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Why Simple Isn’t Easy

May 7, 2018

Living through a track record is very different than viewing it on paper. Even the most efficient track records in history have periods where they would have been very uncomfortable to stick with. Warren Buffett has had multiple 30-50% drawdowns in his career. In the world of indexing, there is nothing magical about the S&P 500. Yet it’s well known how difficult it is for a fund manager to beat it over the long term. A big part of the reason why the S&P 500 beats most fund managers is because of its simple discipline. It continues to apply the same set of rules over and over again. The whole concept of “smart beta” shows numerous ways to create indices that would have beat the market cap weighting process of the S&P 500 over long periods of market history. Perhaps the greatest form of alpha is the ability to follow a simple approach with rigid discipline over the long term. Howard Lindzon of StockTwits recently shared his top ten takeways of the Stocktoberfest conference. Here was #5.

I found this Forbes interview with Jim O’shaughnessy on February 23, 2009 particularly interesting. Keep in mind, February 23, 2009 was within a couple weeks of the market bottom. The Dow was trading around 7,000, more than 50% below its October 2007 high. Predictions for Dow 5,000, 3,000, even 1,000 were being made. With recency bias clouding our better judgement, many investors saw this as all but certain and needed to do something to intervene. The fear in the marketplace was unbelievable and people were in the process of officially devastating their life savings by abandoning their long term plan and selling towards the bottom. This is also a great example, which I wrote about here, on why you can’t rely exclusively on historical data. Given enough time, your maximum drawdown is always ahead of you. Yet read how Jim is telling the exact same story as he always does as a true quant, whether at new highs, or in this case, during a record drawdown. Keep it simple, trust your exhaustive research and data, and follow your plan. It’s simple, but not easy.