Reversion To The Mean Phenomenon: Part IV
This final post of the RTM series will explore the importance of discipline. The academic evidence demonstrates that the determinant of almost all of the risk and return of a portfolio is its asset allocation. It’s important to add that because of recency, the most important determinant of the return that an investor’s portfolio actually produces might be the ability to adhere to whatever the asset allocation the investment policy statement called for. In other words, discipline to adhere to a plan can be more important than the plan itself.
Wise investors know that while reversion to the mean is a powerful force, trying to trade on that information in order to generate excess returns is a loser’s game. One reason is that streaks of abnormally low or abnormally high returns can continue for a long time. The following insightful quote has often been attributed to John Maynard Keynes, perhaps the most famous economist of modern times: “The market can stay irrational longer than you can stay solvent.”