The world of academia often lives in theory. But not for David Booth, the chairperson of Dimensional Fund Advisors, an investment firm with $777 billion in assets under management.
Booth spent his career translating academic research and insight into actionable investing strategies to build a firm that is more than four decades old. In a recent documentary called “Tune Out the Noise,” he and notable Nobel Prize-winning economists including Robert Merton and Myron Scholes, who have ties to Dimensional, recounted their journeys.
In a recent interview with Business Insider, Booth discussed what he learned from his academic mentors and how this shaped his investment approach. The excerpt below was edited for length and clarity.
Business Insider: Who is David Booth outside the investor, who are you as a person, as a human being?
David Booth: Well, I just am one really lucky guy. I went to the University of Chicago when there was an incredible group of people there — all these long lists of Nobel Laureates. I mean, how cool is that? And, then from there, I went to Wells Fargo and worked on the group that started the first kind of passive portfolio, the first index portfolio. And that’s pretty cool. And then taking these ideas and implementing them in the best way possible, given all the academic evidence, and building a business around it. That’s pretty cool. And then along the way, I deliver an art collection I’m really proud of. It excites me every day.
So I’m just a guy. Some people wake up in the morning and say, ‘What I have is not enough.’ I wake up in the morning and say, ‘There’s no reason for me to feel bad about anything.’ I hit the winning prize.
Which big ideas from academic research do you think are most important for investors to understand and use as guidance?
Merton Miller, we had this great conversation on first meeting. He goes, ‘Well, here are the three important things: first, diversification. Diversification is your buddy. Second, fees are important. Third, pay attention to the taxes. Pay attention to those three things; that’s what’s really important.
And I would also add now, when anxiety levels seem to be high in some ways, you have to worry more about the rest of your life other than investing. Life is uncertainty.
A lot of the anxiety is that people are unsure about what’s going to be happening to the economy and so forth, maybe through their jobs or whatever. Those things are really important to focus on. The stock market, in some ways, is always, I’d like to think of as almost self-correcting; it makes mistakes from time to time. Right now, anxiety levels picked up, stock prices dropped, that’s what they do. So, it’s already been baked into the cake unless you think you know more than the market. I think the market kind of reacted in a sensible sort of way, and that’s not always true in one’s personal life.
(A colleague asked Booth to speak on other influential ideas)
Booth: Eugene Fama is my mentor. He is one of the founders of Dimensional and has been an active board member ever since. He came out with this efficient market hypothesis. The implication is it doesn’t make sense to try to outguess the market. You can have a good experience without having to outguess the market. Too many people think that you have to stay awake at night and analyze companies in order to invest. You don’t have to.
Then we have Bob Merton, and he developed a landmark theoretical paper in the early seventies, which has led to what we think of as factor investing, that there’s kind of dimensions of returns that run through the market. Some parts of the market have higher expected returns than others. That was his theory at the time. That replaced the capital asset pricing theory that said that there’s only one measure of risk, which is volatility. So I don’t want to get into details with Bob’s theory because even Fama said it took him several years to really understand it. Then you have a breakthrough in 1992 with Ken French and Eugene Fama developing an empirical model that supported Bob’s theory.
Also in there is Myron Shoals. By now, almost anybody who has followed finance is familiar with the Black-Scholes-Merton model. What it documented is that flexibility has economic value. And that was the second principle around which we built the firm because when these ideas came out, a lot of people went to indexing right away. If you can’t beat the market, indexing is one approach to follow, but indexing is rather mechanical in how you have to manage the money. And if you think of flexibility as having value, then you’d want to have maybe a little more flexibility than being constrained by trying to track the market.
So that’s what we’ve done for the last 43 years. We’ve created multidimensional investment approaches based on solid theory, and we’ve used a little bit of human judgment to attempt to try to outperform indices.
What advice from a mentor transformed your understanding of markets and investors?
Well, it’s basically from my first course. My first course was with Eugene Fama, and it’s an uplifting message: Markets seem to work pretty well in setting prices. That’s pretty uplifting. People are worried that maybe just insiders get all the returns, and they, as investors are outsiders. No, the market is setting prices pretty fairly. So you have a fair shot at investing, and that’s about as uplifting as it gets.
Is there a persistent myth within financial services or markets that you’d like to see finally run its course?
People grow up thinking that in order to get ahead, you have to work really hard and do analysis. And if you’re smarter and work harder and have more resources than the person next door, you can pick stocks better than the guy next door. That just is not true.
If you look at professionally managed portfolios, they don’t show any ability to outperform the market after fees are considered. And that’s a shocking outcome. And that one piece of evidence by itself really revolutionized the investment business. So when you go home at night, don’t spend time trying to analyze financial statements. Spend more time with your kids and buy well-diversified, low-cost portfolios.
