Will Index Investing Make Investors Worse Off?

Many commentators claim that the increased popularity of index funds somehow distorts market prices. Their argument premises that indexing reduces the “efficiency” of price discovery. But should increasing use of index funds really concern investors?

The acceptance of index funds for the portfolio strategy of many investors has received much attention in the financial media. Can index funds become so popular that future expected returns could be worse simply due to “blindly” buying and selling the underlying holdings of a commercial index like the S&P 500? The argument is that due to a rigid process used by “too many” investors, sufficient price discovery may not occur so price “inefficiencies” may occur in financial markets. Using data and reasoning, we can examine this claim to show that markets still work, and that investors can rely on market prices for planning portfolios.


While the popularity of indexing has increased substantially, index fund investors still make up only a modest percentage of investing overall. Data from the Investment Company Institute1 shows that as of December 2017, 35% of total net assets in US mutual funds and ETFs were held by index funds, compared to 15% in December of 2007, an increase well over 100 percent. Nevertheless in 2017 most total fund assets (65%) were still managed by active mutual funds. When the entire securities market is considered, the percentage of index-based mutual funds and ETFs is relatively small even today. As shown in Exhibit 1, domestic index mutual funds and ETFs comprised only 13% of total US stock market capitalization in 2017

Exhibit 1

Exhibit 1 graphic

Exhibit 1. Investor Breakdown in the US Stock Market as a Percentage of Total US Stock Market Capitalization

All totals may not equal 100% due to rounding. Sourced from the ICI Fact Book

It should be observed that many investors use nominally “passive” index ETF vehicles to engage in conventional “active” trading. For example, while both a value index ETF and growth index ETF may be technically classified as “index” vehicles, yet many investors actively trade monthly, daily and hourly between these funds and other ETF indexes with different objectives based on short-term expectations, needs, circumstances, or for speculation. In fact, several index ETFs regularly rank among the most actively traded securities.

Beyond traditional actively managed mutual fund vehicles there are many other market participants who actively buy and sell individual securities. These include actively managed pension funds, hedge funds, and insurance companies, just to name a few. Security prices reflect the viewpoints of all these participating investors, as well as those of mutual funds and ETFs.

Professors Eugene Fama and Kenneth French rhetorically asked the question in a blog post titled “Q&A: What if Everybody Indexed?” They explained that the informational impact of an increase in indexed assets depends to some extent on which market participants switch to indexing:

“If misinformed and uninformed active investors (who make prices less efficient) turn passive, the efficiency of prices improves. If some informed active investors turn passive, prices tend to become less efficient. But the effect can be small if there is sufficient competition among remaining informed active investors. The answer also depends on the costs of uncovering and evaluating relevant knowable information. If the costs are low, then not much active investing is needed to get efficient prices.” 2

Exhibit2 chart illustration

Exhibit 2. Annual Global Equity Market Trading Volume, 2007–2018

In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Includes 2017 total returns for constituent securities in the S&P 500 Index as of December 31, 2016. Excludes securities that delisted or were acquired during the year. Source: S&P data ©2019 S&P Dow Jones Indices LLC, a division of S&P Global. For illustrative purposes only. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.


Trade volume data provides more evidence of how well markets continue to function even while the level of indexing has increased. Exhibit 2 shows that despite an increasing movement toward passive index funds, equity market trading volumes have remained at similar levels over the past 10 years. This indicates that markets globally still function well enough to facilitate large scale price discovery.

In addition to secondary market trading, other paths incorporate new information into market prices. For example, companies themselves can impact their share prices simply by issuing stock and repurchasing shares. In 2018 alone, there were 1,633 initial public offerings, 3,492 seasoned equity offerings, and 4,148 buybacks around the world.3 The derivatives markets also incorporate new information into market prices: the prices of those financial instruments are linked to the prices of underlying equities and bonds. On an average day in 2018, market participants traded over 1.5 million options contracts and $225 billion worth of equity futures.3


Even though historical evidence suggests that increased levels of indexing is unlikely to distort market prices, let’s consider a counterargument: does increased indexing distort available market information and in turn cause prices to become less reliable? In this case, wouldn’t we expect to see stock-picking managers who claim to capture mispricing of securities have more and more success over the years as an increasing proportion of shares are indexed each year?

Exhibit 3 chart illustration

Exhibit 3. Annual Global Equity Market Trading Volume, 2007–2018

Equity mutual fund outperformance percentages are shown for the three-year periods ending December 31 of each year, 2004–2018. Each sample includes equity funds available at the beginning of the three-year period. Outperformers are funds with return observations for every month of the three-year period whose cumulative net return over the period exceeded that of their respective Morningstar category index as of the start of the period. US-domiciled non-Dimensional mutual fund data is from Morningstar. Dimensional fund data provided by the fund accountant. Past performance is no guarantee of future results.

Exhibit 3 shows little evidence to support that assertion. If anything, it suggests the opposite. This chart shows the percentage of active managers that both survive and beat their benchmarks over rolling three-year periods. These data show no strong evidence linking the percentage of indexed equity mutual fund assets to the percentage of actively managed funds successfully outperforming the relative benchmark indices.

Lastly, in a world where a large proportion of index funds could bias prices, we should expect to see some evidence across the holdings of mega index funds. That is, there should be increased uniformity in the relative returns for securities held within the same index as inflows drive prices up among stocks (and outflows drive prices down). The S&P 500 is a widely tracked index with over $9.9 trillion USD indexed or benchmarked to the index and with indexed assets comprise approximately $3.4 trillion USD of this total.4 The S&P 500 Index, however, does not evidence this.

