Don’t Gamble On Unexpected Returns
“The expected value of the unexpected returns must be zero.” –Kenneth French,PhD
Kenneth French is a very smart man. His research, along with Eugene Fama’s, is the basis for how we construct our portfolios here at Verity Capital.Check out the recent article he did for Dimensional Fund Advisors: Dimensional Fund Advisors
Investors should focus on expected returns. This is the best guess on what’s going to happen based on all current available information. The unexpected return is the difference between what does happen and what was expected. These surprises can be good or bad. In other words, the unexpected returns are based on luck, either good luck or bad luck.
Many investors confuse recent realized returns, which are more influenced by unexpected returns, with expected future returns. French’s article shows how the two can differ by a lot.
Using Nobel Prize winning research to construct our portfolios helps us to focus on expected returns and not gambling on unexpected returns.