The theory is attractive in its elegance and simplicity and the clarion call of motivational-speaking gurus the world over,
“Success is like baking a cake, if you follow the recipe that someone else has done successfully, you should get the same results.”
Another one oft heard adage goes, “Success leaves clues.”
Yet that same mantra doesn’t seem not apply when it comes to investing and investments.
You’ve worked hard at your job, saved some money and you want to make sure that your funds work harder for you than you do.
But when it comes time to put down some of that hard-earned cash, you’re already so fatigued from your day job that you neither have the mind space nor the energy to investigate your investments as much as you probably should.
So it comes as no surprise that many investors pursue a number of well-known strategies that have been shown to outperform the market over the long haul.
They figure, reasonably, that if they follow these strategies to the bitter end, they too, will beat the market.
But unfortunately, that hasn’t necessarily been the case. The key difference is time.
Insanity — Repeating The Same Process & Expecting A Different Result
Having witnessed first hand the irrational exuberance of ICOs (initial coin offerings) and the gravity-defying rise of cryptocurrencies late last year, that side of human nature which favors a quick buck was palpable.
But when it comes to investments, market-beating strategies take time.
More than 10 years in most cases it would seem.
But for periods 10 years or less, investors who invest in existing market-beating strategies may have been better off buying an index for a variety of reasons, one of which could simply be timing and bad luck.
The problem, as always is volatility.
To demonstrate how volatility could erode an otherwise sound strategy in short time frames, Nobel laureate Eugene Fama of the University of Chicago and Dartmouth professor Ken French set up an experiment to test an investment strategy’s return in each of the next 120 months and whether those returns were equal to 120 randomly selected months from the past 50 years.
Running this simulation 100,000 times, the pair calculated the number of times a strategy lagged behind its benchmark.
What they found was that over a 10-year period, there was a non-zero possibility that a strategy would lag behind the benchmark.
The key, as with all things in life, is timing and nowhere is this more apparent than with cryptocurrencies.
Short Term, It’s Better To Be Lucky Than To Be Smart
Had you bought Bitcoin when it was worth US$20 and you’d bought a ton of it and hadn’t tossed your private keys in a landfill, Bitcoin would be for you, the best investment this side of the universe.
If however, you’d bought Bitcoin at US$20,000, and you’d bought a ton of it, you’d be looking for said landfill and hoping to toss yourself into it.
With any investment, there is a non-zero probability that you entered it at the wrong time.
So to see what could potentially happen, you’d need to stay invested over a time frame that is more than just beyond a “tip of your nose” time horizon.
What Fama and French found was that even with time-tested and battle-proven strategies, there was a statistically-significant possibility that the strategy would lag the benchmark.
Take for instance value investing, the idea of buying stocks that trade with the lowest price-to-book ratios over those with the highest ratios — so-called “growth stocks.”
Fama and French found that over a 10-year period, there would be a 9% probability that the value strategy would lag the benchmark.
How about small-cap investing?
Over a 50-year period, Fama and French found that there was a 24% probability that small-caps would lag large-caps over any given decade.
And how about the riskless T-bills (used for calculation of the risk-free rate of return and providing Sharpe ratios) versus equities?
The instinctive view would be that over time, equities always outperform T-bills right?
Well, even here, Fama and French found that there was still a 16% probability that you would have been better off holding T-bills versus stocks.
But stretch those investment horizons a little and Fama and French found that even for the investing strategies which are supposed to provide better returns than the benchmark, a non-zero and indeed, a statistically significant probability of a return that would lag the benchmark still exists — 8% to be precise.
What this means is that using the tried and tested investing methodologies still introduced a statistically significant risk that your investment wouldn’t outperform.
What You See Depends On What You’re Looking At
When looking at investing horizons, especially in the cryptocurrency space, it’s tempting to look in shorter time horizons — which is not necessarily a bad way to approach the space.
Let’s not forget that cryptocurrency markets are 24/7 and operate 365 days a year — no labor day weekends and no Fourth of July holidays here.
Depending on who you ask, cryptocurrencies haven’t held their own as an asset class long enough for us to declare them worthless or valuable.
In other words, the jury is still out on their use and who the winners will be.
But what we do know is that their meteoric rise and fall, which some have likened to the dotcom bubble and bust of the early 2000s, has already occurred.
And while once household names like Pets.com no longer exist, the internet still does and we continue to use it in ways that the early dotcom entrepreneurs and internet investors never envisaged possible.
The problem with time horizons is that it’s often difficult to see beyond the tip of our noses.
Things are only clearer with the benefit of hindsight.
The odds of an investment in cryptocurrencies outpeforming a traditional investment over a very long period — possibly 5 years ore more in the cryptosphere, going by Fama and French’s calculation is 92%, but there is an 8% probability that you may end up worse off than in any other investment class.
Even within cryptocurrency investment vehicles, there is a non-zero and statistically significant probability of failure, but the important thing is to understand the odds.
Over the longer term — we’re talking about 10 years or more and in the cryptosphere it may be as short as 5 years — the odds of outperformance are a lot higher.
So what’s an investor to do?
One easy place to start is by taking a stab at understanding blockchain technology.
Contrary to popular belief, it’s not as complex as many pundits make it out to be — you may not understand the code behind it, but understanding the fundamental purpose and mechanics of achieving the stated purpose of decentralized, immutable ledgers, is a good entry point.
With that in hand, take a look at all the projects that are being created as well as the financial innovation surrounding the fundraising process.
From stablecoins to security tokens, opportunities abound.
It’s still early days and many of these projects may well end up worthless, but a recent EY Report recorded that 13% of all ICOs from the Class of 2017 had actually rocked a minimum viable product.
When you consider that almost all ICOs are startups and that statistically 1 in 10 or only 10% of startups survive, ICOs have already beat traditional startups by a non-zero 3%.
Also consider that ICOs have only done that in a year.
When an ICO goes into hibernation, it doesn’t necessarily mean that the founding team have gone off to fill their garages with Lambos — in some cases, they may be quietly hammering away at a product to be launched in the coming days.
A year does not a startup make.
Scale takes time.
And that brings me to my final point.
Although we recently celebrated the 10th anniversary of the Bitcoin whitepaper — that which set off the entire cryptocurrency industry, as an observable investment class, cryptocurrencies have only entered the public consciousness over the last one and a half years — barely a speed bump when it comes to time frames for the consideration of viability.
So are the best days behind us?
I’m going to hazard a guess and say, “no.” Not just because I am involved in this space and have invested a great deal of my life (not to mention finances), but because having personally witnessed dotcom bubbles 1 and 2 float by me — I was determined not to let the third technological revolution pass me by.
Before we dismiss, there is some value in educating ourselves.
If we determine through a period of study and understanding that the blockchain and cryptocurrencies are nothing more than a puff, a mere contrivance to con the masses, then it will die of its own course.
If however, we take the time to truly understand the technology, its potential and consider the possibilities, it’s entirely possible that we will give cryptocurrencies a non-zero chance of revolutionizing everything we know of the world of finance, investment and most importantly, trust.