Successful Investing -
Avoiding Implementation Shortfalls

An issue you'll face as an investor is that of successfully implementing your investment strategy.

It’s nice to see academic studies, backtests, guru’s track records but oftentimes, when you try to implement these strategies, they fail to deliver the superior returns.

One of the most dramatic examples is that of Value Line Timeliness Rank 1. Value Line created a Mutual Fund investing in the 100 stocks with Timeliness rank 1. However it has strongly underperformed the theoretical gain prompting many to critic any mechanical investment strategy.

Here are some key points to consider to maximize your chance of success when implementing your strategy.

Transaction Costs

Most backtesting and academic studies assume no costs. One reason is that costs will be very different depending on which broker you use.

Ensure your Trading Cost is kept under 1%. Reciprocally, always remove a good 1% for transaction costs from any performance number you see.

Check the Broker Fees Calculator to estimate your trading costs depending on your investment strategy.

Bid-Ask spread

This is a hidden fee and can be a Killer. It is too easy not to pay attention to: for instance, Bid-Ask spread is not included in Mutual Fund’s Expense Ratios.

Very few studies or performances from strategies in investment books take into account Bid-Ask spread.

Bid-Ask spread is larger for small Cap (sometimes in excess of 1%) than for large Cap (usually less than 0.25%).

Since you suffer Bid-Ask spread during Buy/Sell, turnover rate and rebalancing frequency are very important.

Value or Growth Strategies with longer rebalancing frequency will suffer less than Momentum strategies with monthly or quarterly rebalancing.


Going back to Value Line, since it puts higher weights on Earnings and Price Momentum, stocks with Timeliness Rank 1 will include a good number of mid and small Caps.

In addition, Value Line Mutual Fund report mentions turn-over rate up to 300+% (*). Combining smaller cap and high turnover help explains part of the Value Line Mutual Fund underperformance versus the paper results.

(*) The Value Line Mutual Fund rebalances its portfolio more often than yearly. If you build your portfolio yourself, you can very well use yearly rebalancing and therefore have a Turnover Rate of no more than 100%.

Can you execute the trades ?

All studies assume that you Buy and Sell Stocks at specific time but can you, in practice, buy or sell at that specific time ?

How often have you seen Stock Picks recommendations - often on week-ends - but then on Monday it is impossible to execute at the Friday’s price because the share skyrocketed 20% at the opening.

Later, the guru proudly announces that his stock pick outperformed but you could not buy at the set price so could not reap the advertised gain.


This can be a major issue for strategies with frequent trades: namely Momentum Investing or Market Timing with frequent signals.

This is not an issue with Value Investing and the suggested Market Timing strategies because they trade much less often, once a year only. Those strategies are therefore less sensitive to precise entry/exit time.

Diversification

Mechanical Stock Picking gained interest after the Dogs of the Dow strategy was detailed in "Beating the Dow". However, the strategy then underperformed in the 90s.

Many attributed this underperformance to the fact that too much money flooded into the strategy thereby reducing its efficiency.
I rather attribute its underperformance to the biggest Bull Market in history where Value Investing was less rewarding than Growth/Momentum.

A take is that any strategy will underperform at some point. This is when your nerves will be at test and when you will be tempted to abandon and switch strategy.

The simple solution – highly recommended - is to diversify with 2 or more strategies: diversify across Market Cap (or different Investing Universes) and across different Investing Style (Value, Growth, Momentum).

Since then, the Dogs have taken their revenge: the Dogs of the Dow has outperformed the Dow Jones and the S&P500 since 2000.

Conclusion for Successful Investing

Whatever your investment strategy, there will be a difference between paper profits and real profits. This is true even with Index Funds.

To maximize your chance of success in the Stock Market:
  • Strive to keep transaction costs below 1%

  • Pay great care to strategies investing in Smaller Cap with high Bid-Ask spread

  • Favor strategies with long rebalancing frequency (1 year)
    Remember: Relative Strength still works with holding period of 1 year. You can always keep some “gambling money” for very short holding periods.

  • Diversify

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