Why I Dumped My Index Funds (An Introduction to Quantitative Investing)

In my last post, I outlined why increasing your portfolio return is the most worthwhile investment of your time and energy. Now I’m going to introduce the investment strategies that have consistently beaten the market for decades.

The first time I heard the term “quantitative investing”, I imagined mazes of cubicles with math/finance graduates working 100 hours a week at big investment banks on Wall St. But once you peel back the scary facade, you find that the reality is not very intimidating.

Instead of picking investments based on a gut feeling, what you hear on the news, what a company’s logo looks like, or other qualitative indicators, quantitative investing uses cold hard numbers. That’s all there is to it. 

In 1991, a strategy called Dogs of the Dow was popularized by Michael B. O’Higgins. Basically, every year you would invest in the ten stocks listed on the Dow Jones Industrial Average index that have the highest dividend to price ratio (also known as dividend yield). As you can see, this strategy beats the market most years. The Dogs of the Dow strategy has faced criticism for not being sophisticated enough. But it isn’t the only quantitative strategy out there — far from it.

Originally published in 1996 and now on its 4th edition (updated in 2011 at the 2009 recession), What Works on Wall Street takes a deep dive into dozens of quantitative strategies and is a must-read if you decide to start experimenting with any of them. This is the book that led me down the path to completely dump the contents my 401(k) and implement a quantitative strategy.

To give you a teaser to the content of this book and a preview for my next post, here is an excerpt that lists all of the strategies sorted by worst year. They were backtested from 1965 to 2009. The highlighted row is a strategy called trending value, which will be the first strategy that we explore in detail.

For the trending value strategy, the average annual return was 21.08%, more than double the S&P 500’s performance. $10,000 invested in 1965 grew to more than $48M by 2009, compared to just over $500k if you’d invested in an S&P 500 index fund (so 2x the return over 40 years gets you 96x the resultcompound interest is amazing). And to implement these strategies, all you need to do is crunch some numbers once a year (with stock data and Excel), buy the stocks that the data is pointing to, hold them until next year, and repeat.

If this intrigues you as much as it did me, buy the book and stay tuned for my next post.