Factor Investing Makes Someone Money, But Maybe Not You

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FIREchief
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by FIREchief » Sun Jun 24, 2018 1:22 pm

vineviz wrote:
Sun Jun 24, 2018 8:40 am
FIREchief wrote:
Sun Jun 24, 2018 8:32 am
Thank you!!! I think you've just written six paragraphs that invalidate a whole bunch of guidance based upon provided by "academic research by Nobel prize winning authors." Best post of the thread since Rick's OP. :sharebeer
Because obviously all those academics, with their Nobel Prizes in economics and PhDs in mathematics, never learned the properties of a normal distribution.
I've clarified my post as indicated above. To your point, most of those "academics" likely understand the pitfalls in using such "research" to try to forecast/predict future market behavior. So, they write papers, obtain research funding, write books and receive awards based upon efforts that "explain" past market behaviors. At best, they develop models that identify certain outputs that correlate in some way with certain combinations of inputs. As anybody with the most basic statistics knowledge understands, a high correlation does NOT establish a cause and effect relationship. I doubt any of them have ever published a paper that claims to be able to forecast future market performance.

That's where our profit seeking middle men come into play (i.e. financial advisors and those who feed them). These lesser educated folks are happy to make the "leap of faith" that something that "explains" historical market performance must be "reliable" for forecasting future market performance. I put reliable in quotes, because we often see such silliness as "the market's forecasted nominal real gain over the next decade will be 4%, but that's only accurate plus or minus 10%, and that's only at a 90% confidence level; so it could really be just about anything." In other words, they thoroughly cover their butts. In still more other words; "nobody knows nothing."
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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vineviz
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by vineviz » Sun Jun 24, 2018 1:43 pm

jalbert wrote:
Sun Jun 24, 2018 1:19 pm
Maybe you’re basing your skepticism on intuition or on something you think someone said in some other context, I don’t know. But if it was as easy to demonstrate the invalidity of these regressions as you keep implying, you’d show us the tests proving it. Right?
You seem to be confusiing a probabilistic result and deterministic result. If a statistical analysis leads to a finding that is not statistically significant, that means the test conveys very little to no information on whether or not the result is correct. Asking me to find a counterexample for the result would be a reasonable response if I stated that the result was deterministically false.
I'm not asking you for a counterexample.

I provided the counterexample, which falsified the original claim (i.e. "X is impossible"), and did so without breaking a sweat.

What I'm asking YOU to do is back up your claim that the regression I provided is invalid. I can't really tell what you think invalidates it: you've mentioned several hypothetical issues. However, every issue you've mentioned has (relatively simple) statistical tests that can prove - or at least indicate - that the issue is at play in a particular regression yet you've not run a single one of those tests on this data as far as I can tell. You've got all the data you need to test the explicit and implicit assumptions I used. But "I don't like the result" is not a test of statistical significance.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by jalbert » Sun Jun 24, 2018 1:50 pm

If you are not convinced about the merits of tilting away from the market portfolio, simply hold the market portfolio. If you do tilt away from the market, then stick with it over the long-term (don’t chop and change every 3-5 years).
I think the uncertainties you experience with the strategy have to be present. If tilting were ever a sure-fire way to beat the market over time, everyone would start doing it and the premia would disappear.
Index fund investor since 1987.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by jalbert » Sun Jun 24, 2018 1:53 pm

What I'm asking YOU to do is back up your claim that the regression I provided is invalid
That wasn’t my claim. My claim was that the F-stat is not an interpretable measure of statistical significance for your sample.
Index fund investor since 1987.

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vineviz
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by vineviz » Sun Jun 24, 2018 2:31 pm

jalbert wrote:
Sun Jun 24, 2018 1:53 pm
What I'm asking YOU to do is back up your claim that the regression I provided is invalid
That wasn’t my claim. My claim was that the F-stat is not an interpretable measure of statistical significance for your sample.
Based on what evidence? Show me some proof, please.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by patrick013 » Sun Jun 24, 2018 4:19 pm

