Articles (72)

Debt: properly used can be very beneficial, but misused can lead an individual down the path of financial ruin. Many financial firms espouse the benefits of acquiring debt by using securities portfolios as collateral for margin loans. Getting a loan against your securities ...Read More

How can we determine whether or not we have identified an exploitable risk premium—a source of higher expected returns that we can implement in our portfolios? To understand the concept of a risk premium, imagine that the only available investment is Treasury Bills, widely ...Read More

In Step 11 of the IFA 12-Step Recovery Program for Active Managers we talk about the implementation of our 100 IFA Index Portfolios. As strong proponents of a passive investment strategy, we have options in terms of what strategies we would like to utilize to build our globally ...Read More

Since the firm’s founding in 1999, investor education has been one of the cornerstones of our business model. Understanding the link between investment knowledge and risk capacity, our commitment to providing empirical insight to how financial markets work makes our ...Read More

We often remind our readers that when dealing with random variables, like returns in the market, it is crucial that you are able to speak the language of statistics, which we call Riskese. In the world of random variables, there is no “black” or ...Read More

Research over the last 4 decades has revealed a robust and persistent value premium – value stocks have outperformed growth stocks over many time periods and markets worldwide. In its most simplest form, value stocks can be defined as having discounted prices based on some ...Read More

“Diversification is your buddy!” – Merton Miller, Nobel Laureate Diversification means different things to different people. Some people understand the timeless adage of “don’t put all of your eggs in one basket,” which strongly emphasizes the ...Read More

The recent severe volatility in China’s share markets has raised questions among many investors about the causes of the fall and the wider implications for the global economy and markets. The Shanghai Composite Index—the mainland stock market barometer and one ...Read More

The active fund industry is notorious for deceiving investors. We mean deceitful in terms of not giving investors the full-picture of their particular fund’s performance. To give an analogy, if we told you that we had magical powers that allowed us to make objects fall out ...Read More

A recent article published in CNBC highlighted the current attention that the fund industry is receiving from lawmakers. Specifically, since the most recent financial crisis and the superfluous amount of risk taken by some of the largest financial institutions in the world, ...Read More

Question: I understand that there is evidence that momentum is one contributing factor to long term performance (in addition to the size and value factors). There is a current advisory service (Fundx) that purports to capture the momentum factor and improve long term performance ...Read More

Anyone who has visited IFA’s office in Irvine will likely have a fond memory of Francis, IFA’s probability machine, named after Francis Galton, an English mathematician who was an expert in many scientific fields. For those needing a refresher or a first ...Read More

“To some men speculation means a way to accumulate money without menial or physical labor- to the inexperienced only!” In Robert Lee Sharp and Wallace H. Matlock’s succinctly sarcastic 1951 book titled Risk and Return: Or How to Live with Wall Street, they both ...Read More

At Index Fund Advisors, we implement portfolios for our clients that are tilted towards the compensated risk and return factors of small cap, value, and profitability. In this article, we will review the paper1 published in 1981 that formally identified the size premium, The ...Read More

There is no arguing the fact that 2014 has been a difficult year for small cap stocks around the world (with the exception of emerging markets) and particularly in the U.S., as shown in the table below: For the U.S., 2014 has been the worst year for small cap ...Read More

The capitalization rate (or cap rate) on a real estate investment property is defined as its yearly net income divided by its price. For example, suppose we have two apartment buildings, both of which have net rental income of $1 million. The first one (which we will call ...Read More

As noted in this CNBC article, The CBOE Volatility Index (VIX) which is widely interpreted to be an indicator of fear has risen by 40% (actually 57% based on the 12/10/2014 close) over the three trading days ending 12/10/2014. VIX measures the market’s expected short-term ...Read More

Mean reversion is the idea that following a period of above-average returns, there is more likely to be a period of below-average returns and vice versa. It can be applied not just to the overall stock market but to different segments of ...Read More

The recently published 40th anniversary issue of the Journal of Portfolio Management features an article titled “Dimensions of Popularity” by Roger Ibbotson and Thomas Idzorek. Ibbotson is perhaps best known for his iconic Stocks, Bonds, Bills, and Inflation which he ...Read More

While the title of this article may seem like an oxymoron, it definitely does not refer to the activity of seeking out mispriced bonds, for the bond market is efficient, with prices incorporating investor expectations of future cash flows and the risk-adjusted discount rates ...Read More

How can we determine whether or not we have identified an exploitable risk premium—a source of higher expected returns that we can implement in our portfolios? To understand the concept of a risk premium, imagine that the only available investment is Treasury Bills, widely ...Read More

Researchers did not have a very good idea about what sources of investment risk actually produced higher returns until ...Read More

Question: Can put or call options be used to achieve a more predictable risk-return tradeoff? For example, should I purchase put options to minimize equity portfolio losses? Note: The question above was originally addressed in DFA’s Fama/French Forum. They gave the ...Read More

While we at Index Fund Advisors have coined the term “pension-gate” to describe the overall mismanagement of public pension investments through active management, the real pension-gate is the massive underfunding of liabilities which will lead to one or a combination ...Read More

A New Book by Gerd Gigerenzer Innumeracy is a word coined by cognitive scientist Douglas R. Hofstadter in the early 1980s to describe a lack of basic mathematical ability as it applies to everyday life. Later that decade, mathematician John Allen Paulos published a book of that ...Read More

Question: Certain researchers have reported1 that low-volatility stocks in the U.S. outperform high-volatility stocks and attribute this apparent anomaly to investor behavioral biases as well as limits to arbitrage. What do you make of their argument? Note: The question above ...Read More

A risk premium is the return in excess of a reference rate that an investment is expected to provide. At Index Funds Advisors, Inc., we often speak of three different equity-related risk premiums. First, the market risk premium is the expected excess return of the total U.S. ...Read More

