Wednesday, September 2, 2015

Gray et al., DIY Financial Advisor

Models beat experts—or, stated more cautiously, models typically beat experts. This is the rallying cry of DIY Financial Advisor: A Simple Solution to Build and Protect Your Wealth (Wiley, 2015) by Wesley R. Gray, Jack R. Vogel, and David P. Foulke, all managing members of Alpha Architect. Whether or not you believe this claim—and despite the seeming preponderance of evidence in its favor there are still a lot of holdouts (take, for instance, the argument of Jon Faust at Jackson Hole against rule-based monetary policy), models have obvious advantages over experts. For one thing, they don’t have cognitive biases that undermine them.

DIY Financial Advisor continues in the fine tradition of Wesley R. Gray’s earlier book, co-authored with Tobias E. Carlisle,
Quantitative Value. (Their new book, Quantitative Momentum, is scheduled to be published in January.) After an extensive review of the literature and the team’s own backtesting, the authors offer up simple, easily implemented investing strategies. For geeks, they provide brief summaries of research papers that point to potentially fruitful areas for further study.

They describe simple models that work--an asset allocation model, a risk management model, and security selection models.

The asset allocation model is, if I remember correctly, the one that Harry Markowitz himself uses—the old-fashioned 1/N, equal-weight portfolio. The authors include tables showing how it performed against much more sophisticated models. The upshot: it came out the overall winner.

The risk management model, which they have dubbed ROBUST, combines a simple moving average strategy with a time series momentum strategy. As the book shows, it performed well across five asset classes—U.S. stocks, international stocks, real estate, commodities, and bonds.

As for stock selection, they describe a value model, a momentum model, and a model that combines these two drivers of stock performance.

The result is a book that every retail investor should read—and that the purveyors of complex strategies should use as a benchmark against which to test their products’ alleged outperformance. It’s clearly written, quantitatively supported, and amply documented. A model of a good investing book.

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