Combining an enduring investment philosophy with a simple formula that helps maintain investment discipline can increase the odds of having a positive financial experience.
“The important thing about an investment philosophy is that you have one you can stick with.”
-David Booth Founder and Executive Chairman
AN ENDURING INVESTMENT PHILOSOPHY
Investing is a long-term endeavor. Indeed, people will
spend decades pursuing their financial goals. But being
an investor can be complicated, challenging, frustrating,
and sometimes frightening. This is exactly why, as
David Booth says, it is important to have an investment
philosophy you can stick with, one that can help you
stay the course.
This simple idea highlights an important question:
How can we, as investors, maintain discipline through
bull markets, bear markets, political strife, economic
instability, or whatever crisis du jour threatens progress
towards our investment goals?
Over their lifetimes, investors face many decisions,
prompted by events that are both within and outside
their control. Without an enduring philosophy to inform their choices, they can potentially suffer unnecessary
anxiety, leading to poor decisions and outcomes that
are damaging to their long-term financial well-being.
When they don’t get the results they want, many
investors blame things outside their control. They might
point the finger at the government, central banks,
markets, or the economy. Unfortunately, the majority
will not do the things that might be more beneficial—
evaluating and reflecting on their own responses to
events and taking responsibility for their decisions.
e + r = o
Some people suggest that among the characteristics
that separate highly successful people from the rest
of us is a focus on influencing outcomes by controlling
one’s reactions to events, rather than the events
themselves. This relationship can be described in
the following formula:
e + r = o (Event + Response = Outcome)
Simply put, this means an outcome—either positive
or negative—is the result of how you respond to an
event, not just the result of the event itself. Of course,
events are important and influence outcomes, but not exclusively. If this were the case, everyone would
have the same outcome regardless of their response.
Let’s think about this concept in a hypothetical
investment context. Say a major political surprise,
such as Brexit, causes a market to fall (event). In a
panicked response, potentially fueled by gloomy media
speculation of the resulting uncertainty, an investor sells
some or all of his or her investment (response). Lacking
a long-term perspective and reacting to the shortterm
news, our investor misses out on the subsequent
market recovery and suffers anxiety about when, or
if, to get back in, leading to suboptimal investment
To see the same hypothetical example from a different
perspective, a surprise event causes markets to fall
suddenly (e). Based on his or her understanding of the
long-term nature of returns and the short-term nature
of volatility spikes around news events, an investor is
able to control his or her emotions (r) and maintain
investment discipline, leading to a higher chance of
a successful long-term outcome (o).
This example reveals why having an investment
philosophy is so important. By understanding how
markets work and maintaining a long-term perspective
on past events, investors can focus on ensuring that
their responses to events are consistent with their
THE FOUNDATION OF AN
An enduring investment philosophy is built on solid
principles backed by decades of empirical academic
evidence. Examples of such principles might be:
trusting that prices are set to provide a fair expected
return; recognizing the difference between investing
and speculating; relying on the power of diversification
to manage risk and increase the reliability of outcomes;
and benchmarking your progress against your own
realistic long-term investment goals.
Combined, these principles might help us react better
to market events, even when those events are globally
significant or when, as some might suggest, a paradigm
shift has occurred, leading to claims that “it’s different
this time.” Adhering to these principles can also help
investors resist the siren calls of new investment fads
or worse, outright scams.
THE GUIDING HAND OF A TRUSTED ADVISOR
Without education and training—sometimes gained
from bitter experience—it is hard for non-investment
professionals to develop a cogent investment
philosophy. And, as we have observed, even the most
self-aware find it hard to manage their own responses
to events. This is why a financial advisor can be so
valuable—by providing the foundation of an investment
philosophy and acting as an experienced counselor
when responding to events.
Dimensional has an enduring investment philosophy
that is shared by the advisors we work with and is the
foundation for how we view the world of investing.
We trust in the power of markets to deliver reliable
returns over time and focus our efforts on helping
investors benefit from as much of the return of the
market as possible.
We know that investing will always be both alluring and
scary at times, but a view of how to approach investing
combined with the guidance of a professional advisor
can help people stay the course through challenging
times. Advisors can provide an objective view and help
investors separate emotions from investment decisions.
Moreover, great advisors can educate, communicate,
set realistic financial goals, and help their clients
deal with their responses even to the most extreme
In the spirit of the e + r = o formula, good advice, driven
by a sound philosophy, can help increase the probability
of having a successful financial outcome.
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
Past performance is no guarantee of future results. There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.
All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.
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