By Michael Sincere
‘The market knows more than you,’ DFA’s David Booth points out. And he never forgets it.
‘Professional money managers don’t do any better than the market. That should be a revelation to people.’ David Booth
David Booth is a visionary investor and the co-founder of Dimensional Fund Advisors, a firm launched in 1981 that brought academic finance to real-world investing. Educated at the University of Chicago, Booth went on to pioneer evidence-based, systematic investing, helping to popularize indexing strategies.
Booth is also the central figure in a recent documentary, “Tune Out the Noise,” directed by Oscar winner Errol Morris. The film explores how academic research at the University of Chicago transformed financial markets, focusing on DFA’s founding and evolution.
Featuring University of Chicago Nobel laureates including Eugene Fama, Myron Scholes and Robert C. Merton, the film focuses on the power of data-driven investing, risk management and behavioral discipline. It tells the story of Booth’s impact on investing and shows how research and science still play a big role in how he invests today.
In this recent interview, which has been edited for length and clarity, Booth discusses his investing philosophy, how his firm seeks to outperform market indexes and what most investors misunderstand about the stock market.
MarketWatch: In “Tune Out the Noise,” you describe your work as a “pursuit of truth.” What do you mean by that?
Booth: A lot of things that people assumed were a virtue didn’t turn out to be true. The basic one is that anybody can beat the market if they just pay attention and work hard. That turned out not to be true. The pursuit of truth involves a lot of research, which gives you insights from the past that hopefully are helpful going forward. People want the absolute truth – but I’m afraid that’s just not available when talking about investments.
MarketWatch: What’s the biggest myth investors believe about who really wins in the market?
Booth: Most people think of themselves as outsiders, while the insiders make all the money. That’s just not the case. The evidence is that professional money managers don’t do any better than the market. That should be a revelation to people. In every phase of life, if you work harder and smarter, you’ll probably do better than the guy down the street, but that’s not true when it comes to picking stocks. Because the market knows more than you, it can be very costly to try to bet against it. Once you accept that the market is your friend, life gets a lot easier. There is less second-guessing.
MarketWatch: Do you have a forecast for the current market environment?
Booth: Many people are comfortable making a forecast, but there’s not much evidence that people can forecast or predict market returns. Too often, people feel like every year they have to make a change. This year is a good example of why just calming down and staying the course is frequently the best solution. We had a lot of volatility, lots of ups and downs. A lot of people got whipsawed trying to time the market.
MarketWatch: Do you ever make changes to your strategy based on what the market is doing?
Booth: We are constantly revising our long-term research to see if the evidence we had before is holding. Maybe we learned something different that we need to include in our long-term strategy. Occasionally, we change our long-term allocations, but we never make changes over the short term.
MarketWatch: In a market full of uncertainty, what gives you confidence that staying invested for the long term still works?
Booth: Some people call me an optimist. What has bailed us out over the long haul is basic human ingenuity. It’s always worked in the past, and I don’t see any reason why it won’t bail us out in the future. What I mean is that people want to make their lives better and the lives of their family better. If something bad happens to them, they don’t sit there and take it. They try to get back on track. That’s what leads to all this ingenuity and progress. It’s frequently three steps forward and two steps backward, but I don’t see a reason why I should be anything other than optimistic over the long term.
MarketWatch: How does that principle shape the way DFA approaches markets?
Booth: We start with the evidence. Is there really any compelling evidence that you should try to time short-term moves in the market? If you look at professional money managers, there’s no compelling evidence they can time short-term moves. And yet, individuals think they can go out and time short-term moves in the market rather than our approach, which is to take advantage of how markets work.
‘Indexing is a rather mechanical and inflexible approach to investing that leaves money on the table.’
MarketWatch: DFA doesn’t try to outguess the market, but the firm is not a traditional index shop. How do you define your approach?
Booth: Our view is that indexing is a rather mechanical and inflexible approach to investing that leaves money on the table. We’ve developed ways of beating index funds. We try not to outguess the market, but work with market mechanisms that can add value to indexing. But it’s close to indexing.
MarketWatch: How does your firm add value beyond traditional index funds?
Booth: We built our firm on the efficient-market hypothesis of Gene Fama, a Nobel laureate who is one of our founders and directors. It doesn’t make sense to try to outguess the market, but as a professional money manager, there are some things we can do to add value over indexing.
For example, while many indexes rebalance as infrequently as once or twice a year, staying flexible allows us to buy and sell securities every day based on up-to-date information on what can improve returns. That flexibility has been a key source of value, because it allows us to seek better prices than index funds may get and helps us avoid holding stocks with lower expected returns.
MarketWatch: What’s the most sensible way for long-term investors to participate?
Booth: In the U.S. stock market, there are huge trading volumes. On both sides of the trade are very sophisticated investors with differences of opinion. I’d rather rely on the overall wisdom of crowds, on the collective judgement about pricing, and not try to guess the market. When I go home at night, I’d rather spend more time playing with the kids than trying to figure out what’s going to happen with the market the next day.
‘Many people are attracted to what we think of as the noise. I don’t understand how a casual investor can think they can take advantage of pricing mistakes.’
MarketWatch: Do you see a reason individuals should choose individual stocks?
Booth: I haven’t come up with one yet, and I’ve been doing this for almost 56 years. It’s silly because the market does a good job of setting prices. Why get in the middle of that when there’s no evidence that you know more than the pros? I know that for some people, picking stocks is fun. If you get a kick out of it, then pick a few names, as long as you don’t bet the ranch on it and hurt yourself too badly. I don’t view that as serious investing. That’s entertainment. Many people are attracted to what we think of as “the noise.” I don’t understand how a casual investor can think they can take advantage of pricing mistakes. Why do they think they can do that?
MarketWatch: What’s the single most important takeaway you want long-term investors to remember from your experience?
Booth: Our mission is to try to help people understand the market and how it works. If you understand how it works, you’ll be more likely to invest. Over the long haul, it’s really important for people to start investing early. The power of compounding means that a 10% return on your investment each year – similar to the stock market’s historical annualized average – would double your money every seven years. Find an investment approach you can stick with rather than trying to time all of the short-term moves in the market.
Michael Sincere is the author of books including “Understanding Stocks,” “Understanding Options” and “Help Your Child Build Wealth.”
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-Michael Sincere
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