FIREchief wrote:
Sun Jun 24, 2018 1:22 pm
vineviz wrote:
Sun Jun 24, 2018 8:40 am
FIREchief wrote:
Sun Jun 24, 2018 8:32 am
Thank you!!! I think you've just written six paragraphs that invalidate a whole bunch of guidance based upon provided by "academic research by Nobel prize winning authors." Best post of the thread since Rick's OP. :sharebeer
Because obviously all those academics, with their Nobel Prizes in economics and PhDs in mathematics, never learned the properties of a normal distribution.
As anybody with the most basic statistics knowledge understands, a high correlation does NOT establish a cause and effect relationship. I doubt any of them have ever published a paper that claims to be able to forecast future market performance.
My stats are a little rusty but I usually get what I want. I have some
data with high correlations, good p-value, and the non-regressor
has such a bad distribution the confidence interval won't fit inside
if it was normal. So I just use the frequency distribution for a data
reference and segmented probability chart. Hard to see if it could be
done better and be more useful. Just some bond spread observations
BTW. Won't go to infinity or anything. Just shows max and min spreads.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by jalbert » Sun Jun 24, 2018 4:47 pm

vineviz wrote:
Sun Jun 24, 2018 2:31 pm
jalbert wrote:
Sun Jun 24, 2018 1:53 pm
What I'm asking YOU to do is back up your claim that the regression I provided is invalid
That wasn’t my claim. My claim was that the F-stat is not an interpretable measure of statistical significance for your sample.
Based on what evidence? Show me some proof, please.
Based on the theoretical foundations and applicability of the F-test being based on preconditions of a limit theorem not satisfied by your sample. The sample is neither random nor composed of independent events, and I doubt is even sufficiently large (sample variance is one way to evaluate that). If this is not understood, I think an introductory mathematical statistics text (as opposed to a cookbook statistical methods text) is a better source for further investigation than a BH thread.
Index fund investor since 1987.

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FIREchief
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by FIREchief » Sun Jun 24, 2018 5:46 pm

patrick013 wrote:
Sun Jun 24, 2018 4:19 pm
FIREchief wrote:
Sun Jun 24, 2018 1:22 pm
vineviz wrote:
Sun Jun 24, 2018 8:40 am
FIREchief wrote:
Sun Jun 24, 2018 8:32 am
Thank you!!! I think you've just written six paragraphs that invalidate a whole bunch of guidance based upon provided by "academic research by Nobel prize winning authors." Best post of the thread since Rick's OP. :sharebeer
Because obviously all those academics, with their Nobel Prizes in economics and PhDs in mathematics, never learned the properties of a normal distribution.
As anybody with the most basic statistics knowledge understands, a high correlation does NOT establish a cause and effect relationship. I doubt any of them have ever published a paper that claims to be able to forecast future market performance.
My stats are a little rusty but I usually get what I want. I have some
data with high correlations, good p-value, and the non-regressor
has such a bad distribution the confidence interval won't fit inside
if it was normal. So I just use the frequency distribution for a data
reference and segmented probability chart. Hard to see if it could be
done better and be more useful. Just some bond spread observations
BTW. Won't go to infinity or anything. Just shows max and min spreads.
LOL Good one! :sharebeer

Are we having fun yet? 8-)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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vineviz
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by vineviz » Sun Jun 24, 2018 6:04 pm

jalbert wrote:
Sun Jun 24, 2018 4:47 pm
The sample is neither random nor composed of independent events, and I doubt is even sufficiently large (sample variance is one way to evaluate that).
It's too bad that no one has ever developed a way to test whether a particular sample is random, i.i.d, or of sufficient size.

If only such tests existed it would be so easy to prove how wrong I am, once and for all. But, alas . . . .

What a shame. :oops:

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by jalbert » Mon Jun 25, 2018 2:39 am

It's too bad that no one has ever developed a way to test whether a particular sample is random, i.i.d, or of sufficient size.
An algorithm exists to decide if a consecutive historical sequence of returns is a random sample of returns. The algorithm would just return “no” for all such samples.
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vineviz
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by vineviz » Mon Jun 25, 2018 7:51 am

jalbert wrote:
Mon Jun 25, 2018 2:39 am
It's too bad that no one has ever developed a way to test whether a particular sample is random, i.i.d, or of sufficient size.
An algorithm exists to decide if a consecutive historical sequence of returns is a random sample of returns. The algorithm would just return “no” for all such samples.
Cool. Run it in this sample and show us.

