5 Minute Read
11 December 2020
By Shane Monks O'Byrne
Millennials are a generation which have endured many financial hardships, having entered the workforce in the fire and embers of the great recession, they are struggling to build the same nest-egg that older generations might have had due to lower wages, mixed with sky-high debt and rent. It seems that millennial investing has never been tougher.
And yet, due to their age, millennials can invest more aggressively and are in a unique position to profit from the bull market that has taken hold. The US stock market is up nearly 100% over the past 5 years. Millennial investing has never been so exciting.
If a 26 year old invested $5 a day, the price of a cup of coffee, on retirement at age 65, they would be sitting on $3.2M! This assumes a 15% growth rate; an interest rate which can be achieved by following structured investing processes such as those outlined in this article.
Let’s cut straight to the chase. Millennials are in a position to achieve extraordinary returns by investing quantitatively. By using computers to aid in stock selection, returns upwards of 15% can be achieved by the everyday investor. This does not mean high-frequency day-trading, in fact sometimes the simplest trading strategies can be the most performant. Quantitative investing is beginning to seriously alter millennial investing for good.
Aikido Finance is the leading resource for quantitative investment strategies. Aikido supplies a catalog of evidence-based investing strategies which have outperformed the market over the past 20+ years. These simple strategies help you build a portfolio in minutes and are tailored for millennial investing.
Let’s explore some of the best investment strategies for the millennial investor.
There are three pillars to being a successful investor.
The best way to invest consistently is to put away x% of your pay cheque each month. The more you put away, the faster you will reach your financial goals.
Millennials are increasingly becoming interested in the FIRE (Financial Independence Retire Early) movement. These investors are interested in fast-tracking their financial freedom through a consistent investing methodology. Assuming a 15% growth rate and a fixed income, here are some crazy stats for the aspiring early retiree! You can check out our blog post here on the FIRE movement.
Only by investing consistently can the investor confidently hope for these results.
For example, per the graphic to the right, if your after tax income is 50k, you spend only 10k a year, and invest the rest, you can expect to retire in 5.8 years. This assumes a 4% rate of withdrawal per year. The graphic is kindly supplied by fourpillarfreedom.
Quick tip #1: Automate your finances. Setup a standing order to automatically transfer funds from your bank to your broker each month.
“Most people overestimate what they can do in one year and underestimate what they can do in ten years.” – Bill Gates
By giving ourselves a long time horizon, we increase the amount of time we have for our investments (or good habits) to compound and grow. Albert Einstein once declared that compound interest was the 8th wonder of the world. Millennial investing requires time.
By investing with a long term mindset, we avoid the nerves that come with market dips. Don’t mind the ups and downs, let compound interest do its job and leave your investments alone! Give your investments time to grow. It takes years, not days. You can check out our blog post here on compound interest investing.
Quick tip #2: Don’t look at your portfolio! I rebalance my portfolio once per month, but never once do I peek in the interim. The performance of my investments is outside my circle of control, so I don’t think about it. Focus on process, not on immediate result. Don’t be a ticker watcher, there’s no need to check every minute. Think long term.
In their macro trends study, Dresdner Kleinwort looked at the success rate of the diagnosis of psychosis by two cohorts: inexperienced medical students, and experienced doctors. They found that the doctors were marginally more successful in their diagnoses than the medical students (64% to 59%). A simple model was then introduced to aid the cohorts in their diagnoses. Both the students and doctors performed much better this time (67% and 75% respectively). However, when the model was used on its own, with no qualitative judgement taken into account whatsoever, it outperformed all other scenarios with an 83% success rate.
So, what can we take from this study? A model is a ceiling which we try to reach, but not a floor on which we build on. We tend to detract from the results of a model rather than build upon them. If a model can help in something as qualitative as diagnostic medicine, imagine how powerful it is when used with something as quantifiable as cash.
