What No One on Wall Street Will Tell You About Investing


While Wall Street is often viewed as the center of the investment universe, a far less exciting – but potentially more powerful – environment exists in the halls of academia. In this environment, professors at schools like Wharton, Yale, MIT, Stanford and the University of Chicago examine decades of financial data in search of patterns and explanatory variables.

Many Americans think of investing as being synonymous with Wall Street, a powerful global symbol of finance and capitalism. At best, that may conjure up images of well-educated, professional money managers poring over company reports to identify the best investments for their clients. At worst, it may spawn memories of unscrupulous characters in movies like Boiler Room or Wall Street trying to get rich at the expense of others. The basic premise is the same — the smartest, hardest-working, or fastest-acting investors have an advantage. They will achieve superior returns, while Mr. and Mrs. Smith, who don’t have access to such expert resources, will lag behind.

But while Wall Street is often viewed as the center of the investment universe, a far less exciting — but potentially more powerful – environment exists in the halls of academia. In this environment, professors at schools like Wharton, Yale, MIT, Stanford and the University of Chicago examine decades of financial data in search of patterns and explanatory variables. Unlike brokerage firms and other financial companies whose existence depends on selling something to someone, these academic practitioners have no vested interest in the outcome of their research. Testing new theories and uncovering new explanations for how financial markets behave – i.e. the pursuit of knowledge – is their ultimate purpose.

Within this vast universe of academic research, some powerful principles have emerged that may provide investors with a roadmap for a more successful investment experience:

1) Broad diversification offers advantages over more concentrated strategies.

2) Professional money managers in general do not produce excess returns sufficient to overcome the higher fees that they charge.

3) “Market-timing,” tactical allocation and other attempts to rapidly adjust portfolio exposures in response to changing market conditions typically fail to deliver on expectations.

4) Taking targeted exposures to certain risk factors — namely value, size, volatility, quality and momentum – may offer higher returns over time.

5) Costs matter.

Broad Diversification

Investment portfolios consist of a variety of financial assets, some that behave very similarly, and some that act very differently from one another. In investing-speak, assets that tend move in the same direction and magnitude are said to be “highly correlated”. Academic research has consistently established the benefits of including assets that are not correlated with one another — such that when one part of the portfolio is doing poorly, another part will likely be faring better. Further, it is important to periodically reexamine the investment mix and to adjust portfolio weightings back to the desired exposures. This periodic rebalancing ensures that the investor’s desired risk and return characteristics are maintained as markets ebb and flow, and that asset drift does not result in unintended and unwanted portfolio exposures.

Professional Money Managers Fall Short

A host of academic studies have evaluated the performance of professional money managers — these include William Sharpe (1966), Burton Malkeil (1995), Michael Jensen (1967) and Mark Carhart (1997). Each of these studies concluded that professional managers, in general, fail to exhibit any ability to outperform an appropriate benchmark, especially after fees and expenses.

Tactical Management Fails to Deliver

In a 2010 whitepaper “A Primer on Tactical Asset Allocation (TAA) Strategy Evaluation,” Vanguard concluded that “Our results show that while some TAA strategies have added value, on average, TAA strategies have not consistently produced excess returns.”

Factor-Based Investing

Led by the Nobel Prize-winning research of Eugene Fama and others, factor-based investing has become a widely accepted investment philosophy in academic and institutional circles. Factor investing is an investment process that aims to harvest higher expected returns that research has indicated may be offered by certain “factors,” which are defined as characteristics relating a group of securities that are important in explaining their return and risk. The factors identified in the research include value, size, volatility, quality and momentum. Embracing a factor-based approach — as opposed to the traditional Wall Street approach based on forecasts, predictions and guesswork – may help investors make informed decisions about various investment approaches and allow for improved investment results over time.

Costs Matter

In its 2010 research paper “How Expense Ratios and Star Ratings Predict Success”, highly-regarded, independent research firm Morningstar concluded “How often did it pay to heed expense ratios? Every time.”

There is no doubt that for 2 identical investments, the one with lower expenses will deliver a higher return than one with higher expenses. That is not a bold prediction, it’s just math. Yet in a world where hedge funds and other exotic investments dominate the headlines, the importance of fees is oftentimes lost in the hopes and dreams of capturing outsized returns.

An Investor Has Choices

Whether an investor is working with a financial adviser, or managing their assets themselves, evaluating their goals and expectations, being realistic about what results are achievable, and understanding their financial personality traits offer a solid foundation for achieving their goals. If working with an adviser, it may be advantageous to seek one such with credentials such as the CFA or CFP that will work in a fiduciary capacity on your behalf — i.e. one who must put your interests ahead of their own – rather than a financial salesperson who is held to a lesser standard. In addition, an adherence to the academic principles outlined above may help to further tilt the odds of success in your favor.

H. William Wolfson, DC, FICC, MS, MPAS is a financial consultant and advisor. After passing the rigorous Certified Financial Planner examination, Dr. Wolfson obtained a Master of Science in Personal Financial Planning from the College for Financial Planning. He was subsequently awarded by the College a Master Planner Advanced Studies. Dr. Wolfson is a member of the Financial Planning Association (FPA). Dr. Wolfson retired after 27 years of active practice and remains active volunteering his expertise to the continued education and success of professional colleagues and investors. Dr. Wolfson may be contacted at drhwwolfson@gmail.com.

John Blood, CFA, CFP earned both MBA and Master of Science in Finance degrees from Boston College, as well as a BS degree in engineering from Rensselaer Polytechnic Institute. John began his investment career as an analyst for Morningstar, Inc., one of the most respected, independent investment research firms in the country. He then spent 10 years as director of research and chief market strategist for Commonwealth Financial Network, the nation’s largest privately held broker/dealer, where he provided investment guidance to advisors with more than $50 billion in assets under management. Most recently, he served for 3 years as vice president and head of broker/dealer distribution for Dimensional Fund Advisors. He founded Disciplined Wealth Strategies to share the knowledge and wisdom he has acquired throughout his extensive investment career. He may be contacted at john@dwswealth.com.