Published by Bob Ciura on April 4th, 2017
There is no shortage of investing experts.
Financial advisors, analysts, traders, and more, will often claim to have the rare insight that can beat the market over prolonged periods of time.
However, the facts disagree: Studies have shown that simple algorithms perform better than experts, across a wide range of fields, including investing.
This article from investment newsletter service Farnam Street summarizes the reasons why.
Put simply, humans are vulnerable to a number of inherent psychological biases that algorithms are not.
For these reasons, Sure Dividend utilizes The 8 Rules of Dividend Investing. It is a system specifically designed to pick the best-in-class dividend stocks.
This article will discuss the major reasons why system-based investing tends to outperform the experts.
Systems Remove Emotions
The big advantage of using a system such as The 8 Rules of Dividend Investing, is that it removes emotion.
When it comes to investing, emotion can be hazardous to your wealth.
Emotions complicate the investment decision-making process, because they complicate our interpretation of facts and statistics.
When presented with a given set of facts, two individuals may have two completely different takes on the situation.
This is why investing experts are inherently flawed—emotions can cloud the judgment of even the most battle-hardened investors.
To quote the linked article above:
The fact that doctors (and psychiatrists, and wine experts, and so forth) cannot even agree with themselves is a problem called decision making “noise”: Given the same set of data twice, we make two different decisions. Noise. Internal contradiction.
Algorithms win, at least partly, because they don’t do this: The same inputs generate the same outputs every single time. They don’t get distracted, they don’t get bored, they don’t get mad, they don’t get annoyed.
In short, systems don’t get emotional, which many investors tend to do—even when they try not to.
It is hard to blame investors for this. After all, our finances are a very emotional thing. When we see a stock soar or crash, we can easily succumb to fear or greed.
This can tempt investors into buying or selling a stock, when the evidence says otherwise.
For example, take Rule #7 of The 8 Rules of Dividend Investing—The Survival of the Fittest Rule.
Under this rule, an investor should sell a stock that reduces or eliminates its dividend.
Why should investors adhere to this rule?
Because evidence has shown that dividend cutters and eliminators have performed significantly worse than every other group of stocks—including dividend originators, dividend payers with no change, and stocks that didn’t pay dividends at all.
According to a study by investment management firm Oppenheimer, stocks that reduced or eliminated their dividends had a 0% return from 1972 through 2013.
And yet, there are times that investors will hold onto a stock that cuts its dividend (or worse, eliminates it altogether).
The investor may rationalize this decision by convincing themselves that the company’s turnaround is imminent.
But the facts are, that these are the stocks that have performed the worst over time, and they should be sold and replaced with stocks that maintain or grow their dividends over time.
Keep it Simple
Using a system of clear-cut rules can help investors improve performance over time.
Importantly, investors should remember to rely on simpler systems, rather than more complex ones.
John Bogle, the founder and retired Chief Executive Officer of asset management firm The Vanguard Group, is a huge proponent of indexing.
In John Bogle’s 2009 book, Common Sense on Mutual Funds, he touches on the problems with the mutual fund industry.
Professional fund managers charge high fees, typically for performance that in many cases is no better than average.
Index funds, meanwhile, offer lower fees and—more importantly—superior performance.
One big reason for this is its relative simplicity.
This is why Sure Dividend’s 8 Rules of Investing can be so valuable. The 8 Rules are a common-sense approach, and are easy to understand.
In essence, these rules stipulate that the investor focuses investment on stocks that have strong brands, competitive advantages, modest valuations, growth potential, and pay rising dividends to shareholders.
A good place to look in search of these types of stocks is the list of Dividend Aristocrats, a group of companies in the S&P 500 that have raised dividends for 25+ years.
The S&P Dividend Aristocrats have consistently outperformed the broader index over the past 10 years, by nearly three full percentage points per year.
Source: Standard & Poor’s
In fact, in the past decade, the S&P Dividend Aristocrats delivered a 10.1% total return each year, compared with a 7.4% annualized return for the S&P 500 Index.
Compare these results with the hedge fund industry, a group that is widely touted as being the savviest investors on Wall Street.
And yet, hedge fund performance is consistently underwhelming—even during bull markets.
According to a study from global investment bank Credit Suisse referenced in this article, from January 1994 to September 2000 (when the market soared), the S&P 500 Index outperformed every major hedge fund strategy by 6% per year.
Hedge fund performance is equally unimpressive in more recent periods. For example, according to the Barclays Hedge Fund Index, which tracks the average return of all hedge funds in the Barclay database, hedge funds delivered a 6.1% total return in 2016.
That was roughly half the total return of the S&P 500 Index last year.
Investors have a tendency assume that the more complex a plan, the better.
Financial experts have conditioned us that they are far better positioned to succeed in the markets than the individual investor.
This is, in part, how they justify the high fees charged by professional money managers.
However, research has shown that investors are better off utilizing a simple investing system, rather than relying on the opinions of experts.
The 8 Rules of Dividend Investing can help investors improve returns, while minimizing added costs of mutual funds or frequent stock trading.