This is the eighth of a ten-part series where we look at Haven’s Ten Commandments, a short list of investing fundamentals we like to teach to our clients. It’s nothing too fancy, but a good foundation we believe everyone should understand.
In previous posts, we’ve established that according to Dr. David Swensen, asset allocation accounts for 90% of your overall portfolio performance. We also talked about how timing and rebalancing account for some of the remaining 10%, and now we will talk about what makes up the rest of that 10%: selection and factors.
Maybe it’s because I like math, but the way I think about it, is quite simply, how does one get the number 9? You could add 1+1+1+1+1+1+1+1+1=9, multiply 3×3=9, or add 4+5=9, and so on and so on. There’s a lot of ways anyone could complete any task, and that includes investing. Just like getting to 9, there are more efficient ways than others, multiplying is more efficient than adding. There’s not necessarily a right and a wrong way, but there are ways more efficient or effective than others.
Warren Buffett, who is today’s most famous and successful investor had long ago adopted the strategy of ‘fundamental value investing’. Value investing is the practice of finding out what a company is actually worth. You combine variables like assets, debts, revenue, industry, and outlook to put a valuation on the company. By multiplying the current share price by the number of shares you get the market capitalization, or what the market values the company. If you think a company is worth more than its market cap, you would expect prices to eventually go up so it’s a good time to buy. If you find a company isn’t worth its market cap it is either a time to sell (if you hold shares) or not to buy.
Common sense says that the market cap should always reflect what a company is worth, but in truth it rarely does, and that’s how bubbles are formed. Bubbles are quick increases in value without any real catalyst. Mostly it’s excitement over a new industry or technology (DotCom bubble, cryptocurrency, weed stocks, etc.) that causes shares to skyrocket without any real news or company developments.
Other less publicized strategies include: dividend investing (investing in companies that offer regular high yielding dividends and reinvesting into the company), size (investing in smaller, riskier companies that can offer higher returns), momentum (investing in the latest hot stocks and emerging markets to capture quick growth), amongst countless others.
There’s not necessarily right and wrong way to invest, but there are ways to invest that are more proven or backed by historical success. By being able to specialize in one or more of these strategies allows you to be in a position that will help you squeeze the most out of your investments. Again, it is small in comparison to asset allocation, but if you ask anyone I’m sure they’d all agree they would take on anything that will help them make the most of their investments. Putting yourself in your more advantageous position is essentially putting yourself in a position to get the best return possible — and since it requires no real extra work, it’s free money.