“If you can’t describe what you are doing as a process, you don’t know what you are doing” – W. Edwards Deming
Most investors fail to beat the market, this is largely due to their qualitative methods of investing and by failing to use a rules-based approach. Millennial investing is best served by using systems, not stories, and trusting evidence, not opinion. The reason that the number of passive index funds (ETFs) is up 350% from a decade ago is because they are performant. They are performant because they follow a rigid strategy and inherently do not time the market. Investing in the S&P 500 index is ultimately a quantitative method of investing.
To be eligible for S&P 500 inclusion, a company should be a U.S. company, have a market capitalization of at least USD 8.2 billion, be highly liquid, have a public float of at least 10% of its shares outstanding, and its most recent quarter’s earnings and the sum of its trailing four consecutive quarters’. Source: https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-brochure.pdf
An ETF (Exchange Traded Fund) is a security which holds a collection of stocks. It removes the necessity for the investor to pick individual stocks by providing a basket of pre-selected stocks.
Even Warren Buffett is fundamentally a quantitative investor. He utilizes the value and quality factors to select only undervalued, high-quality companies. Joel Greenblatt quantified Warren Buffett’s methodology in The little book that beats the market, creating what he called ‘the magic formula’. By selecting only companies with a low EV/EBIT (good value) and a high ROIC (high quality), one could have achieved a 30% annual return between 1988 and 2004.
So, clearly using a rules-based approach works.
Returns go up and returns go down. But in order to obtain an excellent return in the long term, an investor must have a clearly defined investing thesis. This is can be just a few sentances defining the precise investing strategy being followed.
“This year, I will be implementing The Stable Dividend strategy. I will be investing $5000 in US large-cap stocks. These stocks must have a dividend yield greater than 2.5% and a payout ratio of less than 50%. I will then pick the top 20 stocks based on those with the highest debt-to-equity and ROIC. I will rebalance the portfolio monthly and invest an additional $500 each month. This strategy has averaged a return of 11.75% over the past 20 years.“
There are a few things the millennial investor should think about before getting started with investing.
“The best strategy is the strategy you can stick with through thick or thin” – Dr. Wesley Gray
There are three primary types of investing:
Fundamental investing is the purists form of investing. It involves digging deeply into companies, reading their financial statements and potentially doing background research on the management (scuttlebutt investing). While this form of investing will likely yield better results than day-trading, it is seriously time-consuming and probably won’t beat the market. In fact, 90% of fundamental fund managers have failed to beat the market over the past 15 years. Indeed, over the past 20 years, fund managers have averaged a return of just 4.67%! As Malcolm Gladwell discusses in his book Blink, more information doesn’t yield better results, in fact we often make better decisions with a fraction of the information.
Case study 1: CXO tracked the results of 6,582 predictions made by 68 investing gurus made between 1998 and 2012. Despite having some well-known names in the sample, the average of the gurus accuracy (47%) didn’t beat a coin toss. Indeed 42 of the gurus had accuracy scores below 50%.
Case study 2: UC Davis professor Brad Barber studied the buy and sell recommendations of Wall Street analysts. What he found was that the analysts buy recommendations underperformed by 3% per month, while their sell recommendations outperformed by 3.8% per year!
Okay, so clearly the professionals are have a very hard time making any stock market predictions. If the professionals can’t do it, why would the everyday investor even try? If we can’t beat the market , why don’t we just match it!
This is why 45% of funds in the US are now passive. Investors are realising that most of the time it is futile to try and beat the market using traditional means and flocking to ETFs which track well-known indexes, holding a basket of stocks. ETFs are distinguishable due to their low fees, performance, and simplicity. A well-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index.
Indexing is a great strategy for millenials; it is simple to do and most of the time performs better than picking individual stocks. Some of the biggest and best known ETFs are:
A common way to invest in ETFs is to dollar cost average, whereby the investor invests a set amount of money each month into the ETF. It aims to reduce the impact of volatility on the new investment, and allows the investor to add a portion of their pay cheque each month to their portfolio.
