In 2014 JPMorgan found that the average investor made a paltry 2.3% annualized return over the last 20 years. With some portfolios consistently doing better year after year, it’s clear that disciplined investors are doing things differently. So how do we explain the performance gap?
Firstly, disciplined investors avoid emotional decision making full of fear, greed, and pride. They avoid subjective biases, gut feelings, hot tips and endless amounts of information overload. But the funny thing is, if you ask most average investors if they consider themselves disciplined, they’ll say yes even though they clearly aren’t. So what is it that really separates the average from the disciplined investors?
“Rules-based” investing is a simpler, more consistent, and more accountable way to make repeatable investment decisions. Rules-based investing uses empirically proven rules to determine what companies to buy, how many to buy, how much of each to buy, and when to buy them. On the flip side, the rules also determine what companies to sell, how much to sell, and when to sell them. Some of the world’s best investors, including Warren Buffet, William O’Neil, James Simons, and Richard Dennis all used different sets of rules, but rules nonetheless to build their portfolios.
Over the past several years, many new products with rules-based approaches have come to market, especially exchange traded funds (ETFs). They're usually called “smart beta” or “factor” ETFs, and some of their rules work better than others. For the Growth Portfolio, we use proven rules to screen companies on the basis of value, earnings quality, volatility, size, and trend to find opportunities with a higher and safer probability of success. Every part of our investment process is clearly defined and rules-based while other strategies might only use rules selectively.
As investment management becomes more computerized and systematic, rules-based investing will become the mainstream. Traditional stock picking is quickly being replaced for investors who want a more accountable, reliable, and disciplined approach.
Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.