Exhibit 4 shows that in 2008, the first year of the global financial crisis, a year of large net outflows with a negative index return of –37.0%, the returns of underlying individual stocks ranged from 39% to –97%. In 2017, a year with very large net inflows and a positive index return of 21.8%, the constituent returns ranged from 133.7% to –50.3%. Moreover, we would expect that stocks with similar weighting within a conventional market cap-weighted indices would share similar returns. Yet in 2017, Amazon and General Electric returned 56.0% and –42.9%, respectively, despite each accounting for approximately 1.5% of the S&P 500 Index.

Exhibit 4 chart illustration

Exhibit 4. Range of S&P 500 Index Constituent Returns

Upper chart includes 2008 total returns for constituent securities in the S&P 500 Index as of December 31, 2007. Lower chart includes 2017 total returns for constituent securities in the S&P 500 Index as of December 31, 2016. Excludes securities that delisted or were acquired during the year. Source: S&P data ©2019 S&P Dow Jones Indices LLC, a division of S&P Global. For illustrative purposes only. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.


Despite the greatly increased popularity of index-based mutual funds and ETFs, empirical data continue to support the academic notion that informational efficiency of markets works. Annual trading volume has not reduced over the years, so that an enormous volume of market transactions still drives price discovery. Active mutual fund managers continue to underperform by as much as they always have, suggesting that increased indexing makes outguessing the market no easier. Prices of individual holdings within major indices don’t move in lockstep with index fund asset flows. Lastly, while naysayers keep suggesting the “hidden danger” of indexing, the reality is that holdings of index funds are still only a small percentage of the total global investable market.

Investors should be confident that public markets function well; willing buyers and sellers still meet and agree upon prices at which they desire to transact. While indexing has been a great financial innovation, it is only one solution in a universe of alternatives. To become more informed about the possible solutions and strategies, contact a CFP® wealth management professional.


  • Derivative: A financial instrument whose value is based on an underlying asset or security.
  • Options Contract: An options contract is an agreement between two parties to facilitate a potential transaction on an underlying security at a preset price.
  • Futures: A financial contract obligating the buyer to purchase an asset or a seller to sell an asset at a predetermined future time and price.

  • 1ici.org/pdf/2018_factbook.pdf
  • 2famafrench.dimensional.com/questions-answers/qa-what-if-everybody-indexed.aspx
  • 3Options, futures, and corporate action data are from Bloomberg LP. Options contact volume is the sum of the 2018 daily average put and call volume of options on the S&P 500 Index, Russell 2000 Index, MSCI EAFE Index, and MSCI Emerging Markets Index. Equity futures volume is equal to total 2018 futures volume traded divided by 252, where annual volume traded is estimated as the sum of monthly volume times month-end contract value for S&P 500 Mini futures, Russell 2000 Mini futures, MSCI EAFE Mini futures, and MSCI Emerging Markets Mini futures. IPO, seasoned equity offering, and share repurchase data are based on Bloomberg corporate actions data and include countries that are eligible for Dimensional investment.
  • 4Source: S&P Dow Jones.

The Unexpected in Average Returns

“I have found that the importance of having an investment philosophy — one that is robust and that you can stick with — cannot be overstated.” –David Booth, former CEO and Founder, Dimensional Fund Advisors

The US stock market has delivered an average annual return of around 10% since 1926. But short-term results vary widely, and in any given period stock returns can be positive, negative, or flat. When thinking about what to expect, it’s helpful to see the historical range of outcomes experienced by investors. How often have the stock market’s annual returns actually aligned with its long-term average? Rarely.

Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926.1 The shaded band marks the historical average of 10%, plus or minus 2 percentage points. The S&P 500 Index had a return within this range in only six of the past 93 calendar years. In most years, the index’s return was outside of the range — often above or below by a wide margin — with no obvious pattern. For investors, this data highlights the importance of looking beyond the “average” and being aware of a huge range of possible outcomes.

Exhibit 1. S&P 500 Index Annual Returns 1926–2018

Graphic, Exhibit 1 - S&P 500 Index Annual Returns 1926–2018

In US dollars. S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower.


Despite the year-to-year volatility, investors may increase their chances of positive outcomes if they maintain a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, and 10 years in the US market. The data show that, while positive performance is never assured, investors’ odds improve dramatically over longer time horizons.

Exhibit 2. Frequency of Positive Returns in the S&P 500 Index Overlapping Periods: 1926–2018

graphic - Exhibit 2. Frequency of Positive Returns in the S&P 500 Index Overlapping Periods: 1926–2018

In US dollars. From January 1926–December 2018, there are 997 overlapping 10-year periods, 1,057 overlapping 5-year periods, and 1,105 overlapping 1-year periods. The first period starts in January 1926, the second period starts in February 1926, the third in March 1926, and so on. S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower.


Most investors might find it easy to stay the course in years with above average returns. Disappointing periods will test your philosophy or approach for equity investing. Being aware of the normal range of possible outcomes can help investors remain disciplined. Being disciplined increases the odds of having a successful investment experience.

What helps investors better endure inevitable market ups and downs? First, understanding how markets work and having a belief that market prices are fair are a good start. Next, having a scientific investing strategy using sensible global asset classes and not being concentrated only in U.S. large stocks. Then having an investment policy that aligns risk with your true personal preferences and wealth planning goals.

By understanding what matters and working with an experienced CFP® wealth management professional, you will be better positioned for a more reliable retirement outcome with more confidence during whatever troubled markets and times are yet to come.

1As measured by the S&P 500 Index from 1926–2018.

Getting to the Point of a Point

While the Dow and other indices are popularly interpreted as indicators of broader stock market performance, the stocks composing these indices may not represent an investor’s actual portfolio or strategy.

A quick online search for “Dow rallies 500 points” yields a cascade of news stories with similar titles, as does a similar search for “Dow drops 500 points.” These types of headlines may make little sense to many investors, given that a “point” for the Dow and what it means for their own portfolios is unclear. The potential for misunderstanding also exists among even experienced market participants. Given that index levels have risen over time, potential emotional anchors such as a 500-point move do not have the same impact on performance as they used to. With this in mind, let’s consider what a point move in the Dow means and its impact on an hypothetical investment portfolio.


