CHICAGO (Reuters) – For Eugene Fama, the University of Chicago professor and father of modern finance, the key to investing is relatively simple – stay in a low-cost, diversified portfolio to capture virtually all market returns with a mix that’s right for the amount of risk you can stomach.
Yet few people really believe that will work – they don’t like staying still – so they chase active managers or pick stocks themselves, usually buying and selling at the wrong times. They deceive themselves into thinking that they can outwit the smartest managers in the world and their costs won’t sink them.
With the stock market flattening out and perhaps taking a breather from its first-half surge, it’s worth taking a look at Fama’s basic tenets to avoid such bad behavior. (I recently had the chance to speak to him during a conference at the university sponsored by Loring Ward, an investment manager based in San Jose, California.)
Fama is best-known for research with long-time partner Kenneth French, a professor of Dartmouth College, which shows that certain groups of stocks tend to outperform over time: Value stocks bought at bargain prices tend to do better than companies focused on growth. Small companies tend to outpace large ones.
Known as the Fama-French “Three-Factor Model,” company size, style and market risk are essential to employ in a diversified portfolio.