Friday, October 18, 2013

Why You Should Know Gene Fama

from Carl Richards in Behavior Gap Newsletter


You may have seen the news earlier this week that Eugene "Gene" Fama was awarded the Nobel Prize in Economic Sciences. It wouldn't surprise me in the slightest if your reaction was, "Who is Gene Fama?" Unlike some of the other Nobels, the Economic Sciences prize tends to highlight the work of people who don't often land on magazine covers — until they win a Nobel Prize, anyway.

Dr. Fama is a professor at the University of Chicago, and he's often described as the "father of modern finance." Besides acknowledging his amazing accomplishment of winning a Nobel, I also want to talk about Dr. Fama for two other reasons:
  1. I really admire his work, and it's the foundation for much of what we do at the BAM ALLIANCE.
  2. He's about the research, not the sound bite.
Dr. Fama did something pretty amazing (which is why he won the Nobel): He demonstrated that markets are efficient. His findings eventually led to the development of stock index funds.

Beyond the potential of index funds, Dr. Fama's work also showed that it's highly improbable we can pick fund managers who will beat the market this year, let alone beat it the next year or the year after. His research has made a world of difference for the average investor, which leads me to reason No. 2.

Researchers like Dr. Fama don't spend their time coming up with sound bites. Instead they spend months and even years working on big ideas that have the potential to improve our understanding of wildly complex subjects. In short, their work often goes unrecognized by the wider world until something like the Nobel committee shines a light on their efforts.

I bring this up because it seems like we're inclined to give greater weight to the latest headline or cover story instead of time-tested knowledge. It's not surprising because I know that for most of us, we're looking for ways to reduce the complexity and answer our financial questions. Those goals are good ones to have, but if we aren't paying attention, they can lead us to overlook things like Dr. Fama's research in favor of the most recent list of the "10 Hottest Funds." 


To be clear, I'm not suggesting that we bury ourselves in financial research and work through every equation to answer our money questions. Instead, I think we need to challenge ourselves to ask questions about the latest "financial news." Does it really tell us something new and valuable, or does it simply recycle advice based on anecdotes instead of research?

The work of Dr. Fama offers us a reference point, a way to help us separate good advice from the questionable. As I mentioned before, we don't need to understand the research in detail. However, by taking the time to understand the principles and how they apply to us, we're increasing the odds that we won't be distracted from our primary goal of making smart financial decisions.

Carl

P.S. If you're curious and want to know more about Dr. Fama and his work, I suggest you read this piece by John Cochrane.