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The Science of Investing

Most of what passes for investing information and advice isn’t. The majority of what you hear, see, and read about building wealth is designed to encourage you to turn to experts who claim to be able to predict the future or generate high fees for Wall Street. Financial soothsaying has no basis in science. It is more like money alchemy. Like the alchemists of the past, those we have believed to be investing “experts” have consistently been proven wrong.

It only makes sense that science would play a role in advancing wealth creation. Science and technology have dramatically changed our lives over the past several decades.

With the invention of the transistor in 1947, the days of big, hot, fragile vacuum tubes was ending allowing radios to become portable.  My first “transistor” radio packed a whopping ten transistors in its plastic body. Today, we listen to music on iPhones that have over two million transistors.  Just like technology, the science of investing has evolved and advanced over the last 70 years.

In 1947, we believed that the best way to invest was by analyzing stocks and selecting the best one or two in hopes of future growth.  However, in 1952, Nobel Prize winner Harry Markowitz determined the best investment strategy was to create diversified portfolios of stocks to minimize volatility and maximize returns.  Less than twenty years later, economists like Professor William Sharpe showed that the greatest measure of a stock’s potential was its level of risk.  By 1969, Professor Eugene Fama asserted that it was difficult, if not impossible, to make more money than the overall market delivered without taking on commensurately higher risk.

Fast forward to this century in which some academics have shown that active portfolio managers perform no better than if one picked investments based on random chance.  Other academics have found that certain asset classes had greater historical returns and non-correlating volatility, and you can mix those assets into a massively diversified portfolio for better-expected returns and less potential volatility.

One of the investment industry’s problems today is that most financial advisors are still picking investments like its 1947. Just as you wouldn’t listen to music today on a ten transistor portable radio, you shouldn’t base your investments on strategies from the past.  You should be investing like it is 2016 and taking advantage of all the advancements in investing science.

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