Three Investing Pearls From One Of Wall Street’s Top Strategists

Three Investing Pearls From One Of Wall Street’s Top Strategists

29 days ago5 mins

  • Investing Pearl #1: Markets are fairly efficient, so spend more time on your long-term asset allocation, consider investing in index funds, and think of spending time in the market rather than timing the market.

  • Investing Pearl #2: Prices don’t reflect just one outcome. They take into account the odds of multiple scenarios. So make sure you pay attention to those alternative scenarios, even when they’re less likely.

  • Investing Pearl #3: Follow Occam’s Razor. If a single variable can explain something, there’s no need to complicate it with two. In investing, keep things as simple as possible.

Investing Pearl #1: Markets are fairly efficient, so spend more time on your long-term asset allocation, consider investing in index funds, and think of spending time in the market rather than timing the market.

Investing Pearl #2: Prices don’t reflect just one outcome. They take into account the odds of multiple scenarios. So make sure you pay attention to those alternative scenarios, even when they’re less likely.

Investing Pearl #3: Follow Occam’s Razor. If a single variable can explain something, there’s no need to complicate it with two. In investing, keep things as simple as possible.

When it seems like everyone and their beagle are sharing investment tips on social media, there’s something reassuringly authentic about the wisdom that comes from Wall Street’s old guard. I’ve been reading insights from Jan Loeys lately. He’s a veteran strategist at JPMorgan with over three decades of market experience under his belt. Here are three pearls I’ve taken from him.

Markets are fairly efficient. If something is common knowledge, it’s probably already factored into the price.

Markets are savvy. With everyone analyzing, talking about, and trading the same assets 24/7, 365 days a year, publicly available information about those assets gets incorporated into prices almost instantaneously. So, usually, by the time you think you’ve got an exclusive insight or a hot tip, the market’s already had its tea and moved on. In short, betting on your original stock-picking prowess or your ability to time market “tops” and “bottoms” is a tougher game than you might think.

Here’s what that means in practice. First, don’t put all your chips on just a few stocks. Instead, consider a “core-satellite” approach: anchor your portfolio with diversified stock ETFs and then add a touch of your high-conviction picks as the “satellites”. Next, spend less time choosing individual assets and more time thinking about your long-term strategic mix of assets – that is, the balance of stocks, bonds, and other assets that best fit your goals, risk appetite, and particular circumstances. Fact: about 90% of returns are driven by your long-term asset allocation, not some shrewd investment selection within those asset classes. Last, remember that prioritizing “time in the market” will serve you better than “timing the market”. By all means, reducing your exposure to assets that you think are overvalued and overweighting those with more upward potential could add some returns to your portfolio if you get it right. But staying invested in the market – and making sure you don’t jump ship right before the tide turns – tends to produce even higher returns in the long run. Because the biggest risk of all is never investing.

Prices don’t reflect just one outcome. They take into account the odds of multiple scenarios.

Prices in financial markets don’t just represent one specific expected outcome. Instead, they encapsulate a range of possible future scenarios, each with its own likelihood. The price you see is essentially an average of all these potential outcomes, adjusted for how probable each one seems.

For example, imagine investors expect the economy to achieve a “soft landing”, with inflation falling back into line without the perils of a recession. And let’s say they expect that outcome to lead to a 5% gain in the S&P 500. This is the market’s “base case” scenario with a (theoretical) probability of 60%. But let’s assume there’s also a solid 35% chance that a stronger economy sends the S&P 500 higher by 20%. And let’s assume there’s a small 5% chance of a nasty recession that brings the index down by 40%. In this illustrative example, you’d expect the S&P 500 to gain 7.5% (because 60% times 5% gain, plus 45% times 20% gain, minus 5% times 50% loss). Now, what if that relatively small probability of a bad scenario jumps to 10%? Well, even if it’s still an unlikely scenario, the expected return would fall by almost half to 4%. That’s a big change compared to the small adjustment in probability for such an unlikely scenario, and that’s why you often see significant price moves, even without any change to “base case” forecasts.

In practice, it means you shouldn’t just tune into the market’s main narrative, but also pay attention to the side plots, even the unlikely ones. Top investors often excel not by correctly predicting what will happen next, but by spotting mispriced scenarios and capitalizing on them.

Think of it like wagering on the English Premier League: you could potentially make more money from the odds of Brighton winning the league rising significantly – even if that underdog team doesn’t win the league – than from Manchester City actually winning the league, because a win from this powerhouse club would mostly be “in the price”. Again, it’s not all about what’s most likely to happen, but about the other scenarios’ changing odds too.

Follow Occam’s Razor. There’s wisdom in simplicity.

Financial markets are a labyrinth of complexity, shaped by lots of variables that constantly interact and evolve. Toss in behavioral biases, self-fulfilling prophecies, and unexpected external shocks, and predicting their next moves can feel like chasing a mirage. It’s no wonder some investors just freeze, overwhelmed by information and choices, while others craft overly complex strategies, thinking they’ve just cracked the market’s code. (Spoiler: almost all will be painfully assured that they haven’t).

In the investment world, the best tool to deal with this complexity is simplicity. To cut through the noise, reduce the risk of analysis paralysis, and maintain your focus on the things you can control, keep your approach as zen as possible. And that applies to your whole investment process: from analyzing potential investment ideas and managing your portfolio, to defining your own “buy and sell” trading rules. What’s driving the price of your stocks and bonds? A gazillion factors, but mostly economic growth and inflation. How many assets do you need in your portfolio? Probably fewer than you think: a broad stocks ETF and a broad bonds ETF are a great start. Which investment product should I favor? One that’s cheap, liquid, and easy to understand. So remember Occam’s Razor: if one variable can explain something, there’s no need to complicate it with two.

Finimize

BECOME A SMARTER INVESTOR

All the daily investing news and insights you need in one subscription.

Learn More

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

/3 Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.

Finimize
© Finimize Ltd. 2023. 10328011. 280 Bishopsgate, London, EC2M 4AG