Chase the Expected Returns—Not the Unexpected
Listen to Best in Wealth Podcast Episode 161
I expect the stock market to go up every day. What do I mean by that? Is it a realistic expectation? In this episode of Best in Wealth, I dissect a Business Insider article written by David G. Booth about chasing expected returns. I also share WHY his opinion is one that matters. Do not miss it!
Outline of This Episode
- [1:09] Listeners: I need YOU to weigh-in
- [4:04] Just who is David G. Booth?
- [11:36] What David Booth’s Business Insider article tells us
- [22:35] Why you should pursue expected returns
Three facts about David G. Booth
There are three facts you need to know about David G. Booth:
First, David Booth went to the University of Kansas and graduated with a Bachelors Degree in Economics and a Masters Degree in Business. He graduated in 1969 and went to the University of Chicago School of Business. The University of Chicago is home to The Center for Research of Security Prices (CRSP). All information on all stock prices exists at the CRSP. If you are reading research papers, they need to talk about the CRSP.
Second, David Booth was the research assistant to Eugene Fama, the father of modern portfolio theory. He was named a Nobel Laureate and highly recognized in the field of finance.
Third, the University of Chicago School of Business is now called the Booth School of Business. Named after—you guessed it—David Booth.
A brief—but important history—of David G. Booth
David Booth left the University in 1971 to work for Wells Fargo. In the early 1970s, the very first index fund was developed—the S&P 500. Before this, every available mutual fund was actively managed. This S&P 500 fund was only available to institutional investors. In 1976, John Bogle started Vanguard, with the first retail index fund.
In 1981, David left Wells Fargo and started Dimensional Fund Advisors (DFA). Why did he start a company? He believed that a small-cap index could be developed. People said no way—that trading costs would outweigh any benefits of being in an index fund. He believed strongly in the concept, so he built a board of directors, which included the brightest minds in financial market research. He proved everyone wrong. The small-cap index proved to be a winning strategy.
What’s different about Dimensional Fund Advisors?
An index fund beats approximately 83% of actively managed mutual funds. The longer you hold, the better chance you have of beating the equivalent actively managed fund. DFA manages over 600 billion dollars. They follow the science and build strategies around the science.
Since their inception, they have developed numerous successful strategies. Since 2000, only 17% of actively managed mutual funds beat the market. 84% of DFA funds beat the market. Index funds make up trillions of dollars worth of assets. Why is this important? Why am I telling you a story about David Booth? Because you need to listen to him.
What David Booth’s Business Insider article tells us
Please Note: This is not a recommendation to purchase a specific index fund. It is simply talking through an article by someone you should listen to.
David expects the stock market to go up, but is not upset when it does not. He is there to capture the long-term ups. The S&P 500 sees an average 10% annualized return, right? 10% seems sensible. When it is divided throughout the year, you expect your portfolio to grow 0.0275% every day. But the market rarely goes up 10% per year. In the past 100 years, the stock market has never landed on 10%. It has only landed between 8–12% six times.
What happens when it does not hit the historical average? An unexpected return. Pandemics, trade wars, and interest rates impact the market daily. People are trying to explain the unexpected returns, but it is not relevant. David emphasizes that “What happened today may not inform what happens tomorrow.” So what is relevant?
Grasping unexpected versus expected returns
As investors, we have a difficult time grasping expected versus unexpected. There will be years when the stock market is up and years it is down. Staying in your seat is one part of investing that you can control. It is what allows you to get those expected returns.
All you can do as a long-term investor is pursue expected returns, manage your costs, and accumulate compound interest. How? By investing in a broadly diversified portfolio for the long run. One of the best tools you have as an investor is time. Do not panic when you see unexpected returns. Stay in your seat and you will realize those long-term expected returns.
Is your investment philosophy following the science? Do you have data to support your decisions? If you do not, it is time to speak to a trusted financial advisor.
- The Center for Research in Security Prices
- Dimensional Fund Advisors
- David G. Booth
- John C. Bogle
- Eugene Fama
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The Best In Wealth Podcast is hosted by Scott Wellens. Scott Wellens is the principal at Fortress Planning Group. Fortress Planning Group is a registered investment advisory firm regulated by the Securities Act of Wisconsin in accordance and compliance with securities laws and regulations. Fortress Planning Group does not render or offer to render personalized investment or tax advice through the Best In Wealth Podcast. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.