Happy Hour: Build Your Own Smart Beta

by: Novel Investor

I don't own smart beta funds because I don't believe they fit my strategy.

Instead, I stick with a simple approach, four funds - a U.S., developed international, emerging markets, and treasury bonds - adjusting the allocation based on valuation. Basically, I move from expensive to cheap and if all equities are expensive then move from expensive to bonds.

That's the simplified version.

I don't believe smart beta would add enough "extra return" due to the adjustments. It's very possible - I haven't tested it - that I'd get a lower return from smart beta funds due to poor timing and higher costs, so I just stick with the lowest cost approach. Why pay more for something that I might not get? That's the way I see it. It's not perfect but it fits my mentality and it's easy to manage.

But if I could design the ideal smart beta fund around my strategy, it'd be based off a global index weighted by quality and price. The highest weighting would go to the highest quality, lowest priced stocks and move down from there. And I really see no reason to own every stock in said index. I'd eliminate all the highest priced, lowest quality stocks or expensive junk. And it would maintain a "cash position" if too many stocks exceeded a specific low quality and/or expensive limit. And it would do it all at a low cost.

Pipe dreams, I know.

Maybe someday it will be possible to build personally customized funds at a low cost. If it happens, I'm certain someone will screw it up.

Anyways, the point of this was because of a slew of smart beta articles I saw this week. Smart betas "market-beating returns" are nice to look it. That's the draw and the downfall.

Too often people pick funds based on performance - not what best fits their strategy - because they don't have a strategy or their strategy is to chase performance. So most investors will never see those returns. They're not willing to accept periods of less than market returns to get the excess return over time.

Most investors will get better returns simply by being more robotic. Less mistakes lead to higher returns over time. Doing nothing more often with a basket of basic index funds will get you a better return than chasing the best performing smart beta funds. All their doing is spending more money (via higher fees) to make the same costly mistakes.

Once you've got doing nothing down pat, then look into smart beta and factor tilts. If it fits your strategy, then use it. And if not, then don't.

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