Why do most investment strategies underperform the market?
Lots and lots of reasons! Let us break down a few for you:
Anicha: the only Constant … is Change.
Most investment strategies are static: for example, the 60/40 Equity/Bonds portfolio. This worked for a long time but will it work in the future when interest rates are close to zero? Mathematically it is easy to prove that it won’t work.
Another example is the changing asset class environment. 15 years ago, we did not have crypto. Now we do. should we adjust our allocation? Probably!
Humans are buggy machines.
You and; We are awesome. But we also change our mind all the time; we have emotions we don’t always understand, and our decision making is not always rational. This will be reflected in how we create and manage an investment portfolio. We think machines can be better at this.
If you de-risk a system, you also de-return it.
We are thought that we should have a balanced risk strategy to sleep better. That is correct; a balanced strategy will be less volatile. But that goes both ways: up and down. The less risk you take, the less return you will get.
Winning by losing less
If you lose 50% of something, you have to make 100% to break even. If you lose 10%, you have to make 11.1% to break even. The key, therefore, becomes to lose less. If you lose less, you will be winning more. Algo’s are far better at risk management then people are, and algorithms will jump out in cash when they need to. And jump in again when the risk is lower than the probability of making a profit
Why do others invest with a static formula
that in invented in 1952?
Most financial advisors, asset managers and Robo-advisors work with the Modern Portfolio Theory. The theory is not so modern any more as it dates from 1952. The main issue is that this theory makes a few assumptions about the market that are known not to be valid.
The second problem lies in how the theory is applied. In most cases, it means that you underperform the market. Not only that, you will experience these frightening ripping downdrafts as most advisors will make you fully invested all the time.
We are completely different. We have created algorithms that are very dynamic and adjust very quickly to market changes. They still can have a period of negative performance. Still, over the long run, they have proven in backtesting that the return profile is more stable, and you experience fewer heart palpitations!
So why do others still use this theory? It’s easy to implement, and once a whole industry accepts a theory, group-think takes over.
How can you beat the market when most volume is traded by algorithms?
Let’s face it. Computers rule the world; we can’t do without them. If you use an investment strategy that does not use the power of algorithms, you are shortchanging yourself. Simple as that.
Consider the speed, the amount of information and the pattern recognition that computers can do. We don’t live in the matrix, but we sure can use the power of the matrix to become better investors…