Why Discipline is So Important for Investors

by Tom Allen and Mark Hebner - Tuesday, 10 January, 2017

As we come to the end of the year it is important to reflect on some of the lessons learned from 2016. One of the biggest that comes to mind is the importance of discipline when it comes to investing, especially if you are trying to target specific risk premiums found in the market like we do here at Index Fund Advisors.

Since the presidential election, the market has taken off like a rocket and this has come as surprise for many people. For the month of November, the S&P 500 has returned 6.54% through December 21st. For investors who have tilted their portfolios towards small cap and value stocks, like the clients at IFA, the gains have been even greater. IFA Index Portfolio 100, all our equity portfolio, has returned 9.39% over the same time period.

This highlights the overall importance of exercising discipline since, as Weston Wellington from Dimensional Fund Advisors puts it, “the dimensions of expected return can appear quickly, unpredictably, and with large magnitude.”[i] If we were to look at the small cap premium over the last year, we can see exactly what Mr. Wellington is talking about in terms of magnitude.

From the beginning of the year through October 31, 2016, small cap stocks (as measured by the Russell 2000 Index) outpaced large cap stocks (as measured by the Russell 1000 Index) by 0.34%. Over the 1 year period ending October 31, 2016, the small cap premium was actually negative (-0.15%). See table below.

If we look just at the month of November, we see a completely different story. From the beginning of year to November 30, 2016, small cap stocks have now outpaced large cap stocks by 8.01%. Over the 1 year period ending November 30, 2016, the small cap premium has actually turned positive (4.07%) which is about in line with its 88 year historical average (4.26%). See table below.

We have written before on the topic of premiums in terms of their volatility as well as the fruitless endeavor of trying to time them given the random nature of their performance. Investors are better served by being patient and staying the course when it comes to investing for the long term, especially when targeting dimensions of expected return that have been shown to reward the disciplined investor.

[i] Wellington, Weston. “A Vote for Small Cap Stocks?” Down to the Wire. Dimensional Fund Advisors, LP. December 22, 2016.