How to find your best investment strategy – not the one you expect
Are you always searching for a better or the absolute best investment strategy?
If so I have good and bad news.
The best investment strategy doesn’t exist
The bad news is - it doesn't exist!
The good news is it doesn't matter, let me explain.
Your best investment strategy
The best investment strategy you will ever find is not the one with:
- the highest return,
- the lowest Sharpe ratio
- the lowest maximum draw-down
- the strategy currently beating the market
- the strategy that worked best in the last bear market
Your best investment strategy is simply:
- The strategy you can stick with in good times and bad.
- The strategy that lets you sleep comfortably at night, every night.
- It’s the strategy that fits your nature and that you are comfortable with.
(You can find a list of all the best investment strategies we have tested here: Quant investing – best investment strategies)
Why you must be comfortable with it
The reason you must be comfortable with your investment strategy is because it will underperform the market some of the time – this is something that happens to ALL the best investment strategies.
And, sometimes this can go on for a few years.
The thing is - only if you are comfortable with your strategy will you be able to stick with it over these bad times, and that is what you must do.
Don’t change it!
Be very careful before changing your investment strategy.
Because if you change it to, for example the one currently beating the market, you will (most likely) do it at the worst possible time.
Think of the value investors selling cheap companies and buying technology and internet companies, at crazy valuations, just before the internet bubble burst.
You know what happened - they all lost more than just their shirts…
It can of course not be just any investment strategy
It can of course not be any investment strategy.
It must be a strategy:
- That has proven that it works,
- In different markets,
- Over long periods of time,
- In up and down markets.
But don’t worry about finding a strategy that fits your nature, there are more than enough to choose from.
(You can find a list of all the best strategies we have tested here: Quant investing – best investment strategies)
These are good investment strategies
The following are examples of good strategies that are worth looking at, they meet all of the above requirements.
The Magic Formula investment strategy
The Magic Formula investment strategy was explained in the great book called The Little Book That Still Beats the Market (this book changed my investment strategy) by the very successful hedge fund manager Joel Greenblatt.
This strategy buys quality undervalued companies but, as Joel clearly states in the book it also underperforms the market some of the time.
But this is a good thing because, because if it did not underperform, too many people will use it and it will stop working.
As I said, this is true for all investment strategies.
You can read more about the Magic Formula here:
How to (step by step) implement the Magic Formula investment strategy
Dividend Investment Strategy
This is most likely the oldest value investment strategies. The oldest and a good book I read on it was The Theory of Investment Value by John Burr Williams
I'm sure you also read, or have seen reports showing you the outperformance of a high dividend yield investment strategy over long periods of time.
But it has got its problems
Even though this strategy may look good it has got its problems as Mebane Faber pointed out in this excellent article What You Don’t Want to Hear about Dividend Stocks.
What killed a dividend strategy for me – 48% tax
The thing that killed a high dividend yield investment strategy for me is taxes.
Because of withholding taxes and taxes on dividends here in Germany I lose nearly 48% of the dividend before it gets paid into my bank account and I can reinvest it again.
I am sure in your country this is not much different.
There are a lot of alternatives
Don’t worry if you like a high dividend yield strategy there are a lot of better alternatives.
You can read about them in the following two articles:
Dividend investor - This ratio beats dividend yield
Dividend income investing – this is what really works (data driven)
Value Investing Strategy
Value investing has a LONG list of research and back tests (more than any other strategy) that convincingly proves that it outperforms the market substantially over the long term.
Long periods of underperformance
But it also has long periods of underperforming the market.
Not only that but as a value investor you have to be careful of value traps (companies that look cheap but whose business just keeps on declining), for example Kodak, Nokia and Blackberry.
The big question – do you buy more?
And then you also have the BIG question all value investors face; do you buy more of a company after it has fallen 20% or more or do you sit tight and look for other undervalued companies, to spread your risk?
I hardly ever invest more as many a value investor has been wiped out by the thinking "if I liked it at price X I should like it even more at price X -30%".
Read more about value investing here
You can read more about value investing here:
Ever looked at quantitative value investing? You should.
Is there something like a long term quant value investing strategy?
Are you fishing in a pond that is just too small? Global value investing proven
Earnings Yield (EBIT / Enterprise Value) Investment Strategy
In the great book Qualitative Value Wes Gray and Tobias Carlisle convincingly proved that you can substantially outperform the market with one simple ratio- EBIT to Enterprise Value, also called Earnings Yield.
But it also has its negative side
But as good as it is it also had substantial periods of underperformance. That's not even speaking of the cliff diving falls you have to live with if you use the strategy over long periods of time. But it recovers and beat the market every time.
In order for you to stick with this strategy through the substantial falls and periods of underperformance you have to believe in the strategy and also that it will work again - that is why you have to study the research.
