Is Loss Aversion the Answer?
Top 5 of the Week of July 9
Jesse Livermore, Chris Meredith, CFA, and Patrick O’Shaughnessy, CFA, kick off our Top 5 this week for O’Shaughnessy’s blog with a view on Value’s recent subpar performance. Jack Vogel, PhD—writing for Alpha Architect—discusses the problems with factor regressions. From ETF.com, Larry Swedroe examines the ongoing debates still raging about index investing.
For Newfound Research, Corey Hoffstein considers when to trend follow and when to avoid it. From Enterprising Investor, David Gal, PhD, asks what loss aversion really means for investors…
Don’t Abandon Value Just Yet
- Given the choice between a trending stock or a low/negative growth investment, investors are far more likely to choose the former rather than the latter at the moment
- However, the low priced stock could be the right choice in terms of Value Investing because high growth and high momentum investing is difficult due to timing being vital
- And, despite Value’s recent performance, history shows that it’s produced excellent returns after similar underperforming periods in the past—so stick with it
No Panacea Here
- While factor regressions allow for the analysis of factors’ effects on funds it does come with its own issues
- Interpreting factor loading can be difficult due to the factor definition and that loadings come with information still embedded within them—which means they can’t tell us much about the current portfolio
- There are ways around this, it’s just important to remember that factor regressions are not a cure-all
Trending Questions
- The first debate about passive investing still goes on to ask if it’s superior to active management, while the second ongoing debate weighs a total market approach against “tilting” a portfolio towards factors
- But once research is published about the benefits of factor premiums will they not stop performing if everyone uses them?
- Always be sceptical about data-mining in research though, and ensure you believe strongly in your reasons for chosen factor premiums to help you stay disciplined during inevitable periods of low performance
Which side of the debates are you on? Share your comments in the section below
Wrestling with Decisions
- Choosing between lump sum investing (LSI) or dollar-cost average (DCA) can be an emotionally fraught decision
- History shows us that LSI outperforms DCA over the last hundred years—but where trend following signals should help in the short-term, their predictive power is mixed at best
- Downside risk grows with negative trend signals, so investors looking to make a quick move should choose DCA in negative trending markets to bypass any risk of immediate loss
Is Loss Aversion the Answer?
- Investors attribute great importance to the subject of loss aversion, given that many believe it has significant connotations for investment decision-making
- Loss aversion can lead to investors becoming unreasonably risk averse and anxious when they overweight losses in relation to their gains
- While research shows that being overly risk averse is no doubt true of some investors due to loss aversion, it can also be mistaken for simple inertia in others
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.
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