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In US dollars. Source for 1916 and 1966: Historical Statistics of the United States, Colonial Times to 1970/US Department of Commerce. Source for 2017: US Department of Labor, Bureau of Labor Statistics, Economic Statistics, Consumer Price Index—US City Average Price Data.
Investing for the long term and other “tips”
As the value of a dollar declines over time, investing can help grow wealth and preserve purchasing power. Investors should know that over the long haul stocks have historically outpaced inflation, but there have also been short-term stretches where this has not been the case. For example, during the 17-year period from 1966–1982, the return of the S&P 500 Index was 6.8% before inflation, but after adjusting for inflation it was 0%. Additionally, if we look at the period from 2000–2009, the so-called “lost decade,” the return of the S&P 500 Index dropped from –0.9% before inflation to –3.4% after inflation.
​
Despite some periods where stocks have failed to outpace inflation, one dollar invested in the S&P 500 Index in 1926, after accounting for inflation, would have grown to more than $500 of purchasing power at the end of 2017 and would have significantly outpaced inflation over the long run. The story for US Treasury bills (T-bills), however, is quite different. In many periods, T-bills were unable to keep pace with inflation, and an investor would have experienced an erosion of purchasing power. After adjusting for inflation, one dollar invested in T-bills in 1926 would have grown to only $1.51 at the end of 2017.
Exhibit 2. Growth of $1, 1926–2017
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S&P and Dow Jones data © 2018 Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Past performance is no guarantee of future results. Actual returns may be lower. Inflation is measured as changes in the US Consumer Price Index.
While stocks are more volatile than T-bills, they have also been more likely to outpace inflation over long periods. The lesson here is that volatility is not the only type of risk that should concern investors. Ultimately, many investors may need to have some of their allocation in growth investments that outpace inflation to maintain their standard of living and grow their wealth.

One additional tool available to investors who are concerned about both stock market volatility and inflation are Treasury Inflation-Protected Securities (TIPS). TIPS are guaranteed by the US Treasury and as such are considered by the marketplace to have low risk of default. The Treasury issues TIPS with a variety of maturities, and these securities are easily bought and sold. Unlike traditional Treasury securities such as T-bills, TIPS are indexed to inflation to protect investors from an erosion in purchasing power. As inflation (measured by the consumer price index) rises, so does the par value of TIPS, while the interest rate remains fixed. This means that if inflation unexpectedly rises, the purchasing power of any principal invested in TIPS should also increase.[1] Although they may not offer the long-term growth opportunities that stocks do, their structure makes TIPS an effective risk management tool for investors who are concerned with managing uncertainty around future purchasing power.

Conclusion
Inflation is an important consideration for many long-term investors. By combining the right mix of growth and risk management assets, investors may be able to blunt the effects of inflation and grow their wealth over time. Remember, however, that inflation is only one consideration among many that investors must contend with when building a portfolio for the future. The right mix of assets for any investor will depend upon that investor’s unique goals and needs. A financial advisor can help investors weigh the impact of inflation and other important considerations when preparing and investing for the future.
[1]. Market prices incorporate market participants’ expectations about the future. Therefore, market participants’ expectations about future inflation should be incorporated into current prices. These expectations are referred to as expected inflation. Unexpected inflation refers to unexpected changes in inflation that deviate from prior market expectations. Unexpected inflation should be considered a primary driver of inflation risk. 
Source: Dimensional Fund Advisors LP. Past performance is not a guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit. All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.
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    By Tim Baker, CFP®

    Advice and investment design should rely on long term, proven evidence. This column is dedicated to helping investors across the country, from all walks of life to understand the benefits of disciplined investing and the importance of planning.

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