Your Wealth Journey Investment Insights: New Factors for an Evidence-Based Portfolio

Today’s post is a continuation of this post. It might be helpful for you to read that post first and then pop back over here to continue the discussion about evidenced-based portfolios.

Did the recognition of “three-factor investing” solve the market? Well, no. Not really. Someone will always be identifying additional market factors at play.

There will always be those seeking to find patterns to gain an advantage in the market. Two newer factors discussed in academic circles are profitability and momentum:

• The Profitability Factor – Highly profitable companies have delivered higher returns over low-profitability companies.

• The Momentum Factor – A stock's recent performance tends to continue to do the same for longer than random chance seems to explain.

A Closer Look at New Factors

Before we get ahead of ourselves, let’s discuss a few caveats.

1. Wet Paint Warning – While these “new” factors may have existed for some time, our ability to isolate them is more recent.
2. Cost versus Reward – Just because a factor exists in theory, that doesn’t mean it can be implemented in real life. We must be able to capture an expected premium without generating costs beyond its worth.
3. Dueling Factors – Sometimes, it can be difficult to build one factor into a portfolio without sacrificing another. For example, as Jared Kizer explained in a Multifactor World blog post, “One generally can’t tilt toward both value and momentum at the same time, because the two strategies tend to be highly negatively correlated.” Benefits and tradeoffs must be considered at the fund level as well as for your individual goals.

As a result, opinions vary on how profitability and momentum should play a role in current portfolio construction.

These new factors are a bit like new shoes. As you continue on your journey, it may be enticing to try them out. They might work well, but you still don’t know how they might react in all conditions.

But, wait. These aren’t shoes. This is your life, your prosperity, your future. We’re here to help you assess whether they may make sense for you. So, let’s explore how to think about investment information.

Investment Information: A Double-Edged Sword

Relentless questioning from scholars and practitioners is essential to evidence-based investment theory and application. Progress is good and necessary. But you need only glance at daily headlines to notice a never-ending stream of ideas from conflicting voices of authority.

Staying informed is helpful, but being inundated with jargon-filled jibberish can do as much harm as good.

Investment Reality: Choose Your Allies Carefully

So, how do you know who to follow and who to ignore?

This is why you have an advisor. A professional in your corner can separate the emotional response from the informed, forward-thinking one. We must ask pointed questions that can take years to resolve:

• Have the results been replicated across factors, over time and around the world?
• Is there robust analysis, not only from industry insiders but from disinterested academics?
• Has it survived extensive peer review?

It becomes fairly obvious, when we answer these questions, what is useful and what is not. If it isn’t leading you to your destination, you’re better off forgetting it.

The Rub

We’re looking for the smoothest journey for you. When we identify a new route that might make that journey easier, we must be careful not to overreact. You never know what may lie around the next bend on an uncharted path.

Staying the course will almost always serve you well. But it doesn’t hurt to keep an eye out for new information.

Read More from Atlas Wealth Advisors

• Becoming a Better Investor
• Start Your Retirement Journey Series
• Find Your Financial Focus
• Discover Your Wealth Perspective Now

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