The Dow Jones Industrial Average was first calculated in 1896 and currently consists of 30 large cap US stocks. The Dow is a price-weighted index, which is different than more common market capitalization-weighted indices like the S&P and Russell indexes.1 An example may help put this weighting methodology difference in perspective. Consider two companies that have a total market capitalization of $1,000. Company A has 1,000 shares outstanding that trade at $1 each, and Company B has 100 shares outstanding that trade at $10 each. In a market capitalization-weighted index, both companies would have the same weight since their total market caps are the same. However, in a price-weighted index, Company B would have a larger weight due to its higher stock price. This means that changes in Company B’s stock would be more impactful to a price-weighted index than they would be to a market cap-weighted index. The relative advantages and disadvantages of these methodologies are another topic, but our purpose of discussing these differences is to point out that design choices can have a large impact on index performance figures. Investors should be aware of this impact when comparing their own portfolios’ performance to a particular index.


Movements in the Dow are often communicated in units known as points, which signify the level of index change. Because of this different methodology, investors should be cautious when interpreting headlines that reference point movements. A move of, say, 500 points in either direction is much less meaningful today than in the past largely because the overall index level is much higher today than it was many years ago. Exhibit 1 plots the magnitude of this decline in percentage terms over time. A 500-point drop in January 1985, when the Dow was near 1,300, equated to a nearly 39% loss. A 500-point drop in December 2003, when the Dow was near 10,000, meant a much smaller 5% decline in value. And a 500-point drop in early December 2018, when the Dow hovered near 25,000, resulted in only a 2% loss.

Dow Jones and S&P 500 data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. The chart illustrates what a 500-point drop would have been in percentage terms for the Dow Jones Industrial Average on a daily basis. It assumes a 500-point loss took place each trading day from January 1, 1985, to February 1, 2019, and uses daily historical closing values of the Dow Jones Industrial Average to compute the percentage change. Percentage change does not indicate the actual change in the Dow during the period shown. Actual results may vary.

The chart illustrates what a 500-point drop would have been in percentage terms for the Dow Jones Industrial Average on a daily basis. It assumes a 500-point loss took place each trading day from January 1, 1985, to February 1, 2019, and uses daily historical closing values of the Dow Jones Industrial Average to compute the percentage change. Percentage change does not indicate the actual change in the Dow during the period shown. Actual results may vary.


Furthermore, while the Dow and other indices are interpreted by the media as indicators of broad stock market performance, the stocks composing these indices do not represent what may be a globally diversified portfolio even if entirely in equities. For context, the MSCI All Country World Investable Market Index (MSCI ACWI IMI) covers just over 8,700 large, mid, and small cap stocks in 23 developed and 24 emerging markets countries with a combined market cap of more than $50 trillion. The S&P 500 includes 505 large cap US stocks with approximately $23.8 trillion in combined market cap.2 The Dow is a collection of 30 large cap US stocks with a combined market cap of approximately $6.8 trillion.3

Even though the MSCI ACWI IMI, S&P 500, and Dow are all stock market indices, each one tracks different segments of the market, so their performance can differ significantly over time, as shown in Exhibit 2. Since 1995, the Dow has outperformed the S&P 500 and MSCI ACWI IMI by an average of 0.5% and 3.3%, respectively (based on calendar year returns). However, relative performance in individual years can be much different. For example, in 1997, the Dow underperformed the S&P 500 by 8.4% but outperformed the MSCI ACWI IMI by 13.9%.

Performance of MSCI ACWI IMI, S&P 500, and Dow by Calendar Year Dow Jones and S&P 500 data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2019, all rights reserved.

MSCI ACWI IMI is the MSCI All Country World Investable Market Index (net dividends). Their performance does not reflect fees and expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. It is also important to note those planning long-term investment management strategies are concerned about other asset classes besides stocks. Depending on investor needs, a professionally diversified portfolio targeted toward the risk preferences, risk capacity and risk adhesion of a family a will often include a mix of global stocks, bonds, commodities, and any number of other assets not represented in a commercial stock index. A portfolio’s performance should always be evaluated within the context of an investor’s specific goals and time horizons for planning. Understanding how a personal portfolio compares to broadly published indices like the Dow can give investors context about how headlines apply to their own situation—or when comparing portfolios with a friend or colleague. An acute case of “returns envy” can often result in disappointment or even disaster if a sound strategy is abandoned simply to out-perform a neighbor.


News headlines are written to grab your attention. A headline publicizing a 500-point move in the Dow is intended to trigger an emotional response and, depending on the direction, will sound either exciting or ominous enough to warrant reading the article. However, for serious wealth management, attention-getting headlines rarely offer practical insight for achieving reliable planning outcomes, especially for those investors with a philosophy based on modern financial science and a strategy integrated with their individual goals, needs, and preferences in a broadly diversified and cost-effective manner.

1Market capitalization is the product of price and shares outstanding.

2500 companies are included in the S&P 500 Index. However, because some of these companies have multiple classes of stock that meet the requirements for inclusion, the total number of stocks tracked by the index is 505.

3Market cap data as of January 31, 2019.

Déjà Vu All Over Again

“Wild Week Leaves Investors Reeling” is the front-page headline of today’s Wall Street Journal. After remarking on the week’s “sharp plunges and euphoric rises,” it goes on to rhetorically ask: “What is behind the remarkably sudden swings in the market?”

February 2019 Investment fads are nothing new. When selecting approaches for their portfolios, individual investors searching for “better returns” are often tempted to seek out the “latest and greatest” investment opportunities they are seeing or reading about in the popular media. Over the years, many approaches—more recently using “low cost” index, “smart beta” or exchange traded funds—have sought to capitalize on economic developments such as the perceived relative strength of geographic regions or countries, technological changes in the economy, or the popularity of different natural resources. But serious investors planning for long-term goals like retirement should be aware that that the influence of short-term trends may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a new marketing idea every week.”