Quantitative investing is a systematic or rules-based approach to investing. It is the search for above average returns using data. Historically, this form of investing has been confined to sophisticated financial institutions or to those with deep data-science, coding, and financial knowledge. Quantitative investing generally falls into two categories: Day trading and factor investing.
Trading is a speculative form of investing where a trader buys or sells securities usually based on price patterns. This form of investing is not advised for most. 80% of traders lose money, 10% break even, and 10% make money consistently. As Nassim Taleb outlines in his book Fooled by Randomness, many of the traders who do make money do so through random occurrences. There is a high knowledge barrier to entry in day trading and a likeliness to eventually implode.
Factor investing is the evidence-based, scientific approach to investing. It involves targeting quantifiable characteristics or “factors” that can explain differences in stock returns. This type of investing is best suited to millennial investing due to the data-driven approach. The benefits of which include outperformance, risk management, diversification, and less effort than fundamental investing or trading.
Factor investing is still new and quite unknown to the general public and is currently going through massive growth and democratization. The factor industry is estimated at $1.9 trillion and is projected to grow to $3.4 trillion by 2022. It has been growing at 30% per year over the last decade. Source: https://www.blackrock.com/us/individual/investment-ideas/what-is-factor-investing#seek-outperformance
Quick tip #3: Aikido Finance is the leading resource for quantitative investment strategies. Aikido supplies a catalog of evidence-based investing strategies which have outperformed the market over the past 20+ years. These simple strategies help you build a portfolio in minutes.
Lets look at some example factor-based strategies and examine their returns.
Joel Greenblatt quantified Warren Buffett’s methodology in The little book that beats the market, creating what he called ‘the magic formula’. **The strategy ranks US stocks by EV/EBIT (Value factor) in Ascending order and ROIC (Quality factor) in descending order. The strategy selects at least 20 companies and rebalances once per year. This strategy achieved a 30% annual return between 1988 and 2004.
Quick tip #4: You can check out The Magic Formula Website to see the companies that currently screen in the strategy. Similarly, you can check out Aikido’s Magic Strategy which has increased analytics.
Tobias Carlisle found in his research that using just the value portion of the magic formula performed better than the entire thing. So, he curated the Acquirer’s Multiple, a strategy which selects 20 companies with the lowest EV/EBITDA (Value factor)
Quick tip #5: You can check out The Acquirers Multiple website to see the companies that currently screen in the strategy. Similarly, you can check out Aikido’s Acquirers Strategy which has increased analytics.
James O’Shaughnessy wrote What Works on Wall Street, the bible of quantitative investing. It catalogs hundreds of simple investing strategies and is a must read for the aspiring quant. One of the best performing strategies in the Micro-cap Value Momentum strategy. The strategy selects 25 micro-cap companies from the United States with a price-to-sales less than one, positive three and six month price momentum, and ranked by one year price momentum. This simple strategy has returned an average of 18.1% since 1965.
Quick tip #6: I have setup a screener for this strategy which you can check out here. It will give you the companies which currently fit the bill!
Some other famous quantitative strategies include The Dogs of the Dow and the Dividend Aristocrats strategies. But there are thousands of great quantitative strategies out there. A nice resource for finding these strategies is the book What Works on Wall Street , though you will need to then screen the strategy using Finviz or another online screener. An all-in-one platform is Aikido Finance which has a catalog of quantitative investment strategies, a built in screener, and the ability to create and rebalance your portfolio all from inside the application.
Quantitative (factor) investing is more performant, better risk-adjusted, and evidence-based. The technology-based, data-driven nature of this form of investing, as well as the fact that it is relatively under-utilized makes it the perfect vehicle for the millennial investor seeking to build an outperforming portfolio. After all, to do better than others, you have to do something different from others.
Interested in getting started with this form of investing? You can check out Aikido’s catalog of quantitative investing strategies here.