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Design the Right Portfolio Recipe

Top 5 of the Week of June 11

From Of Dollars and Data, Nick Maggiulli kicks off our Top 5 with the dangers of leverage. For Newfound Research, Justin Sibears highlights the importance of the recipe and the ingredients in Factor Investing. And Michael Harris, from Price Action Lab, reveals how data shared by some academics can be actively misguiding.

From ETF.com, Larry Swedroe discusses the problem with lotterylike investments. And A Wealth of Common Sense’s Ben Carlson asks if long-term investors should be in bonds…


The Journey Matters

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  • In our blinkered states as investors trying to maximize returns as much as possible, we forget that it is leverage ratios that can wipe us out
  • Even if you’re on to a bunch of sure winners in your portfolio, hitting a volatile patch of even a few days can cause your leverage to throw you out of the game
  • Research simulations also show the higher the leverage ratio, the higher your risk of going broke—in your bid for ‘sure’ returns, don’t forget the “journey is more important than the destination”

How is your journey mapped out? Share your comments in the section below
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Design the Right Portfolio Recipe

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  • Constructing a successful portfolio is like cooking an elegant dish; it requires the right ingredients mixed according to a recipe—throwing everything haphazardly together doesn’t work
  • Factor investing often concentrates too heavily on the ingredients for selecting investments (e.g., value, momentum, etc.) and the recipe is overlooked
  • But, the level of potential customization for the portfolio construction recipe is nearly limitless and can cause a major impact on performance, so due care is needed

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Guys, It’s Not Working

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  • While academics may actively misguide traders and hedge funds to fight data-mining bias, they are overlooking a significant problem
  • History shows that data-mined and over-optimized strategies have worked to deliver large alpha and have established performance records that are still in use by some funds
  • It is changing market conditions that affect strategies, due to being mean-reverting, overly crowded by trend-following, and there being an increase in dumb money inflow

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High Stakes Lotterylike Investments

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  • Even though the odds of high returns aren’t in their favor, there are investors who like lotterylike investments—ones that “exhibit positive skewness and excess kurtosis”
  • This is the equivalent of paying a premium rate to gamble money as they’re such highly volatile stocks
  • In an ideal world, arbitrageurs would balance out such activity and push stocks to their “right” price—however, this doesn’t happen, and rational investors are unable to correct mispricing

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Long-Term Thinking

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  • If history shows that stocks have outperformed bonds by 300% since 1926, is there any point investing in bonds with a long-term investment horizon?
  • While the numbers indicate strongly in favor of stocks, there were three past periods where bonds proved the wiser choice; their value is also in part due to their risk-reducing benefits
  • While it may seem like a good idea, being wholly invested in stocks is a major gamble, and there is something to be said for the stabilizing effects of bonds too

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Top 5 of the Week is a summarized collection of financial investment articles that we like and think you might like too. Having written thousands of pages of equity strategy and company research between us, we understand the allure of the ever-changing world of finance. Investing is an art form—and like everything, something you can work on and improve at. There are some excellent writers out there on the finance web, some offer a running commentary on today’s market, some are doing research, some have tips on how to Become a Better Investor, and some just lift the cloud of fog behind a lot of financial jargon. Each week we will keep you up to date with the top 5 articles worthy of your attention.


 

Anything you would like to discuss about this week’s top 5? Do you have another favorite that isn’t mentioned here? Feel free to add it below. Let’s start a discussion in the comments section!

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DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article. The Become a Better Investor Team doesn’t necessarily endorse any stocks or shares mentioned in the articles or the author of such articles linked to and summarized in Top 5 of the Week and cannot guarantee the accuracy of its information.