Looking back at popular investment fads over recent decades can illustrate how often trendy investment themes come and go, along with investor money and their hopes. In the early 1990s, attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan. A decade later, much was written about the emergence of the “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets. Similarly, funds targeting hot industries or novel trends with clever names have come into and fallen out of vogue. In the 1950s, the “Nifty Fifty” were all the rage. In the 1960s, “go-go” stocks and funds piqued investor interest. Later in the 20th century, growing belief in the emergence of a “new economy” led to the creation of funds poised to make the most of the rising importance of emerging information technology and telecommunication services. With the “Tech Bust” we all know how that turned out. During the 2000s, 130/30 funds, which used leverage to sell short certain stocks while going long others, became increasingly popular. In the wake of the 2008 financial crisis, “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded. As investors reached for yield in a low interest-rate environment in the following years, other funds sprang up that claimed to offer increased income generation for those taking increased credit risks, and new strategies like unconstrained bond funds proliferated. More recently, strategies focused on peer-to-peer lending, cryptocurrencies, and even cannabis cultivation and private space exploration have become more fashionable. In this environment, so-called “FAANG” stocks and concentrated exchange-traded funds with catchy ticker symbols have also garnered inordinate attention among investors and gathered huge sums of speculative money that once again is not turning out so well.


Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess or out-smart the market by constantly trading in and out of what’s hot today is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world who set prices. With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making just the right call on a specific industry, region, or individual security over a specific period or time. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it. We often hear about winners, but rarely about losers. It is important to know that most investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still even existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured. The survival results of the exploding number of cheaply-traded ETFs are not any better.


When confronted with choices about whether to add additional types of stocks, funds or other assets to a portfolio, it may be worthwhile to ask the following questions:

  • What is this change claiming to provide that is not already in my portfolio?
  • If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal more reliably?
  • Am I comfortable with the range of potential outcomes?
  • Do I know what they may be if something goes wrong?
  • Will this change improve my investing confidence or my peace of mind?

If investors are left with serious doubts after asking any of these questions, it may be wise to use caution before proceeding. Within equities, for example, the basic market portfolio of many index funds offers the benefit of exposure hundreds or thousands of companies possibly doing business around the world (depending on your selections) and possibly broad diversification across industries, sectors, and countries. While there can be good reasons to deviate from a market portfolio—perhaps tilting toward dimensions of size, value or profitability as we recommend—investors planning long-term outcomes should understand the potential benefits and risks of doing so. In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a knowledgeable CFP® professional can help individual investors create an integrated plan that better fits the needs, values and risk preferences of their families. Pursuing a globally diversified approach without U.S. familiarity bias; managing expenses, turnover, and taxes; and staying disciplined through market volatility and positioned to see market declines as opportunities not to be feared; all can help improve investors’ chances of achieving their long-term financial goals, and gaining greater peace of mind through a professional wealth management process.


Fashionable investment approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research grounded in the science of capital markets and smart flexible implementation may be the most reliable path to truly capturing the potential of what global capital markets have to offer.

CFP® professionals are fiduciaries with a duty of loyalty and care, and individually licensed by the Certified Financial Planner Board of Standards. Source: Dimensional Fund Advisors LP. Past performance may not be indicative of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. There is no assurance that any investing strategy will be successful. Diversification does not eliminate the risk of market loss. 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. Investors should talk to a knowledgeable financial advisor or CFP® professional prior to making any investment decision. Eugene Fama and Kenneth R. French are members of the Board of Directors of the general partner of, and provides consulting services to, Dimensional Fund Advisors LP.

Special Client Edition – Year-End 2018

“Wild Week Leaves Investors Reeling” is the front-page headline of today’s Wall Street Journal. After remarking on the week’s “sharp plunges and euphoric rises,” it goes on to rhetorically ask: “What is behind the remarkably sudden swings in the market?”

U.S. stock markets and many international developed markets grew strongly during a very long bull run in the aftermath of the global market crisis of 2007-2009. Over the last three years, an unusually low level of market volatility has been noted frequently by many commentators. During this last quarter of 2018, that low volatility has given way to the steepest decline since 2002, steeper even than that of 2008, which like 2002, continued to decline even further. The S&P 500 index had dropped 15% in December until this last week.

With the stabilization of the last three days, will markets continue to decline? We don’t know. And for policy management of multi-dimensional structured strategies, it should not matter.

The increased volatility of the stock markets has caused anxiety for many investors, new and old. The Dow Jones Averages had declined nearly 20% (to constitute a “bear” market) but many factor indexes show declines of more than 20% based on prices since the year 2018 began. Most of our clients with balanced equity/fixed income strategies, however, will experience much-reduced negative performance for 2018, likely ranging between minus 6% to minus 8%. While I am sorry for the unhappy news, that is well within normal parameters.

Media — like the Journal — and industry experts will endlessly speculate and prognosticate regarding which political or social event is driving market turbulence (most likely rising interest rates, aided and abetting the Federal Reserve in our opinion). But the driving force of huge swings is almost certainly the new technological reality that roughly 85% of all major market trading is on autopilot—controlled by machines, models, or passive investing formulas. These collectively have created an unprecedented massive herd of robot investors that trades incredibly fast in unison. Human beings simply don’t react that fast. But this is a new era.

Algorithms, or investment recipes, automatically buy and sell based on pre-set inputs or simplified forms of artificial intelligence. “Momentum” of market movements is a critical factor input. Today, quantitative hedge funds, or those that rely on mathematical computer models rather than on traditional research and human intuition, account for 28.7% of trading in the stock market, according to the Tabb Group — doubled since 2013.

