Disciplined Investment Strategies

What are Disciplined Investment Strategies and more importantly
why use them? From his book What Works on Wall Street, James
O’Shaughnessy wrote, “The price of a stock is still determined by people.
And as long as people let fear, greed, hope and ignorance clouds their judgment, they will continue to misprice stocks and provide opportunities to those who rigorously use simple, time-tested strategies to pick stocks.” In English he is trying to say that people let emotions get in the way of good sound decisions when it comes to picking stocks. I would like to add that letting emotions get in the way of most decisions would lead to problems.

Disciplined Investment Strategies remove the human element by taking a large group of stocks like an index (such as the S&P 500) and screening them down by applying single or multiple disciplined formulas. The logic behind a disciplined investment formula driven portfolio is simple, but very effective. The investor does not have to decide what to buy or sell, or when to do so. The all-important factor here is that emotions (fear, greed, hope and ignorance) are no longer part of the equation. By eliminating the “human element”, bad decisions are taken out of the stock picking and managing process.

Without getting too technical, the disciplined investment formulas should be given some consideration here. Picking effective stock portfolios is certainly more involved than just screening an index down. Some very smart people have helped in creating the formulas we use. Terms like price to cash flow, price to sales, market capitalization, earnings momentum and others are the basis for the resulting portfolios.

Past Performance

There are no crystal balls to predict the future and past performance is no guarantee of future results. However, what better tool do we have available to us? We all look to past performance to help us gauge where we think we should invest our money. The problem with looking at the past performance of mutual funds as compared to our Disciplined Investment Strategies systems is consistency. Not only have most mutual funds failed to outperform the S&P 500 but, all too often, their stock selection process is erratic. Without an articulated strategy or process, which is consistently adhered to, mutual fund performance can’t be attributed to anything in specific. If the manager fails to follow the same disciplined repeatable formula year in and year out, it would be impossible to determine what drove their successes or failures. In this example we can clearly understand why the mutual fund industry is constantly telling us past performance is no guarantee of future results. How could it be if the selection process varies from year to year? This is where a disciplined, repeatable process is needed. Disciplined Investment Strategies do not bend to political changes, terrorist attacks, technology bubbles or housing bubbles. The stocks that are in these strategies would be the same because the disciplined investment process has not changed. We now have a better idea how markets may react because we know how a specific strategy performs during a certain time in history. If one strategy did very well during the late 1990’s and did terrible in the early 2000’s we would have some idea of what this strategy might do in similar situations.

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