Bill Hall: An investment model is a framework for analyzing financial information. And as an experienced Wall Street professional, I call tell you that a number of them can result in investment success. But the ones that are most profitable — and have the best chance of growing your money over the long-term — share several characteristics.
Common Characteristic #1— They are easy-to-use
In today’s complex markets, where the number of potential investment opportunities to analyze is almost infinite, you need something that can be applied over-and-over again in a time-efficient way.
For the best investment models, their predictive power lies in their simplicity and is not cloaked in complexity. And many require a minimal amount of time to apply and maintain to produce favorable results.
Common Characteristic #2— They don’t rely on luck
Some traders and investors live by the credo that it is better to be lucky than good. But many of these market hotshots are trading with other people’s money — not with their own precious capital — so they can afford to rely on chance every now and again.
But for the rest of us — when investing for our own financial security — it is far better to be good than to even think about luck … even as a last resort or an occasional alternative.
Before best-selling financial author Michael Lewis wrote “The Big Short,” which explains how the collapse of subprime mortgages caused the 2009 financial crisis, he wrote a book about baseball titled “Moneyball.” In it, Paul DePodesta, a key member of the Oakland A’s baseball brain trust, tells a story about playing blackjack in Las Vegas.
A card player to DePodesta’s right, sitting on 17, asked for a hit. Everyone at the table gasped, and even the dealer asked the player if he were sure. The player nodded yes and, the dealer, to everyone’s surprise, turned over a four.
The gambler had a perfect hand, with 21. “Nice hit,” said the dealer.
As DePodesta points out, it was indeed a great hit, but it was also a very lucky hit. Calling for a card when you’re sitting on 17 almost always ends up as a losing hand for the player and a moneymaker for the house — which is why the dealer complimented the rash gambler, no doubt hoping he would press his dumb luck even further, so the house could win back its losses.
In the markets, most investors who are fortunate enough to get a lucky short-term win on a quick trade are eager to press their luck again and again … even when it turns against them. But over time, relying on luck is guaranteed to be a losing strategy.
It’s the proven, practical investment models that you are seeking, because they put the investment odds in your favor.
Common Characteristic #3— They keep their eye on the long-term
It’s the “what have you done for me lately” focus on short-term results where most investors fail in reaching their financial goals. In too many instances, investors make the mistake of dwelling solely on short-term outcomes without considering the longer-term process required to obtain the kind of returns they need and want.
This focus on generating quick results is, to some degree, understandable. For many everyday investors, results — whether it’s the monthly returns on your portfolio or the bottom-line net earnings for a company — are what ultimately matter. And results are typically easier to evaluate than processes.
Common Characteristic #4— They emphasize process over results
The world’s top-money masters know that it’s the continuous application of a well-executed process that will make their portfolios grow over time.
A good process must be trusted even when it occasionally fails … and it will. But many inexperienced investors — like blackjack players — often make the critical mistake of assuming that a good process always yields good outcomes and that bad outcomes imply a bad process.
On the other hand, the most-successful investors all emphasize the process over the outcome. That’s because they know that — with the gift of time — a good process consistently applied will produce winning results.
An Example of a Successful Model
As an example of an investment that uses the Better Model approach to earn superior investment returns, consider the WisdomTree MidCap Dividend Growth Fund (NYSEARCA:DON).
DON is uniquely positioned to benefit from an expansion in the U.S. economy and is sponsored by the highly regarded investment firm Wisdom Tree. This ETF has returned 21.2 percent since mid-November.
DON’s laser-like focus on the mid-cap sector of the U.S. market will likely provide the biggest bang for every dollar invested as long as the U.S. continues to be favored by global investors. That’s because U.S. midcap stocks should perform well as another round of Fed-provided stimulus ripples through the economy and financial markets.
In addition to the upside opportunity, Wisdom Tree uses a proven, proprietary algorithm that carefully sifts through the entire universe of U.S. mid-cap companies and selects those stocks that have the best combination of potential for appreciation and current dividend yield. This dividend provides a cash-in-hand payback that further boosts returns when the market goes up and cushions the fall when markets go down.
That’s why Morningstar has consistently awarded DON the highly-coveted five-star ranking.
Sure, it’s had volatility along the way as shown in the chart below. But investors who focused on the process the fund uses and not the short-term results have pocketed almost 50 percent on a cumulative basis over the past three years.
Remember, it’s over time — not overnight — that enduring returns are earned in the investment markets. And the entire process of profitable investing begins with identifying and applying a Better Investment Modelover-and-over again.
Next week, I’ll explain how Building Block #2, superior information, can improve your returns.
Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaMare based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.
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