Add to that an increasing number of passive funds such as ETFs, index investors, market makers, and those not buying because of fundamental views such as Dimensional Fund Advisors, and you get about 85% of all trading volume according to JP Morgan. Herein is crisis and along with it, a new opportunity for investing.


On Friday the 21st and Monday the 24th we rebalanced most clients’ portfolios in a simplified but customized manner back to target policy allocations. We do not depend on an automated rebalancing algorithm. We call this our “Phase One” of our management process in a decline.

Since we largely employ Dimensional funds that trade as of day end, we waited for a special period of bad news and a day that most machines would not operate. Friday tends to be the day, since quants don’t want open positions over a weekend and I guessed that most had booked a fancy holiday get-away and either would be unlikely to change plans or be able to do so. It created optimal conditions for rebalancing. It was a gift that just kept on giving. The two days after Christmas were a record rise for the Dow Jones average and major U.S. indexes.

Blind faith in machines and models leaves investors vulnerable to biased and irrational outcomes. The solution? That which Dimensional Fund Advisors has used in its trading process since its inception — a healthy dose of skepticism and human oversight when trading securities. Remember this about computers and robo-advisors: it’s an algorithm, not an authority.


While peace of mind may not have been part of the holiday season due to continuing market declines and substantial swings, volatility is a normal part of all investing. Risk and expected return are related. The idyllic pattern of growth of the past several years that sucked in so many investors to make big bets by over-allocating into U.S. growth stocks could not last.

Additionally, we all know that reacting emotionally to turbulent markets and changing sensible investment strategies and management process is likely to be far more harmful to long-term outcomes and peace of mind than a periodic market drawdown. We remember that we have to be right twice: both when you sell, and then when you buy back.

We will discuss these matters more in our next Planning Perspectives. Should you have questions about our actions before our next planning meeting or have concerns about “Phase 2” should global markets continue their declines into 2019, please call or email us.

This is what we’ve expected for months. The problem is, when we get what we want, we may not want what we get — at least for a while. For those upset by the news, turn off the computer, and ignore the media. Enjoy family and friends as we welcome in what may yet be a very happy New Year.

Carefully Considering Ownership Costs

Costs matter. Whether you’re buying a car or selecting investments for your portfolio, the costs you expect to pay are likely an important factor in making a financial decision.

People rely on different sources of information to make informed decisions. When buying a car, for example, the sticker price indicates about how much you may expect to pay for a car. But the costs of car ownership do not end there. Taxes, insurance, fuel, routine maintenance, and unexpected repairs (and where repairs are made) must be considered for complete ownership costs. While some costs are easily observable, other equally important ownership costs are obscure. Similarly, when selecting investment vehicles for constructing a portfolio both explicit and implicit costs must be considered to properly evaluate how cost‑effective a wealth planning strategy may be.


Mutual funds are the simplest way to illustrate this. Like all investments, mutual funds have differing management costs, all of which impact net investor return. The most easily observable measure of cost to identify is the expense ratio, which must be disclosed. Like a car’s sticker price, expense ratios tells you much about what you can expect to pay for different mutual and exchange traded funds. For investors looking to save on costs, expense ratios influence many decisions.

Exhibit 1 illustrates the “outperformance rate” for the proportion of surviving active equity mutual funds beating their relative category index over a 15-year period. To clarify the link between expense ratio and performance, outperformance rates are shown by quartiles and sorted by their expense ratios. The chart shows that the outperformance rate of active funds has not only lagged but been inversely related to expense ratio. Just 6% of active funds in the highest expense ratio quartile beat their index, compared to 25% for the lowest expense ratio quartile.

Exhibit 1. High Costs Can Reduce Performance, Equity Fund Winners and Losers Based on Expense Ratios (%)

The sample includes funds at the beginning of the 15-year period ending December 31, 2017. Funds are sorted into quartiles within their category based on average expense ratio over the sample period. The chart shows the percentage of winner and loser funds by expense ratio quartile; winners are funds that survived and outperformed their respective Morningstar category benchmark, and losers are funds that either did not survive or did not outperform their respective Morningstar category benchmark. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Equity fund sample includes the Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Small Blend, Small Growth, Small Value, and World Stock. For additional information regarding the Morningstar historical categories, please see “The Morningstar Category Classifications.”

Index funds and fund-of-funds are excluded from the sample. The return, expense ratio, and turnover for funds with multiple share classes are taken as the asset-weighted average of the individual share class observations. For additional methodology, please refer to Dimensional Fund Advisors’ brochure, Mutual Fund Landscape 2018. Past performance is no guarantee of future results.

Dead weight from high expense ratios presents a challenging hurdle for many active equity funds to overcome. From the investor’s viewpoint, selecting among funds with similar asset allocations having a low expense ratio of 0.25% vs. those about 1.25% potentially could mean savings of $10,000 per year on every $1 million invested. As Exhibit 2 illustrates, that difference can add up over time. However, at least some investment managers of higher-cost funds may be able to enhance performance sufficiently to offset their high costs.

Exhibit 2. Hypothetical Growth of $1 Million at 6%, Less Expenses

For illustrative purposes only and not representative of an actual investment. This hypothetical illustration is intended to show the potential impact of higher expense ratios and does not represent any investor’s actual experience. Assumes a starting account balance of $1 million and a 6% compound annual growth rate less expense ratios of 0.25%, 0.75%, and 1.25% applied over a 15-year time horizon. Performance of a hypothetical investment does not reflect transaction costs, taxes, other potential costs, or returns that any investor would have actually attained and may not reflect the true costs, including management fees of an actual portfolio. Actual results may vary significantly. Changing the assumptions would result in different outcomes. For example, the savings and difference between the ending account balances would be lower if the starting investment amount were lower.