Then, show us that the sample is SUFFICIENTLY non-random to make the regression statistics unreliable.

Sounds like proving your point would be child’s play.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by jalbert » Mon Jun 25, 2018 3:26 pm

Sure. I can run the algorithm in my head. It returns no. The sample is not random.

If we had access to a larger data set for min-vol portfolios, it is likely we easily could demonstrate the effect of sample bias in non-random samples for the value loading of min-vol products. The products have not been around a long time.

Here is an example of non-random historically contiguous samples getting significantly different value factor loadings for the fund IJS, indicative of bias in the measurement method.

IJS from 8/1/2000 to 7/31/2008, the HML factor regressed to 0.61:

https://www.portfoliovisualizer.com/fac ... sion=false

IJS from 8/1/2008 to present, the HML factor regressed to 0.41:

https://www.portfoliovisualizer.com/fac ... sion=false

In each test, the F-stat indicated an excellent p-value for the regression, and the t-stat for the value factor indicated an excellent p-value for the parameter estimation, but the value loading result is outside the 95% confidence interval derived from the other test.

Of course the probabilistic nature of statistical models does not preclude each experimental result being a random outlier among the 5% of experiment instances that will lie outside the 95% confidence interval of a different instance of the experiment. This is why it is often not possible to falsify a statistical result deterministically, and it is incumbent on a researcher to demonstrate validity of experimental methods.

It did not take me very long to find these anomalous time periods. This is why most historical backtesting is so problematic. This will be my last posting for this discussion.
Last edited by jalbert on Mon Jun 25, 2018 5:02 pm, edited 1 time in total.
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vineviz
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by vineviz » Mon Jun 25, 2018 5:01 pm

jalbert wrote:
Mon Jun 25, 2018 3:26 pm
Sure. I can run the algorithm in my head. It returns no. The sample is not random.
That's what I thought: you're just making up your objections out of thin air.
jalbert wrote:
Mon Jun 25, 2018 3:26 pm

IJS from 8/1/2000 to 7/31/2008, the HML factor regressed to 0.61:

https://www.portfoliovisualizer.com/fac ... sion=false

IJS from 8/1/2008 to present, the HML factor regressed to 0.41:

https://www.portfoliovisualizer.com/fac ... sion=false

In each test, the F-stat indicated an excellent p-value for the regression, and the t-stat for the value factor indicated an excellent p-value for the parameter estimation, but the value loading result is outside the 95% confidence interval derived from the other test.
We both know that this is not what the t-stat is measuring.

In a linear regression, the null hypothesis is that the regression coefficient is zero and so the t-stat is designed to tell us whether the estimated coeffecient is statistically different from zero, which obviously it is in both the periods you tested. That's a success.

It's neither surprising nor relevant that the mean coefficient estimates differ between the two periods, even with statistical significance. It certainly isn't anomalous.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by HomerJ » Tue Jun 26, 2018 8:48 am

FIREchief wrote:
Sun Jun 24, 2018 1:22 pm
That's where our profit seeking middle men come into play (i.e. financial advisors and those who feed them). These lesser educated folks are happy to make the "leap of faith" that something that "explains" historical market performance must be "reliable" for forecasting future market performance. I put reliable in quotes, because we often see such silliness as "the market's forecasted nominal real gain over the next decade will be 4%, but that's only accurate plus or minus 10%, and that's only at a 90% confidence level; so it could really be just about anything." In other words, they thoroughly cover their butts. In still more other words; "nobody knows nothing."
This should be carved in stone somewhere.

Great post.
The J stands for Jay

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by hale2 » Tue Jun 26, 2018 2:40 pm

Deighve wrote:
Sun Jun 24, 2018 7:17 am
Rick,

I recently read your excellent book All about Asset Allocation

In the multi asset class portfolio you suggest 10% small value ad 5% microcap. I liked this portfolio and was thinking of moving in that direction. Has your thinking on this changed at all?

