When the storms of economic and geopolitical strife hit, the foundations of your investment strategy truly get tested. If the expectations for your Investment Strategy are disconnected from reality, uncertainty will abound and costly decisions will follow. As a fiduciary, we must provide the best evidence-backed answers to all investment questions, to ensure that we are doing the best for those we take care of and for the public in general. When we lecture at the University of Florida, we make a point to instruct students that investment strategy cannot be deductively reasoned. That is, we cannot arrive at a true or false conclusion declaring which investment strategy will always be best. We must instead arrive at a probabilistic conclusion, which tells us whether a strategy is more or less likely to outperform other strategies over the long-term. Probabilistic conclusions should only be reached after careful examination of all of the available history, data, and evidence on investing strategies. After evaluation, time-tested and proven long-term investment strategies emerge and they are listed below.

It should immediately be noted that owning one stock (or a few), is not a successful long-term strategy on average and should not be employed. It is listed here because many people tend to start their investing journey by purchasing a few individual stocks, so it serves as a useful comparison to the more successful long-term strategies. All of the strategies except for dual momentum are buy and hold, where the portfolio is set up at the start and then left alone through thick and thin. In contrast, the dual momentum strategy systematically makes trades, moving from stocks to bonds, or from one asset class to another. All of the strategies have upsides and downsides and all of the strategies except for owning one stock are viable to use as a long-term strategy. From the chart, we can see that Dual Momentum is the best long-term strategy overall, as it offers the best performance and the least risk. We keep using the word long-term because it is the most accurate way to assess whether or not an investment strategy is worth using. However, many people do not use long enough time periods when selecting investment strategies, and this is a major reason why they underperform. 

To illustrate the importance of using a long-term evaluation period, we will use the data from the table above to run a Monte Carlo simulation, which is a mathematical technique used to estimate the probability of 10,000 different outcomes, ranging from very bad economic environments to very good ones. We will run these simulations over several testing periods, 1 year, 5 years, and 45 years. We will present them in that order, from the very short term to the very long-term. This analysis will reveal that focusing on the short term can lead to incorrect conclusions and can make underperformance far more likely. 

Let’s look at the chart below for the probable outcomes of the various investment strategies during a 1 year period. The dollar value is the median return and the blue rectangle is the standard deviation from the average, which indicates the most likely range of outcomes from the bottom 10% to the top 10%. The better the strategy, the further to the right the bottom 10% is and the higher the median return. (Less risk and more return)

From the chart, it’s clear that owning one stock is the riskiest strategy and also the one that offers the highest upside, while its median return is about the same as most of the other strategies. If you were feeling confident in your stock picking, you might choose to invest in one stock, as it offers the best potential top 10% return. If you fancy yourself as a great stock picker, you will generally ignore the risk of potentially ending up in the bottom 10%. The Dual Momentum strategy, which was best over the long-term is also still the best here, as it offers the least risk and best median return. However, the differences in performance seem quite small and any one of these strategies could be the best during a 1 year time period, as each one will excel and/or struggle depending on the environment. If you simply used a 1 year time period to choose your investment strategy, you might not feel like there is a big difference between the strategies over the long run and perhaps it is worth the risk of trying to hit a home run by picking the right stock or perhaps it best to switch from one strategy to another depending on the year. Let’s look at a 5-year time period to see what we can glean.

Over a 5-year time period, which some people incorrectly consider to be a long time,  the ranking of median return remains nearly the same and some of the bottom 10% values would still leave you with almost no return. (This means that it is quite possible to have a proven long-term strategy not make a positive return over 5 years.) Owning one stock still offers the highest possible top 10% result, but carries with it the lowest bottom 10%, and the lowest median value.  Dual Momentum is once again the best overall strategy with the highest expected return and least risk. However, looking at the variance represented by the blue rectangles, it is still quite likely for any of the strategies to beat the other ones during this short time frame. This could once again lead you to believe that switching to whichever strategy is hot might be the best way to go. Let’s look at the performance of these strategies during a 45-year time period, which is more or less an investing lifetime for most people and a more proper way to evaluate an investment strategy. 

Over the long-term, the picture becomes much clearer as the strategies begin to separate performance-wise due to the compounding results of employing each strategy each year. Owning one stock results in the lowest median return, the lowest bottom 10% return, and the second-lowest top 10% return. (It had the highest top 10% in the short-term tests) Notice just how much different this result for owning one stock is from the 1-year test and keep in mind that the 45-year test is simply employing the 1-year test 45 times in a row. There was at least some defensible rationale for why you might try to hit a home run with one stock over the 1 year time period when compared to other strategies, but the long-term results show you how foolish it is to employ that strategy each year as it costs you dearly in performance.  Of the buy and hold strategies, the best one is owning multiple assets, as it offers the best median return, and the best top 10% and bottom 10% return but it isn’t the best strategy overall.  

The best overall strategy by a wide margin is once again dual momentum, making it our winner in every time period we tested. From here, it’s logically straight forward to choose dual momentum as your investment strategy so that you can enjoy the best chance at both short-term and long-term investing success.  However, remaining on that path may not be easy, as poor short-term poor performance will test your belief and confidence in the reliability of the expected long-term performance outcomes. The degree to which you have realistic beliefs and performance expectations will largely determine your investing results. Take, for example, 2022 thus far, which has the featured the worst start to the stock market in 50 years and the worst start for US Treasury Bonds since 1788. 

Not a pretty picture…but also not an unexpected one if we have a realistic view of investment strategies and their expected return ranges, both on the positive and negative side. The ranking of real world return performance follows the downside risk expectations of each strategy that we have displayed thoroughout this article. However, many people don’t have realistic expectations of their investment strategy, which is why their investment strategy becomes disconnected from reality during difficult times or periods when their strategy is underperforming relative to other ones. They can begin to convince themselves that although their selected strategy worked in the past, it will no longer work in the future, so it’s best to find something else.  This disconnection can cause them to abandon a time tested strategy in favor of another one that has done better over the short term, even if the strategy they are switching to has a lower long-term expected return. (Recency Bias) They might also leave the time tested strategies all together, instead choosing to create and employ strategies that don’t exist in the real world, such as the hindsight strategy, where they tell themselves after an event that they should have seen it coming and should have made a change.  Such a mindset can lead them to believe that they should be able to get positive results each and every year because they can teach themselves to see what the future holds somehow by applying the lessons of hindsight. They might also employ an overconfidence strategy, where they don’t expect any bad results to happen to them because they think they have control over the situation or because they are special and bad results simply don’t happen to them. The results of such unrealistic and false investment expectations are an increase in stress, fear, and the likelihood of making bad investment decisions.

Thankfully, these experiences don’t have to define your investing journey if you are willing to trust in the long-term data and evidence and set realistic expectations of what that journey will be like. Accept the realities of both the upsides and downsides of investment strategies as well as your lack of ability to predict or control when those outcomes will happen. It’s only then that you will be able to stand firm through the storms as you journey along the most likely path to long-term investment success. 

James Di Virgilio

Author James Di Virgilio

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