Where is all this from?

April 10, 2025

When you walk into One Day In July for an initial consultation, you are likely to hear about who we are, what we do, why the company was formed, index funds, the investment plan, low fees, and how all of this can help you in your investing path. So where did all this come from?

All the elements that underpin our advice were not pulled out of thin air or arrived at arbitrarily because they fit with the “flavor of the month”; they are foundational to finance theory itself. You must go back decades to understand this.

Starting in the middle of the last century, several key individuals dramatically shaped finance as we understand it today, and left a lasting body of knowledge that should serve as a guidepost to good understanding and sound decision making.

The 1950s: The late Harry Markowitz, Nobel Prize winner who pioneered the concept of modern portfolio theory, is best known for his work on the tradeoff between risk and return, as illustrated by the “efficient frontier.” Once a portfolio is efficient, meaning it lies on the efficient frontier, the only way to capture higher return is by taking on more risk, and the only way to reduce risk, is to accept lower return. The big takeaway – risk and return are linked at the hip, and diversification is your friend.

The 1960s: William Sharpe, Nobel Prize winner and a student of Markowitz’s, created a single factor asset-pricing model, the Capital Asset Pricing Model, which was born out of the need to derive Markowitz’s efficient frontier in a simple and elegant way. Markowitz’s and Sharpe’s work led us to the “market” portfolio and, importantly, the idea that you are only compensated for taking on risk you can’t diversify away: “market risk,” expressed in finance speak by a term called “Beta.” Put differently, if you can diversify away a risk, say risk inherent to an individual company, then you shouldn’t be compensated for it. If there’s one chart you need to grasp in finance, it is the Capital Market Line, which illustrates efficient portfolios when the market portfolio is combined with the risk-free asset, Treasury bills, notes, or bonds. You might notice our portfolios contain these two categories, a collection of equity funds to mimic the market portfolio, and Treasuries for downside protection. This construction is no accident.

Sharpe also developed the concept of risk adjusted returns, through a widely used ratio now called the Sharpe Ratio (he preferred the name “Reward to Variability Ratio”). This ratio demonstrates how much return you received for the risk you took. A higher Sharpe Ratio is better, and if your portfolio lives on the Capital Market Line, as it should, it has attained the highest feasible Sharpe ratio for the risk taken.

The late Michael Jensen, economist and Harvard professor, utilized the Capital Asset Pricing Model, with an additional term he called “Alpha” to test if mutual funds could outperform the market, for a given level of risk. The findings were less than outstanding. In Jensen’s words, "Very little evidence [was found] that any individual [mutual] fund was able to do significantly better than that which we expected from mere random chance."¹ The word Alpha has become widely used in the industry, despite its elusive nature.

Industry folks now widely confuse and mislabel reported performance as Alpha, assuming “outperformance,” when it was nothing more than Beta (market risk). Here’s what I mean. The market has a Beta of 1. Let’s say the market returns 10%, and my fund earns 12%, so I tell my golf buddies how I beat the market. But I’ve ignored that my fund has a higher Beta than the market, and it should have earned 15% (given its level of risk). Had I earned 16%, then I could claim 1% Alpha, but what’s worse is I only earned 12%, which is technically underperformance. I took on more risk than the market but didn’t get fully compensated for it. Here’s a more relatable example. Say you’re going to hop in a Ferrari and race your friend’s Honda Accord across the United States. If you arrive at the coast first, you haven’t outperformed, you just did what was expected. Now if you beat a Porsche 911 GT3, then perhaps you can claim outperformance. But remember, the Ferrari and the Porsche are more likely to break down or end up in a fiery mess on the side of the road.

Stretching for the elusive Alpha, “outperformance,” via stock picking or actively managed funds, can become especially troubling in years when markets go down. Buckle up. You’ll note our investment plan does not stock pick, market time, rely on actively managed mutual funds, or any other return-destroying practices.

Late 1960s and 1970s: Eugene Fama, Nobel Prize winner, is widely known as the father of the Efficient Market Hypothesis. Basically, what it says is that markets fully price all available information, meaning they are highly efficient. The stock tips you receive from financial media or your golf buddy, the reports you scour over, the podcast you listen to, it is all available information, and millions of folks actively competing on price, through billions of dollars traded every day, have acted very quickly on all that information. Put differently, once information is known, it is reflected in market prices so quickly, that it is highly unlikely you can profit by trading on it, net of all costs. Financial media will insinuate otherwise and encourage us to act on our worst instincts. Taking action in the quest for “outperformance” will assuage our need for control, but all we’ve done is place expensive bets with a low probability of success…we’ve entered the casino. When you walk into a One Day In July office, you will see no TVs tuned to financial networks with “breaking news” banners, streaming tickers, or sophisticated looking market “heat maps.” You will see calm people doing their jobs.

Moving forward: While much of the industry ignores the teaching of the past, motivated by self-interest as opposed to your interest, One Day In July not only remembers this foundational work but understands it and implements it. Decades of evidence support this academic work and our approach, which provides you with an informed foundation for your investment success. When choosing an advisor, consider what informs their opinions, think about their incentive structure, and remember that bells and whistles are just that.

- John Bass

1. "The Performance of Mutual Funds in the Period 1945-1964", Michael C. Jensen, Journal of Finance, Vol. 23, No. 2, pp. 389-416, 1967