Thanks very much,

Deighve
I was wondering when someone would point out this inconsistency. Makes me wonder if this was his true belief at the time the book was written and now his thoughts have evolved. Of course, the book was also written when he had a company to grow so allocations may have been developed more complex than necessary.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by Rick Ferri » Wed Jun 27, 2018 7:46 am

There is no inconsistency. I made suggestions in the book for people who wish to pursue a small amount of factor exposure in their portfolio. The allocations were based on the data available st the time. If I were to give the same allocation advice today, it would be mostly total market and a slice of small value (no micro-cap because it’s simply too hard to do and too costly).

Rick Ferri
The Education of an Index Investor: flounders in darkness, finds enlightenment, overcomplicates strategy, embraces simplicity.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by hale2 » Wed Jun 27, 2018 9:03 am

Your thinking has changed over time, which is what I thought. That's fair and completely understandable.

My initial portfolio was based on your book. It has changed somewhat over time as based on things I have learned here from you and other posters.

Hopefully people on here will realize that changing advice over time is perfectly reasonable before they attack others, such as Swedroe and Merriman, for giving current advice that conflicts with things they have said or written years ago.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by Rick Ferri » Wed Jun 27, 2018 9:09 am

Food for thought: The only portion of my advice that has changed over the years is the factor portion (Larry is the same way). This itself may signal a bigger problem with factor investing.
The Education of an Index Investor: flounders in darkness, finds enlightenment, overcomplicates strategy, embraces simplicity.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by Leesbro63 » Wed Jun 27, 2018 9:23 am

My observation, for what it's worth, is that Rick Ferri has been the "most right" of the financial gurus who have posted here over the years. He stated clearly in 2008 that perhaps this was the last great investment opportunity for pre-retiring Babyboomers. Those who had the guts to buy, or at least rebalance (I did not...but didn't sell either), were handsomely rewarded. And those who stayed the course with intermediate term bonds, and who did NOT listen to Dr. Bernstein (I did), have been handsomely rewarded. Rick seems to be the most "generic" but also the most successful. Choose the right allocation, stick with it through thick and thin without tinkering. And probably the results will be superior than alternatives.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by Random Walker » Wed Jun 27, 2018 12:03 pm

Rick,
I wonder if some of your change in recommendation is related to do it yourself investor behavior? Do you think a DIY simple 3 fund investor is less likely to tinker with the portfolio? Thanks,

Dave

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by patrick013 » Wed Jun 27, 2018 3:42 pm

I think one problem with factors is the indexed used. The
S&P SC growth outperformed S&P SC value this current bull market.
The Russell MC value outperformed over the last 22 full annual
periods over other Russell general indexes. The data used for
factor charts available to the public is based on CRSP data.
Going back pre-1962 is kinda ancient. You could set 30 years
as a basic number of prior years of data to analyze. Not too
ancient and including about 3 full business cycles of current data
reflecting current conditions regardless of t-stats when total
returns are looked at. Perhaps more data but not all of it.

Of course Factors like to use premiums and excess returns rather
than a total return tabloid so that makes regressors work a little
harder.

It's nice having growth and value invested as when one stalls the
other rises a bit for withdrawing from gains as available. Plus
the returns follow market beta indications and information quite
well and the old saying "as the 500 goes so does the market".

Taking gains from momentum and putting them into quality is the
most unique method I've heard factor wise. Similar to age-in-bonds
which always captures stock gains to a bond account as age rises.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by Rick Ferri » Wed Jun 27, 2018 5:16 pm

Random Walker wrote:
Wed Jun 27, 2018 12:03 pm
Rick,
I wonder if some of your change in recommendation is related to do it yourself investor behavior? Do you think a DIY simple 3 fund investor is less likely to tinker with the portfolio? Thanks,

Dave
We're all entitled to receive market returns. They are sitting there waiting for us, taunting us and tempting us to accept them. Yet most people do not. We refuse to believe it's that easy. We refuse to accept very simple strategies that take what the market is offering. Why? That's difficult for this layman to explain. It has something to do with being a human being.

I've learned the most difficult part of being a successful investor isn't in choosing an ideal asset allocation, or an ideal portfolio strategy (three fund or otherwise), it's the ability to stay the course over the long-term regardless of market conditions. The less we mess with our portfolio, the greater likelihood we will outperform our more active self.

