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How To Find Your Best Investment Strategy – Not The One You Expect

By Guest Post. Originally published at ValueWalk.

Are you always searching for a better or the absolute best investment strategy?

Superior investment performance can be attributed to some combination of 3 basic drivers

If so I have good and bad news for you.

It simply doesn’t exist

The bad news is – it doesn’t exist!

The good news is it doesn’t matter, let me explain.

Your best investment strategy

The best investment strategy you will ever find is not the one with:

  • the highest return,
  • the lowest Sharpe ratio
  • the lowest maximum drawdown
  • the strategy currently beating the market
  • the strategy that worked best in the last bear market

Your best investment strategy is simply:

  • The strategy you can stick with in good times and bad.
  • And is also the strategy that lets you sleep comfortably at night, every night.
  • It’s the strategy that fits your nature and that you are comfortable with.

(You can find a list of all the best strategies we have tested here: Quant investing – best investment strategies)

Why you must be comfortable with it

The reason you must be comfortable with your investment strategy is because it will underperform the market some of the time – this is something that happens to ALL strategies.

And, sometimes this can go on for a few years.

The thing is, only if you are comfortable with your strategy will you be able to stick with it over these bad times, because that is what you must do.

Don’t change it!

Be very careful before thinking of changing your strategy.

Because if you change it to, for example the one currently beating the market, you will (most likely) do it at the worst possible time.

Think of the value investors selling their cheap companies and buying technology and internet companies, at crazy valuations, just before the internet bubble burst.

You know what happened – they all lost more than just their shirts…

It can of course not be any strategy

It can of course not be any investment strategy.

It must be a strategy:

  • That has proven that it works,
  • In different markets,
  • Over long periods of time,
  • In up and down markets.

But don’t worry about finding a strategy that fits your nature, there are more than enough to choose from.

(You can find a list of all the best strategies we have tested here: Quant investing – best investment strategies)

These are good investment strategies

The following are examples of good strategies that are worth looking at, they meet all of the above requirements.

The Magic Formula investment strategy

The Magic Formula investment strategy was explained in the great book called The Little Book That Still Beats the Market (this book changed my investment strategy) by the very successful hedge fund manager Joel Greenblatt.

This strategy selects quality undervalued companies but, as Joel clearly states in the book it also underperforms the market some of the time.

But this is a good thing because, because if it does not underperform, too many people will use it and it will stop working.

This is true for all investment strategies.

You can read more about the Magic Formula here:

How to (step by step) implement the Magic Formula investment strategy

A better alternative to the Magic Formula?

Does the Magic Formula also work in Finland?

Does the Magic Formula also work in Belgium, Luxembourg and the Netherlands?

Ever heard of the price to book magic formula?

Earn a back-tested 600.5% more with the right Magic Formula investment strategy

The Magic Formula investing and 6 month momentum investment strategy

Dividend Investment Strategy

This is most likely the oldest value investment strategies. The oldest and a good book I read on it was The Theory of Investment Value by John Burr Williams

I’m sure you also read, or seen reports showing you the outperformance of a high dividend yield investment strategy over long periods of time.

But it has got its problems

Even though this strategy may look good it has got its problems as Mebane Faber pointed out in this excellent article What You Don’t Want to Hear about Dividend Stocks.

What killed a dividend strategy for me – 48% tax

The thing that killed a high dividend yield investment strategy for me is taxes.

Because of withholding taxes and taxes on dividends here in Germany I lose nearly 48% of the dividend before it gets paid into my bank account and I can reinvest it again.

I am sure in your country this is not much different.

There are a lot of alternatives

Don’t worry if you like a high dividend yield strategy there are a lot of better alternatives.

You can read about them in the following two articles:

Dividend investor – This ratio beats dividend yield

Dividend income investing – this is what really works (data driven)

Value Investing Strategy

Value investing has a LONG list of research and back tests reports (more than any other strategy) that convincingly proves that it outperforms the market substantially over the long term.

Long periods of underperformance

But it also has long periods of time when it underperforms the market.

Not only that but as a value investor you have to be careful of value traps (companies that look cheap but whose business just keeps on declining), for example Kodak, Nokia and Blackberry.

The big question – do you buy more?

And then you also have the BIG question all value investors face; do you buy more of a company after it has fallen 30% or more or do you sit tight and look for other undervalued companies, to spread your risk?

I hardly ever invest more as many a value investor has been wiped out by the thinking “if I liked it at price X I should like it even more at price X -30%”.

Read more about value investing here

You can read more about value investing here:

Ever looked at quantitative value investing? You should.

Is there something like a long term quant value investing strategy?

Are you fishing in a pond that is just too small? Global value investing proven

Earnings Yield (EBIT / Enterprise Value) Investment Strategy

In the great book Qualitative Value Wes Gray and Tobias Carlisle convincingly proved that you can substantially outperform the market with one simple ratio- EBIT to Enterprise Value, also called Earnings Yield.

But it also has its negative side

But as good as it is it also had substantial periods of underperformance. That’s not even speaking of the cliff diving falls you have to live with if you use the strategy over long periods of time. But it recovered and beat the market every time.

In order for you to stick with this strategy through the substantial falls and periods of underperformance you have to believe in the strategy and also that it will work again – that is why you have to study the research.

You can read more about EBIT to Enterprise Value (Earnings Yield) here:

A simple ratio beats the world’s best value funds

Earnings Yield combined with 6m price momentum

Value Composite One and Two Investment Strategy

James O’Shaughnessy in the latest version of his book What Works on Wall Street explained two excellent investment strategies he called Value Composite One and Value Composite Two.

The strategy uses five valuation ratios to select investment ideas which is a good idea because it finds undervalued companies using different points of view.

The post How To Find Your Best Investment Strategy – Not The One You Expect appeared first on ValueWalk.

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Click here to see some testimonials from our members!