"A basic money making principle is be on the right side of the supply and demand curve"

Dimensional Fund Advisors 2019 Matrix Book Data

Annualized Rates of Returns 1939 to 2018

• One Month U.S. Treasury Bill (Cash): 3.6%
• $1,000 invested over that period of time grows to roughly $16,934
• Long Term Government Bonds: 5.6%
• $1,000 invested over that period of time grows to roughly $78,183
• S&P 500: 10.7%
• $1,000 invested over that period of time grows to roughly $3,402,590
• Dimensional US Large Cap Value Index (Large relatively cheap companies): 12.9%
• $1,000 invested over that period of time grows to roughly $16,425,377
• Dimensional US Small Cap Index (Small companies): 13.3%
• $1,000 invested over that period of time grows to roughly $21,796,802
• Dimensional US Small Cap Value Index (Small relatively cheap companies): 15.7%
• $1,000 invested over that period of time grows to roughly $116,591,990

Human beings (in general) don’t like short term uncertainty.  

The long term return data shown above illustrates that point well.  The asset class with the most certainty in the short term (cash) has the lowest long term return, and the asset class with the most uncertainty in the short term (Relatively cheap small companies) has the highest long term return.

A basic principle in making money is simple...supply and demand.  

When you own something that is high demand, but low supply, you can make lots of money because the price of what you own gets bid up and there are plenty of people to sell to.  

In investing, since most investors don’t like short term uncertainty, emotionally intelligent investors have the potential to earn above average returns by stepping in to provide capital to companies that have high uncertainty (limited supply/low demand) in the short term and waiting patiently until the demand for those assets to increase.

What’s not shown in the data above is the painful years involved in owning uncertain asset classes.  They can (and have) gone through long periods of time (years) of where they under-perform asset classes with more short term certainty.

Nothing is ever guaranteed to continue to happen just because it has happened in the past, however, the principle of supply and demand is a timeless principle has proven true since the beginning of recorded business and rings true in many other aspects of life.  

This is why I (and many other smart investors) believe that as long as you have the majority human beings investing in markets valuing short term stability over long term potential return, history should continue to repeat itself as the supply and demand principle plays itself out.   

Also, know that the goal of investing is not to earn the highest return possible.  The goal of investing (in my humble opinion) is to earn the return needed to help you reach your financial goals while maintaining your sanity.  

Let me give you a basic practical example of how to apply this knowledge to building a portfolio to help you reach your goals:

• A portfolio built for a financial goal with a 0 to 5 year time-frame should be invested conservatively, which means mostly in cash and bonds.
• A portfolio built for a financial goal with a 5 to 15 year time-frame should be invested moderately, which means pretty evenly split between stocks and bonds.  The stock portion could be mostly large and large cap value stocks.
• A portfolio built for a financial goal with a time-frame that’s 15 years or longer can be invested aggressively, which means mostly stocks with more money in large value, small cap, and small cap value stocks than the average stock market index (for example the CRSP which looks at the entire US stock market).  

I’m obviously oversimplifying the portfolio building process for teaching purposes.  

In real life, there are more factors to consider when building a portfolio like the investor’s risk tolerance, unexpected surprises, and how in demand uncertain asset classes have been in the recent past.  

(Data Source: Dimensional Fund Advisors' 2019 Matrix Book)

Notes on each index from the Dimensional Fund Advisors 2019 Matrix Book

S&P 500 INDEX S&P data ? 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

ONE-MONTH US TREASURY BILLS ? 2019 and earlier, Morningstar. All rights reserved. Underlying data provided by Ibbotson Associates via Morningstar Direct.

LONG-TERM GOVERNMENT BONDS ? 2019 and earlier, Morningstar. All rights reserved. Underlying data provided by Ibbotson Associates via Morningstar Direct. Includes US government bonds with an average maturity of 20 years.

DIMENSIONAL US LARGE CAP VALUE INDEX January 1975–present Compiled by Dimensional from CRSP and Compustat data. Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market with market capitalizations above the 1,000th largest company whose relative price is in the bottom 30% of the Dimensional US Large Cap Index after the exclusion of utilities, companies lacking financial data, and companies with negative relative price. The index emphasizes securities with higher profitability, lower relative price, and lower market capitalization. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: non-US companies, REITs, UITs, and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to March 2007. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. Prior to January 1975 Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market with market capitalizations above the 1,000th largest company whose relative price is in the bottom 25% of the Dimensional US Large Cap Index after the exclusion of utilities, companies lacking financial data, and companies with negative relative price.

DIMENSIONAL US SMALL CAP INDEX January 1975–present Compiled by Dimensional from CRSP and Compustat data. Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market whose market capitalization falls in the lowest 8% of the total market capitalization of the eligible market. The index emphasizes companies with higher profitability. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: non-US companies, REITs, UITs, and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to March 2007. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. Prior to January 1975 Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market whose market capitalization falls in the lowest 8% of the total market capitalization of the eligible market.

DIMENSIONAL US SMALL CAP VALUE INDEX January 1975–present Compiled by Dimensional from CRSP and Compustat data. Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market whose relative price is in the bottom 35% of the Dimensional US Small Cap Index after the exclusion of utilities, companies lacking financial data, and companies with negative relative price. The index emphasizes securities with higher profitability, lower relative price, and lower market capitalization. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: non-US companies, REITs, UITs, and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to March 2007. The calculation methodology was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. Prior to January 1975 Targets securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market whose relative price is in the bottom 25% of the Dimensional US Small Cap Index after the exclusion of utilities, companies lacking financial data, and companies with negative relative price.

Phillip Washington, Jr.  is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.