Bottom line: we don't need an ideal asset allocation between stocks and bonds to be successful, and don't need to pick perfect funds; we need to believe in the philosophy, invest in a sensible strategy, and have the die-hard discipline to leave it alone.

I don't know if anyone who frequent's this board on a regular basis can do that or has done that, but it's the ideal we should strive for.

Rick Ferri
The Education of an Index Investor: flounders in darkness, finds enlightenment, overcomplicates strategy, embraces simplicity.

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by livesoft » Wed Jun 27, 2018 5:30 pm

Random Walker wrote:
Wed Jun 27, 2018 12:03 pm
Do you think a DIY simple 3 fund investor is less likely to tinker with the portfolio?
I think an investor who is so busy doing something else is less likely to tinker with the portfolio. We see lots of folks on this forum who tell us how busy they are that they need someone else to look after their portfolio for them.
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by iceport » Wed Jun 27, 2018 6:54 pm

Rick Ferri wrote:
Wed Jun 27, 2018 5:16 pm
Random Walker wrote:
Wed Jun 27, 2018 12:03 pm
Rick,
I wonder if some of your change in recommendation is related to do it yourself investor behavior? Do you think a DIY simple 3 fund investor is less likely to tinker with the portfolio? Thanks,

Dave
We're all entitled to receive market returns. They are sitting there waiting for us, taunting us and tempting us to accept them. Yet most people do not. We refuse to believe it's that easy. We refuse to accept very simple strategies that take what the market is offering. Why? That's difficult for this layman to explain. It has something to do with being a human being.

I've learned the most difficult part of being a successful investor isn't in choosing an ideal asset allocation, or an ideal portfolio strategy (three fund or otherwise), it's the ability to stay the course over the long-term regardless of market conditions. The less we mess with our portfolio, the greater likelihood we will outperform our more active self.

Bottom line: we don't need an ideal asset allocation between stocks and bonds to be successful, and don't need to pick perfect funds; we need to believe in the philosophy, invest in a sensible strategy, and have the die-hard discipline to leave it alone.

I don't know if anyone who frequent's this board on a regular basis can do that or has done that, but it's the ideal we should strive for.

Rick Ferri
Rick—

This has got to be one of the best posts of year. Thanks for your perspective — it really rings true.

I've struggled with the urge to make adjustments over the years, though not any more. This was the lesson I was slowest to learn.

Great to see you posting here again!
"Discipline matters more than allocation.” ─William Bernstein

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by whodidntante » Wed Jun 27, 2018 7:24 pm

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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by Fallible » Wed Jun 27, 2018 8:10 pm

Rick Ferri wrote:
Wed Jun 27, 2018 5:16 pm
Random Walker wrote:
Wed Jun 27, 2018 12:03 pm
Rick,
I wonder if some of your change in recommendation is related to do it yourself investor behavior? Do you think a DIY simple 3 fund investor is less likely to tinker with the portfolio? Thanks,

Dave
We're all entitled to receive market returns. They are sitting there waiting for us, taunting us and tempting us to accept them. Yet most people do not. We refuse to believe it's that easy. We refuse to accept very simple strategies that take what the market is offering. Why? That's difficult for this layman to explain. It has something to do with being a human being. ...
Layman you may be, Rick, but I think you explained that human element quite well in your book, All About Asset Allocation (Chapter 13 on behavioral errors), basing it on growing research and your two decades of working with individual investors: “A sensible investment plan never fails an investor, the investor fails the plan.”
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FIREchief
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Re: Factor Investing Makes Someone Money, But Maybe Not You

Post by FIREchief » Wed Jun 27, 2018 8:23 pm

Rick Ferri wrote:
Wed Jun 27, 2018 5:16 pm
Bottom line: we don't need an ideal asset allocation between stocks and bonds to be successful, and don't need to pick perfect funds; we need to believe in the philosophy, invest in a sensible strategy, and have the die-hard discipline to leave it alone.

I don't know if anyone who frequent's this board on a regular basis can do that or has done that, but it's the ideal we should strive for.
There are many who can and have done this. I stuck with 100% stocks through two big crashes (and two even bigger recoveries). Was that "sensible?" Most would say no, but I was handsomely rewarded. I'm am certain that I am not alone, although the 100% equity crowd seems to stay in the background more often than not. :sharebeer
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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