The poor track record of so many active mutual funds with high expense ratios has led many investors to select mutual funds based solely on expense ratio. That could be a mistake. As with a car’s sticker price, an expense ratio does not measure the complete cost of ownership. For example, index funds often rank near the bottom of their peers’ expense ratios. These funds are designed to track or match the components of arbitrary indexes formulated by commercial index providers, such as Russell or MSCI.

Important investment management decisions, such as which securities to include or exclude, are not within an index fund manager’s discretion and effectively outsourced to the index provider. Additionally, the prescribed reconstitution schedule for an index, when certain stocks are added or deleted to that index, may force index fund managers to buy stocks when demand is high and sell stocks when demand is low, increasing costs. Price-insensitive buying and selling is required for an index fund to “stay true” to the underlying index mandate. Diminished overall returns can result from sub-optimal transactions: for a given amount of trading (or turnover), the cost per unit due to a strictly regimented trading tends to be higher. These indirect costs are unpublished.

Further, because indices of commercial providers are reconstituted only infrequently (typically once per year), index funds that track them buy and sell underlying holdings based on stale eligibility criteria. For example, the characteristics of a particular “value” stock1 may have changed since the last reconstitution date, but those changes would not affect that stock’s inclusion in its commercial value index. Incoming cash flows into a value index fund, say, may continue to purchase securities that could be more like growth stocks2 (and vice versa). To avoid being different than the index they mimic, index managers invest using a rear-view mirror rather than watching the road ahead.

For active stock picking approaches, both the total amount of trading and the cost per trade usually will be higher than with indexing strategies. If an active manager trades excessively or inefficiently, commissions and price impact from increased trading will progressively eat away at returns. Using our car analogy, this is like incessantly jamming on the brakes or accelerating quickly. Subjecting any car to such abusive treatment results in added wear and tear and greater fuel consumption, increasing the total cost of ownership over time. Moreover, for investors holding funds in taxable accounts, excessive trading increases cost of ownership by realizing income subject to tax sooner.

Unnecessary turnover and higher costs per trade can be avoided, such as with portfolio strategies managed by Dimensional Fund Advisors. In contrast to both highly regimented index and high-turnover active strategies, a flexible management approach reduces the costs of immediacy, and thus enables opportunistic execution. Reducing implicit costs adds value. Keeping turnover low, remaining flexible, and transacting only when the potential benefits of a trade outweigh the costs, help keep overall trading costs even lower. This not only reduces complete total costs of ownership but also translates into higher portfolio returns.


Estimating the complete cost of owning any investment vehicle, like mutual funds, can be difficult to assess in advance. There are both implicit and explicit costs. Deciding requires a thorough understanding of costs beyond looking at expense ratio disclosures. Investors should think beyond any single cost metric and instead evaluate the total cost of ownership relative to the potential total benefit for total portfolio return based on a clear understanding of how a management methodology may reliably improve results.

Rather than focus too much time on evaluating investment costs, successful families should spend more time evaluating independent Certified Financial PlannerTM professionals with the right education and expertise that may help them take control of their financial future and make the truly informed decisions necessary to gain real peace of mind and enjoy a more abundant retirement.

1A stock trading at a low price relative to a measure of fundamental value, such as book value or earnings.

2 A stock trading at a high price relative to a measure of fundamental value, such as book value or earnings.

Midterm Elections: What Do They Mean for Markets?

It’s almost Election Day in the US once again. For those who need a brief civics refresher, every two years the full US House of Representatives and one-third of the Senate are up for reelection.

While the outcomes of the elections are uncertain, one thing we can count on is that plenty of opinions and prognostications will be floated in the days to come. In financial circles, this will almost assuredly include any potential for perceived impact on markets. But should long-term investors focus on midterm elections?.


We would caution investors against making short-term changes to a long-term plan to try to profit or avoid losses from changes in the political winds. For context, it is helpful to think of markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that incorporate the aggregate expectations of those investors. This makes outguessing market prices consistently very difficult.1 While surprises can and do happen in elections, the surprises don’t always lead to clear-cut outcomes for investors.

The 2016 presidential election serves as a recent example of this. There were a variety of opinions about how the election would impact markets, but many articles at the time posited that stocks would fall if Trump were elected.2 The day following President Trump’s win, however, the S&P 500 Index closed 1.1% higher. So even if an investor would have correctly predicted the election outcome (which was not apparent in pre-election polling), there is no guarantee that they would have predicted the correct directional move, especially given the narrative at the time.

But what about congressional elections? For the upcoming midterms, market strategists and news outlets are still likely to offer opinions on who will win and what impact it will have on markets. However, data for the stock market going back to 1926 shows that returns in months when midterm elections took place did not tend to be that different from returns in any other month.


Exhibit 1: Congressional elections and annual returns

Exhibit 1 shows the frequency of monthly returns (expressed in 1% increments) for the S&P 500 Index from January 1926–August 2018. Each horizontal dash represents one month, and each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months where returns were between 1% and 2%). The blue and red horizontal lines represent months during which a midterm election was held, with red meaning Republicans won or maintained majorities in both chambers of Congress, and blue representing the same for Democrats. Striped boxes indicate mixed control, where one party controls the House of Representatives, and the other controls the Senate, while gray boxes represent non-election months. This graphic illustrates that election month returns were well within the typical range of returns, regardless of which party won the election. Results similarly appeared random when looking at all Congressional elections (midterm and presidential) and for annual returns (both the year of the election and the year after).


While it can be easy to get distracted by month-to-month or even one-year returns, what really matters for long-term investors is how their wealth grows over longer periods of time. Exhibit 2 shows the hypothetical growth of wealth for an investor who put $1 in the S&P 500 Index in January 1926. Again, the chart lays out party control of Congress over time. And again, both parties have periods of significant growth and significant declines during their time of majority rule. However, there does not appear to be a pattern of stronger returns when any specific party is in control of Congress, or when there is mixed control for that matter. Markets have historically continued to provide returns over the long run irrespective of (and perhaps for those who are tired of hearing political ads, even in spite of) which party is in power at any given time.

