From Jim O'Shaughnessy, I particularly liked #6:
You can see that over all rolling 3-year periods, that group beats other large stocks 81% of the time by an average 3.24% per year. When you extend it to all rolling 10-year periods, the base rate increases to 97%. Now, if you think about this, the base rate offers us an 80% chance of winning over any three-year period, but it also informs us that we have a 20% chance of losing to the benchmark over any 3-year period.
But very few investors pay much attention to base rates, and study after study has shown that when you introduce any information in addition to the base rate, people usually ignore the base rate in favor of the often-useless anecdotal information. Even though the rational thing to do is bet with the base rate and accept that we will not always be right, we are forever rejecting the long-term evidence in favor of the short-term hunch, even though our probability of being correct plummets.
We also ignore probabilities when we enthusiastically buy a story stock that is incredibly expensive—the 3-year base rates for buying stocks with the highest PE ratios is just 20%, meaning you will lose in 8 of 10 of all rolling 3-year periods.
The bottom line? Knowing the past odds of how often and by what magnitude a strategy either outperforms or underperforms its benchmark gives you an incredible edge that many people ignore. Successful active investors know this and pay close attention to this information, thereby putting the probabilities on their side.
Submitted March 14, 2017 at 12:47PM by TheRealAntacular http://ift.tt/2n6ukg2
