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tony

Academicians Axioms

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I found these academic axioms listed on the internet. They seem to be right on but I am concerned about

#12 as I always thought dollar cost avaeraging was the way to go.

 

I found this quite interesting. Do you aggree or disagree with any of them? Some of you may have seen this before. I don't know.

 

Tony

 

 

 

 

 

Listing of the “Academician’s Axioms follows immediately. Primary academic research contributors to each axiom are given in parenthesis.

 

1. Historically, equities have outperformed bonds and inflation, but with increased risk as measured by return’s volatility (standard deviation). Alternate investment classes (like hard assets) offer acceptable diversification benefits, but mostly with inferior yearly returns. Equity investment products provide superior returns over alternate investments in the long haul. (Ibbotson, J. Siegel)

 

2. Application of scientific methodology and rigorous mathematics to financial modeling and returns measurement enforce order and discipline on the investment process. Since uncertainty dominates investment forecasts, probability theory, statistics and Monte Carlo simulation code familiarity are requisite tools needed to prosper in this environment. (Samuelson, Sharpe, Black, Scholes, Melton)

 

3. The Efficient Frontier permits an investor to realize maximum investment returns at an acceptable risk (volatility) level. Asset allocation using worldwide investment options to enhance diversification allows the investor to closely approach that optimum market position. (Markowitz, Sharpe)

 

4. A mix of short term risk-free government bonds and an Efficient Frontier array of equity investments permits risk (volatility) adjustment while still maintaining the goals of the reward-risk tradeoff. (Sharpe, Tobin, Treynor)

 

5. Market returns follow a random walk pattern and therefore are not predictable in the short term, but more reliably projected in the longer term. Therefore, statistical methods must be deployed in assessing market returns prospects. (Samuelson)

 

6. Individual specific investment product risk can be diversified away with a broad asset allocation portfolio. The remaining risk is embedded market systemic risk and is not subject to removal by diversification. The beta term from the Capital Asset pricing Model (CAPM) formulation provides one imperfect measure of that risk. (Sharpe)

 

7. The original CAPM does not completely capture all the nuances of the marketplace. Markets are not totally efficient, but are defined as weakly, semi-strong or strongly related to the Efficient Market Hypothesis. (Fama, French)

 

8. Multiple factors must be introduced to more fully explain individual product or market price movements. Size effects and value/growth effects are 2 such factors. (Fama and French) Modest, transitory momentum effects have been observed (Carhart) A multi-factor Arbitrage Pricing Theory (APT) has been developed, but is data and computer intensive to implement. (Ross) Institutions deploy these complex market models.

 

9. Individual and institutional investors do not always act or react in a logical, predictable manner. Their irrational actions are detrimental to their investment success. These reflex reactions are rooted in many false beliefs and prejudices. They are characterized in evolving behavioral finance studies. (Kahneman, Tversky, Thayer)

 

10. It is very difficult to better passive investment performance. Active management infrequently delivers excess returns (like 10 % to 20% of the time) that exceed index benchmarks (less than a 2 % incremental increase) . Those excess returns are not persistent over any reasonable timeframe. (Bogle, Malkiel) A few academics disagree and measure positive benefits from active management. (Lakonishok) This debate continues.

 

11. Investment gurus succeed about as often as the average investor. As a group they demonstrate no special insights or forecasting ability. Their composite value added advice is marginal at best, and has been catastrophic to wealth in many documented cases. True experts exist, but are rare indeed. (Hulbert, L. Siegel, CXOadvisory.com)

 

12. Dollar Cost Averaging (DCA) strategies reduce returns in most instances. Unknowable future return profiles sometimes cause DCA to be the superior tactic, but not usually. All things being equal, invest resources as soon as they become available. (Greenhut)

 

13. Calendar events such as end-of-month effects incrementally contribute to portfolio return and have persisted over the market’s long history. (Fosback, Damodaran)

 

14. Investment technical analysis (TA) is a fatally flawed pseudo-science. Very little evident exists to support its pattern recognition basis nor its ability to project future returns. It provides an acceptable graphic summary of historical returns. Few wealthy investors who solely adhere to TA methods have been identified. (Malkiel)

 

15. Trading frequently is hazardous to an investor’s wealth. Investors typically recover only 1/3 of market returns because of late herd instincts and adaptation of the “###### hands” fallacy. Females generate higher returns than males do because of more conservative investment policies. (Carhart, Odean, Barber)

 

16. Costs do indeed matter. Active investor’s returns often fail to compensate for the additional costs incurred by active management. Lower costs generate higher end-wealth for both the individual and institutional investor cohorts. (Sharpe, Bogle)