Exhibit 2. Growth of $1 Invested in the S&P 500 Index and Party Control of Congress January 1926–August 2018

Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. S&P data ©2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

Equity markets can help investors grow their assets, and we believe investing is a long-term endeavor. Trying to make investment decisions based on the outcome of elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, to pursue investment returns.

1.This is known as the efficient market theory, which postulates that market prices reflect the knowledge and expectations of all investors and that any new development is instantaneously priced into a security.

2. Examples include: “A Trump win would sink stocks. What about Clinton?” CNN Money, 10/4/16, “What do financial markets think of the 2016 election?” Brookings Institution, 10/21/16, “What Happens to the Markets if Donald Trump Wins?” New York Times, 10/31/16.

The ABCs of Education Investing

With school back in session in most of the country, many parents are likely thinking about how best to prepare for their children’s future college expenses. Now is a good time to sharpen one’s pencil for a few important lessons before heading back into the investing classroom to tackle the issue.


According to recent data published by the College Board, the annual cost of attending college in the US in 2017–2018 averaged $20,770 at public schools, plus an additional $15,650 if one is attending from out of state. At private schools, tuition and fees averaged $46,950.

It is important to note that these figures are averages, meaning actual costs will be higher at certain schools and lower at others. Additionally, these figures do not include the separate cost of books and supplies or the potential benefit of scholarships and other types of financial aid. As a result, actual education costs can vary considerably from family to family.

To complicate matters further, the amount of goods and services $1 can purchase tends to decline over time. This is called inflation. One measure of inflation looks at changes in the price level of a basket of goods and services purchased by households, known as the Consumer Price Index (CPI). Tuition, fees, books, food, and rent are among the goods and services included in the CPI basket. In the US over the past 50 years, inflation measured by this index has averaged around 4% per year.1 With 4% inflation over 18 years, the purchasing power of $1 would decline by about 50%. If inflation were lower, say 3%, the purchasing power of $1 would decline by about 40%. If it were higher, say 5%, it would decline by around 60%.

While we do not know what inflation will be in the future, we should expect that the amount of goods and services $1 can purchase will decline over time. Going forward, we also do not know what the cost of attending college will be. But again, we should expect that education costs will likely be higher in the future than they are today. So, what can parents do to prepare for the costs of a college education? How can they plan for and make progress toward affording those costs?


To help reduce the expected costs of funding future college expenses, parents can invest in assets that are expected to grow their savings at a rate of return that outpaces inflation. By doing this, college expenses may ultimately be funded with fewer dollars saved. Because these higher rates of return come with the risk of capital loss, this approach should make use of a robust risk management framework. Additionally, by using a tax-deferred savings vehicle, such as a 529 plan, parents may not pay taxes on the growth of their savings, which can further lower the cost of funding future college expenses.

While inflation has averaged about 4% annually over the past 50 years, stocks (as measured by the S&P 500 Index) have returned around 10% annually during the same period. Therefore, the “real” (inflation-adjusted) growth rate for stocks has been around 6% per annum. Looked at another way, $10,000 of purchasing power invested at this rate over the course of 18 years would result in over $28,000 of purchasing power later on. We can expect the real rate of return on stocks to grow the purchasing power of an investor’s savings over time. We can also expect that the longer the horizon, the greater the expected growth. By investing in stocks, and by starting to save many years before children are college age, parents can expect to afford more college expenses with less savings.

It is important to recognize, however, that investing in stocks also comes with investment risks. Like teenage students, investing can be volatile, full of surprises, and, if one is not careful, expensive. While sometimes easy to forget during periods of increased uncertainty in capital markets, volatility is a normal part of investing. Tuning out short-term noise is often difficult to do, but historically, investors who have maintained a disciplined approach over time have been rewarded for doing so.


Working with a CFP® professional who has a transparent approach based on sound investment principles, consistency, and trust can help investors identify an appropriate risk management strategy. Such an approach can limit unpleasant (and often costly) surprises and ultimately may contribute to better investment outcomes.

A key part of maintaining this discipline throughout the investing process is starting with a well-defined investment goal. This allows for investment instruments to be selected that can reduce uncertainty with respect to that goal. When saving for college, risk management assets (e.g., bonds) can help reduce the uncertainty of the level of college expenses a portfolio can support by enrollment time. These types of investments can help one tune out short‑term noise and bring more clarity to the overall investment process. As kids get closer to college age, the right balance of assets is likely to shift from high expected return growth assets to risk management assets.

Diversification is also a key part of an overall risk management strategy for education planning. Nobel laureate Merton Miller used to say, “Diversification is your buddy.” Combined with a long-term approach, broad diversification is essential for risk management. By diversifying an investment portfolio, investors can help reduce the impact of any one company or market segment significantly negatively impacting their wealth.

Additionally, diversification helps take the guesswork out of investing. Trying to pick the best performing investment every year is a guessing game. We believe that by holding a broadly diversified portfolio, investors are better positioned to capture returns wherever those returns occur.


Higher education may come with a high and increasing price tag, so it makes sense to plan well in advance. There are many unknowns involved in education planning, and no “one-size-fits-all” approach can solve the problem. By having a disciplined approach toward saving and investing, however, parents can remove some of the uncertainty from the process. A CFP® wealth professional can help you clarify your goals, present different portfolio approaches, and help you understand the likely outcomes for an informed decision.

A CFP® professional can help you craft a plan most likely to realize your family’s educational goals. An informed strategy for college funding, integrated with your own informed retirement strategy, will help put you in control of your financial future and gain greater peace of mind.

1.Source: US Department of Labor, Bureau of Labor Statistics, Economic Statistics.

