This section will combine the rules I put forward on the home page with the philosophy I put forward on the Basic Investment Philosophy page to create a basic investment strategy that will earn competitive investment returns with very little fees.  This strategy will form the basis for most of the other strategies put forward on this site.  Note that what I discuss in this section does not take into account your individual wealth, income and risk tolerance profile.  We will put forward recommended investment mixes for various individual profiles in other sections of this site.

 

So, we're trying to combine the following items when forming our basic investment strategy:

 

Rules	Philosophy
Minimize Fees	Minimize Volatility/Maximize Returns
Keep It Simple	Diversify Intelligently
Don't Try to Time the Market	Take all Relevant Correlations Into Account
Take Advantage of Long-Term Reversion to the Mean	Take Advantage of the Natural Forces at Play in the Economy
	Beware of the Unnatural Forces at Play in the Economy

 

As outlined in two seminal research papers by Eugene Fama and Kenneth French published in 1992 and 1993, most active managers beat the 'market', as defined by popular stock indices, by picking investments with exposure to two variables: a book-to-market equity ('value') variable and a size variable.  The value variable comes from buying stocks that are inexpensive relative to their fundamental business metrics.  For example, if I buy the stock of a company that produces $1.00 of earnings per share of stock it has issued, and I pay $5.00 for one share of stock, I paid 5 times earnings for this stock.  If I buy another stock of a company that produces $1.00 of earnigns per share of stock it has issued, and I pay $10.00 for one share of stock, I paid 10 times earnings for this stock.  Value measures tend to correlate with each other, so that a stock whose book (accounting) value of net equity is high when compared to the market trading price of the stock is also likely to have a low price-to-earnings ratio.  The size variable comes from the size of the company, so that buying a stock of a smaller company produces a lower size variable than buying the stock of a larger company.  Fama and French found that portfolios with higher value characteristics and lower size characteristics earned higher investment returns than portfolios with other characteristics.  Just before the Fama & French papers were published, another researcher, Narasimhan Jegadeesh, found that unusual price reversals of stocks that had strongly underperformed the market over a 2-3 year term were correlated with value characteristics.  This makes intuitive sense, as companies who have run into difficulties were likely forgotten by the market, but if they're able to restructure and turn the business around, they'll emerge as ignored and inexpensive stocks.  They will then outperform other stocks as fund managers discover their improvement in performance and buy them up.  The papers published by Fama and French led to a long-term heated debate in finance academia about whether or not their findings represented a persistent and real investment anomaly, a temporary phonomenon or a persistent phenomon explainable by risk/return philosophy and hence not an anomaly.  We won't bother with this debate here.  The important point is that many successful investors throughout the past century have followed a strategy of purchasing stocks that had certain characteristics.  I do, however, believe that 'growth' investing, buying the expensive stocks of companies that are growing rapidly, can also be an effective approach at times.  To me, the market oscillates between favouring one of these two approaches.  This is why we will apply the concept of long-term reversion to the mean to our selection of investments based on their size and growth/value characteristics.

First off, let's choose the investment products we will use in our strategy.  We want a diversified portfolio with exposure to multiple sectors and multiple geographies.  We will apply the concept of long-term mean reversion to the selection of growth vs. value and small-cap vs. large-cap stocks within our major geographical categories.  The investments we select will form our core portfolio.  We can modify the core portfolio by adding fixed-income investments and other asset classes to reduce volatility.  The final step will be tailoring the portfolio for individuals with exposure to individual industries or regions in their other assets, including real estate holdings, and/or in their income streams.

 

I favour iShares because they're a trusted name in ETFs that have been in the market for a long time.  I'll generally pick an iShares ETF if I can find one that covers the market segment I'm interested in investing in.  However, if iShares doesn't provide the ETF I'm looking for, I'm happy to move on to other reputable providers to find the appropriate ETF.  We can invest in most of the world's stock markets through the use of iShares.  If you're Canadian, you likely have a natural bias to only invest in Canadian mutual funds or stocks and bonds.  By doing so, you're investing all of your funds in a market that represents only 3.7% of the world's stock market capitalization.  So, you're avoiding investing in 96.3% of the world's stocks.  It seems like a crazy approach to investing, but most Canadians invest only in Canada, or only a small portion of their funds internationally through an international mutual fund.  We want a much higher exposure to other countries.  The table below outlines the current breakdown of global market capitalization by major country: