John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.
It's easy to make investing overly complicated.
Every day, nearly 10,000 U.S. mutual funds and exchange-traded funds compete for investor dollars with thousands of listed stocks, not to mention a dizzying array of options, futures and derivatives and trillions of dollars of bonds. Every day, fund managers are trying to lure investors with new strategies to make money.
Fund managers will attempt to wow investors with fancy-looking mathematical models and strategy desks filled with high-paid PhDs, perhaps to justify their high fees. After all, as an investor, you want to believe you are getting something extra for paying those fees. And if the markets are so complex, it must take a complicated strategy to beat them.
But what are you really getting? Active managers have had a tough time over the long term beating their benchmarks, despite all their in-depth research and sophisticated portfolio modelling. In fact, the research has shown the most effective investment strategy is the simplest: a portfolio of diverse investments managed consistently with low turnover and low fees.
As investing greats Warren Buffett and Peter Lynch will tell you, simpler is often better. In fact, Mr. Lynch put it this way: "The simpler it is, the better I like it."
Low-fee index funds have gotten enormously popular because they take the guesswork and the high costs out of investing for most people.
They make it easy for investors to generate more money than they pay in fees and provide a systematic way of investing that takes the emotion out of the equation. They are the simple solution to the all-too-common perception that investing needs to be complicated to be successful.
As Morgan Housel, the economics and finance columnist, points out in a recent video presentation about investing, simple isn't so easy for people to accept. It isn't as intellectually stimulating as a screen full of sophisticated equations. It means accepting that an investment manager isn't always an expert with a secret formula for winning.
First, investors should start out with a plan and, again, simpler is better. Invest according to goals, whether that be retirement or a child's education. The goal will act as the guidepost for the investing timeline and risk. That will help with allocation decisions. A very long time horizon can tolerate a higher exposure to stock markets. A very short horizon should probably steer to interest-bearing cash. Then pick the fund or portfolio that meets the criteria and leave it alone, only occasionally rebalancing.
Mr. Buffett, arguably one of history's best investors, has a fairly simple formula based on a long-term mindset.
He picks stocks of companies that show potential for long-term growth and have protective moats around their businesses. He is willing to commit money for decades, just like an owner of a business. As with Mr. Lynch, Mr. Buffett also sticks with brands he likes. He's a long-time investor in Coca-Cola and a big fan of Cherry Coke, for example.
Over a 30-year period, Mr. Buffett's investment vehicle Berkshire Hathaway Inc. returned 18.6 per cent a year against the 13.5-per-cent return of the average private-equity fund. That 5 per cent a year outperformance mostly accounts for the high fees charged by private-equity funds.
That's not to discredit Mr. Buffett's skill in picking strong companies with undervalued stocks. But it does go to show how important fees are in relation to investment returns.
Like any good consumer, investors should make things simple for themselves and buy discounted stocks of strong but underappreciated companies or, even simpler, pick a fund that invests that way and doesn't charge a high fee.
And it doesn't have to mean buying an index fund. There are simple quantitative models and funds that offer the same advantages and low fees, too. The idea is to eliminate the self-doubt and emotion that so often accompanies investing.
At Validea, we have built quantitative screening models built on the approaches inspired by successful investors such as Mr. Buffett, Mr. Lynch and Benjamin Graham.
These aren't overly complex or black-box strategies, and many are quite simple. I've found that buying groups of stocks with certain fundamental and value characteristics and following the models with discipline over time – and doing it cost effectively – are the ingredients for success.
Here are three high-scoring stocks based on those models.
Johnson Outdoors Inc. (JOUT): The maker of kayaks, canoes and other outdoor leisure equipment scores well on two of the guru models, fitting under the small-cap growth banner. It has a relatively high number of inside holders (nearly 20 per cent) and its price/earnings to growth ratio shows it steadily beats estimates.
Lear Corp. (LEA): This automotive supplier beat fourth-quarter earnings estimates earlier this month and tracks two of our guru models, including that of Mr. Lynch. Its price/earnings to growth ratio indicates it is what Mr. Lynch would call a "fast grower" with sustainable EPS momentum.
Gentex Corp. (GNTX): The firm makes automatic-dimming mirrors and driver-assistance technologies for the transportation industry. The stocks gets high scores from value and growth models, making it one of the few names in our database that achieves a 70-per-cent score or better from six different guru strategies.
John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF
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