Alternative Reality

Diversification has been called the only free lunch in investing.

This idea is based on research showing that diversification, through a combination of assets like stocks and bonds, could reduce volatility without reducing expected return or increase expected return without increasing volatility compared to those individual assets alone. Many investors have taken notice, and today, highly diversified portfolios of global stocks and bonds are readily available to investors at a comparatively low cost. A global stock portfolio can hold thousands of stocks from over 40 countries around the world, and a global bond portfolio can be diversified across bonds issued by many different governments and companies and in many different currencies.

Some investors, in search of additional potential volatility reduction or return enhancement opportunities, may even try to extend the opportunity set beyond stocks and bonds to other assets, many of which are commonly referred to as “alternatives.” The types of offerings labeled as alternative today are wide and varied. Depending on who you talk with, this category can include, but is not limited to, different types of hedge fund strategies, private equity, commodities, and so on. These investments are often marketed as having greater return potential than traditional stocks or bonds or low correlations with other asset classes.

In recent years, “liquid alternatives” have increased in popularity considerably. This sub-category of alternatives consists of mutual funds that may start from the same building blocks as the global stock and bond market but then select, weight, and even short securities1 in an attempt to deliver positive returns that differ from the stock and bond markets. Exhibit 1 shows how the growth in several popular classifications of liquid alternative mutual funds in the US has ballooned over the past several years.

Graph of Number of Liquid Alternative Mutual Funds in the US

The growth in this category of funds is somewhat remarkable given their poor historical performance over the preceding decade. Exhibit 2 illustrates that the annualized return for such strategies over the last decade has tended to be underwhelming when compared to less complicated approaches such as a simple stock or bond index. The return of this category has even failed to keep pace with the most conservative of investments. For example, the average annualized return for these products over the period measured was less than the return of T-bills but with significantly more volatility.

Chart of Performance and Characteristics of Liquid Alternative Funds in the US vs. Traditional Stock and Bond Indices

While expected returns from such strategies are unknown, the costs and turnover associated with them are easily observable. The average expense ratio of such products tends to be significantly higher than a long-only stock or bond approach. These high costs by themselves may pose a significant barrier to such strategies delivering their intended results to investors. Combine this with the high turnover many of these strategies may generate and it is not challenging to understand possible reasons for their poor performance compared to more traditional stock and bond indices.

This data by itself, though, does not warrant a wholesale condemnation of evaluating assets beyond stocks or bonds for inclusion in a portfolio. The conclusion here is simply that, given the ready availability of low cost and transparent stock and bond portfolios, the intended benefits of some alternative strategies may not be worth the added complexity and costs.


When confronted with choices about whether to add additional types of assets or strategies to a portfolio for diversification beyond stocks, bonds, and cash it may help to ask three simple questions.

  1. What is this alternative getting me that is not already in my portfolio?
  2. If it is not in my portfolio, can I reasonably expect that including it will increase expected returns or reduce expected volatility?
  3. Is there an efficient and cost-effective way to get exposure to this alternative asset class or strategy?

If you are left with doubts about any of these three questions it may be wise to use extreme caution before proceeding. A wealth management professional with the right knowledge, expertise, education and experience can help you answer these questions and ultimately decide if a given investing strategy is right for you.

Since few investors can ever know enough on their own to make a fully informed decision, we suggest the first decision you can make in wealth planning is: who can you trust to put your interest first and foremost? We suggest a fiduciary advisor specializing in wealth management is most likely to put you in control of your financial future, show you how to better manage uncertainty, and help you gain confidence and peace of mind.


Absolute Return: Funds that aim for positive return in all market conditions. The funds are not benchmarked against a traditional long-only market index but rather have the aim of outperforming a cash or risk-free benchmark.

Equity Market Neutral: Funds that employ portfolio strategies that generate consistent returns in both up and down markets by selecting positions with a total net market exposure of zero.

Long/Short Equity: Funds that employ portfolio strategies that combine long holdings of equities with short sales of equity, equity options, or equity index options. The fund may be either net long or net short depending on the portfolio manager’s view of the market.

Managed Futures: Funds that invest primarily in a basket of futures contracts with the aim of reduced volatility and positive returns in any market environment. Investment strategies are based on proprietary trading strategies that include the ability to go long and/or short.

Category descriptions are based on Lipper Class Codes provided in the CRSP Survivorship bias-free Mutual Fund Database.

1Short positions benefit if the borrowed security falls in value.

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. Investors should talk to a wealth management professional prior to making any investment decision.

Investing involves risks including possible loss of principal. Stocks are subject to market fluctuation and other risks. Bonds are subject to increased risk of loss of principal during periods of rising interest rates and other risks. There is no assurance that any investment strategy will be successful. Diversification does not assure a profit or protect against loss.

E+R=O, a Formula for Success*

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, Dimensional Fund Advisors


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 investors, maintain discipline through bull markets, bear markets, political strife, economic instability, or whatever crisis du jour threatens progress towards their 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.


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 short-term 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 returns (outcome).

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 long-term plan.


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.


Without education and training — sometimes gained from bitter experience — it is hard for non-investment professionals to develop a cogent investment philosophy. And 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.

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 market events.

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.

*Jack Canfield, The Success Principles: How to Get from Where You Are to Where You Want to Be (New York: HarperCollins Publishers, 2004)

Adapted from “E+R=O, a Formula for Success,” The Front Foot Adviser, by David Jones, Vice President and Head of Financial Adviser Services, EMEA.

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. Investors should talk to a wealth management professional prior to making any investment decision.

Investing involves risks including possible loss of principal. Stocks are subject to market fluctuation and other risks. Bonds are subject to increased risk of loss of principal during periods of rising interest rates and other risks. There is no assurance that any investment strategy will be successful. Diversification does not assure a profit or protect against loss.