You can read more about EBIT to Enterprise Value (Earnings Yield) here:
A simple ratio beats the world’s best value funds
Earnings Yield combined with 6m price momentum
Value Composite One and Two Investment Strategy
James O'Shaughnessy in the latest version of his book What Works on Wall Street explained two excellent investment strategies he called Value Composite One and Value Composite Two.
The strategy uses five valuation ratios to find investment ideas which is a good idea because it finds undervalued companies using different points of view. For example, sales, cash flow and earnings.
But, in spite of using five valuation ratios, even this strategy underperforms the market sometimes.
You can read more on the Value Composite investment strategies here:
This combined valuation ranking gives you higher returns - Value Composite One
How to implement a true microcap strategy that works – data driven
How and why to implement a Value Composite One investment strategy world-wide
How and why to implement a Value Composite Two investment strategy world-wide
The Investment Strategy We Like Best – Qi Value
Similar to the multi-ratio investment strategies developed by James O'Shaughnessy mentioned above we have developed our own multi-factor valuation indicator we call Qi Value.
We put it together from all the best ratios and indicators we have ever tested.
It is calculated using the following ratios:
Which is calculated as: Earnings before interest, taxes, depreciation and amortisation (EBITDA) / Enterprise Value
Calculated as: Operating Income or earnings before interest and taxes (EBIT) / Enterprise Value
(You can read more about earnings yield here: A simple ratio beats the world’s best value funds)
FCF (Free cash flow) Yield is calculated as Free Cash Flow / Enterprise Value
And free cash flow is equal to cash from operations - Capital expenditure
Liquidity (Qi) is calculated as Adjusted Profits / Yearly trading value. You can read more about Liquidity Qi here: Liquidity (Qi.) indicator identifies neglected (mispriced) companies
Not only does Qi Value use three different ratios to find out if a company is undervalued it also includes liquidity indicator to find companies that do not trade a lot compared to the profits they generate. We have found this a great way to identify companies that outperform the market.
This investment strategy of course also has times when it does worse than the market.
You can read more about the Qi Value investment strategy here:
This overlooked ratio, large funds and hedge funds can’t use, gives you higher returns
Beat the market with small companies BUT you have to do this
This investment strategy is working even better than we expected +711%
This can help the return of all investment strategies
Irrespective of what investment strategy you choose we strongly suggest that you add the Piotroski F-Score, also called the F-Score.
The F-Score is a simple to add indicator that helps you choose high quality companies and helps you avoid value trap companies.
It does this by helping you find companies with healthy and improving financials.
More on the Piotroski F-Score
I am not going to write about it here (this article is too long already) but if you would like more information about the Piotroski F-Score, including how it is calculated take a look at this article: This academic can help you make better investment decisions – Piotroski F-Score.
You can read more about the F-Score here:
Can the Piotroski F-Score also improve your investment strategy?
Use the Piotroski F-Score to seriously improve your returns
How to find cheap companies with good fundamental momentum
Beat the market with small companies BUT you have to do this
Piotroski F-Score back test
They all underperform but this is a good
I am sure you have noticed that ALL of the above strategies underperform the market some of the time.
That is a good thing because, if not, too many people will use them, and they will stop working.
Because they all underperform is the reason why you must be completely convinced of your strategy and feel comfortable with it (fit your nature) as only then will you be able to stick with it when it underperforms.
Simple Is Better
When you look for strategies that have beaten market our experience has been that the simpler the strategy is the better it is in the long-term.
Not only are simple strategies easier to implement they also easy to understand and this helps you to stick with a strategy through good times and bad.
It's no good if you follow an investment strategy based on a system you don't understand because this will only lead to you abandoning it after bad performance (most likely the worst time to do this).
So how can this article help me?
This is all very interesting and it makes sense but what must I do next, you may be thinking.
1. Find strategies that have beaten the market
First thing is to find investment strategies that have beaten the market over long periods of time. You can do this by looking at the strategies page on our website which you can find here: The best investment strategies we have found.
2. Choose the one you feel comfortable with
Look at all the strategies and find one that you feel most comfortable with. NOT the one with the highest return. This will most likely be a strategy that you understand and that fits your nature.
For example if you're a bargain hunter a value investing strategy will probably be the best for you.
3. Read and study it so you can stick with it
Read as much as you can about the strategy, paying attention to:
- why it works
- how long it has been tested
- does it work on different markets worldwide
- does it have long periods of underperformance
- does it recover, and how long does it take, after periods of underperformance
You must convince yourself
This may seem like a lot of work but it really isn't.
All this research will convince you that the strategy works and this knowledge will help you stick with it through good times and bad.
And that's the most important thing – finding an investment strategy that works and have the ability to stick with it.
Wishing you profitable investing
It costs less than a cheap lunch for two and has all the ratios and indicators you need.
Why not sign up now
while it's still fresh in your mind?