 

17. Mutual Fund excess returns outperformance (seeking positive alpha) is difficult to attain, and more difficult to maintain. The persistence of superior performance falls away rapidly as measurement period expands. Using past performance records to identify funds that will generate excess returns above valid benchmarks is an equally daunting task. (Jensen, Bogle, Israelsen)

 

18. The options market as a major investment alternative was made possible by the development of options pricing equations like the Black-Scholes formula. It brought discipline and transparency to an uncontrolled segment of the investment marketplace. The only unknown in the options equation is the volatility estimate. (Black, Scholes, Miller)

 

Note that most of these academic axioms are somewhat negative with respect to active investment strategies. In general, the academic researchers conclude that it is improbable to anticipate excess returns above market returns. As a consequence of their studies, academic financial and investment wizards generally hold passive, market representative portfolios. This list of Academician’s axioms is not complete. It is a first attempt at constructing such a list. I am sure some elements of it will be challenged. They should be.

 

 

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12. Dollar Cost Averaging (DCA) strategies reduce returns in most instances. Unknowable future return profiles sometimes cause DCA to be the superior tactic, but not usually. All things being equal, invest resources as soon as they become available. (Greenhut)

 

**********************

 

Odd. I thought the whole point of DCA strategies was that you didn't have a huge wad of cash available to dump in the market, hence the decision to take a little piece out of each paycheck and build wealth over time?

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12. Dollar Cost Averaging (DCA) strategies reduce returns in most instances. Unknowable future return profiles sometimes cause DCA to be the superior tactic, but not usually. All things being equal, invest resources as soon as they become available. (Greenhut)

 

**********************

 

Odd. I thought the whole point of DCA strategies was that you didn't have a huge wad of cash available to dump in the market, hence the decision to take a little piece out of each paycheck and build wealth over time?

 

Not necessarily, DCA is a benefit to monthly contributions, but is not the only venue for it's usage. If you had a large chunk of money.. let's say 1 million, some people would be worried about dropping it into the market on day 1 - then seeing a market drop on day 2. DCA would help minimize the risk of seeing a downturn in the market shortly after a large purchase. The investor may choose to spread the buying across several days, months, years, etc.

 

Some people are under the impression that DCA would help maximize returns on money invested. That isn't necessarily the case. It's main usage is to reduce risk. As you know, more risk = more potential rewards.

 

Also, as long as the money isn't invested, the investor is losing out on opportunity costs of being in the market.

 

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12. Dollar Cost Averaging (DCA) strategies reduce returns in most instances. Unknowable future return profiles sometimes cause DCA to be the superior tactic, but not usually. All things being equal, invest resources as soon as they become available. (Greenhut)

 

**********************

 

Odd. I thought the whole point of DCA strategies was that you didn't have a huge wad of cash available to dump in the market, hence the decision to take a little piece out of each paycheck and build wealth over time?

 

Not necessarily, DCA is a benefit to monthly contributions, but is not the only venue for it's usage. If you had a large chunk of money.. let's say 1 million, some people would be worried about dropping it into the market on day 1 - then seeing a market drop on day 2. DCA would help minimize the risk of seeing a downturn in the market shortly after a large purchase. The investor may choose to spread the buying across several days, months, years, etc.

 

Some people are under the impression that DCA would help maximize returns on money invested. That isn't necessarily the case. It's main usage is to reduce risk. As you know, more risk = more potential rewards.

 

Also, as long as the money isn't invested, the investor is losing out on opportunity costs of being in the market.

 

 

Fair points, all. But I guess this brings us back to the inherent not knowing of what the market is going to do today, or this week, or this month. Invest it all now, and you're hoping it'll take off immediately (though if you can leave the money invested for 20 years, it matters a lot less what happens in week one). On the other hand, invest only part of it now, and you miss the market's gains (should they occur) for as long as some of your money remains on the sidelines.

 

Either way, I think you make a good point: DCA isn't "always" a winning strategy.

 

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Vince is correct when he says DCA is a risk management tool. Long term DCA is not a winning strategy according to most studies because the market has historically gone up, thus you are buying at higher and higher prices. The fact however that most people don't have a lump sum to invest and are making investments out of their paychecks leads to the conclusion that though they are Dollar Cost Averaging, they really don't have a choice....they are essentially making a series of lump sum investments.

 

History shows that a person has a higher probability making a lump sum payment than DCA, but as someone alluded to, it can be difficult to drop a $1mm into the market and then watch it dropped by 400 points the next day - thus DCA is a risk management tool.

 

 

ScottyD

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