Question: Does an equity strategy focusing on stocks with above-average dividend yield offer an appealing risk/reward tradeoff? Have dividend-paying stocks outperformed non-dividend payers in the U.S.? Note: The question above was taken from DFA’s Fama/French Forum. Here ...Read More

What is the proper role of fixed income in a diversified portfolio? As far as we at Index Fund Advisors are concerned, fixed income performs two vital functions. First, it dampens the volatility of the equity side of the portfolio which facilitates the adjustment of the overall ...Read More

Last year, we wrote this article about momentum, which as the name suggests, is the tendency of securities that have outperformed (or underperformed) the market over a three- to twelve-month period to continue to outperform (or underperform) the market. In other words, momentum ...Read More

If you have ever spent any time in a casino, it is likely that you have seen supposedly random events that appeared to be non-random. Perhaps the roulette wheel came up red seven times in a row, for example. If your reaction was to place a large bet on ...Read More

In a popular children’s story, the young hero pins all his hopes on finding one of a handful of “golden tickets” hidden among millions of candy bars. It seems many people approach investing the same way. The notion that the path to long-term wealth lies in ...Read More

According to Investopedia, liquidity is defined as the degree to which an asset can be bought or sold in the market without affecting the asset’s price. If you have ever attempted to sell a large block of a thinly traded stock, then you know what liquidity (or rather ...Read More

"The probable is what usually happens." - Aristotle Say "HELLO" to Francis, IFA’s newest probability machine, named after Francis Galton, an English mathematician who was an expert in many scientific fields. (Click here to play the video of Francis in action) ...Read More

In the field of finance, standard deviation represents the risk associated with a security (stocks or bonds), or the risk of a portfolio of securities (including actively managed mutual funds, index mutual funds, or ...Read More

As of the end of 2013, the S&P 500 Index has not only fully recovered from the 51% drop that began in late 2007 and lasted through March of 2009, it has actually gained 37% beyond the high point in 2007, equating to an annualized return of 5.3%. We ...Read More

Question: Should I be concerned about the recent news about the Fed reducing bond buys soon and its effects on my portfolio? Answer: Lately, it seems that a day does not go by without a story like this one which talks about the eventual tapering of the Federal Reserve’s ...Read More

"The current understanding of asset prices relies in part on rational investors and their concerns about risk and in part on psychology and behavioral finance." 2013 Nobel Prize Committee Announcement, October 14, 2013   “This year’s Prize in Economic Sciences ...Read More

In recent weeks, we have published two articles (here and here) on direct profitability and its potential use as a dimension of expected returns. Since these articles were somewhat abstract in nature and focused on very generalized results, we wanted to switch gears in this ...Read More

The third risk factor in the Fama/French model is the amount of exposure to low priced stocks, which is measured by a book-to-market (BtM) value ...Read More

According to the one-factor CAPM, alpha is the amount by which an active money manager outperforms a broad market ...Read More

One problem for investors is the high level of error when drawing conclusions from a small sample of stock market data, like the last 3, 5 or 10 ...Read More

When constructing or evaluating a domestic equity portfolio, Index Fund Advisors has traditionally utilized the three-factor asset pricing model that Professors Eugene Fama and Ken French introduced1 in 1993. This model states that the expected return of a broadly diversified ...Read More

There are many terms used by investment professionals and academics in their quest to define ...Read More

Throughout IFA’s Website, you will find references to the three-factor model formulated by Professors Eugene Fama and Ken French, which says that the expected return of a broadly diversified stock portfolio in excess of a risk-free rate is a function of that ...Read More

As the investment time horizon lengthens, the actual average annual compound return achieved by a stock portfolio converges to its expected ...Read More

At Index Funds Advisors, Inc. we have consistently warned investors away from the complex financial products put out by the large Wall Street firms. Most of the "innovation" that occurs in finance is only for the benefit of the issuing companies and is often harmful to retail ...Read More

In this concluding article in the series exploring different ways investors might attempt to increase the income generated by their portfolios, we look at high-yield bonds. These securities offer a higher coupon payment than Treasuries and investment-grade corporate bonds at the ...Read More

In this continuing series exploring different ways investors might attempt to increase the annual income received from their portfolios, we look at mortgage real estate investment trusts (REITs). A REIT is a security that sells like a stock and invests in real estate either ...Read More

Caution: Technical Discussion to Follow—READ AT YOUR OWN RISK. As the old saying goes, there are three kinds of lies: lies, damned lies, and statistics. It is true data can be tortured with statistical tools that will make it confess to almost anything. On the other hand, ...Read More

Option Theory Does Not Refute Time ...Read More

"The only thing we have to fear is fear ...Read More

"You've already paid for the risk, so it might be good to stick around for the expected ...Read More

"Return generation is the responsibility of the market, which sets prices to compensate investors for the risks they bear. ...Read More

"Nobody told me there'd be days like ...Read More

"Some investments do have higher expected returns than others. Which ones? Well, by and large they're the ones that will do the worst in bad ...Read More

"For a long career full of breakthroughs that have advanced our understanding of financial markets, and his early fundamental work on efficient markets, we are proud to have Professor Fama as the first recipient of this prestigious award." ...Read More

"When you look at the results on an after-fee, after-tax basis over reasonably long periods of time, there's almost no chance that you end up beating the index ...Read More

William Sharpe tells us that if we want to achieve higher expected returns, we must be able to both emotionally and financially be able to withstand the increased volatility that inevitably comes with higher expected returns. Risk is the source of ...Read More

Charles Ellis was an early proponent of indexing. His quote addresses two important points: First, we should expect the stock market to rise over time, but take us on some ups and downs along the way. Second, the more educated we are about risk (the ...Read More