6 - Personal Investment Strategy
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Step 6 of 10 Personal Financial Planning Steps in the Right Direction
This is one of the “10 Steps in the Right Direction” that make up The Pasadena Financial Planner’s personal financial planning and personal investment management process. For a summary of these ten steps, see Your Family Financial Planning. To find an in-depth article for each step, just click the Sitemap link at the top of this page. Also, you can reach us by using the contact form below, and you can subscribe to our Objective Family Financial Planning Blogs by clicking the orange RSS icon to the left. Please enjoy reading this article. Thank you!
Without a rational personal investment system based on scientifically verified investment management strategies, individual investors will make inferior decisions based on false assumptions.
Given the extremely large number and variety of available securities, investors need a rational basis to select among them. Thousands of brokerage firms and investment management companies compete for the investment assets of individual investors and their families. Unfortunately you cannot rely upon securities industry personnel to tell you what is the best investment strategy for you. You can be much more assured that they will tell you to do what benefits them and the profits of their investment management companies. Unfortunately, many financial services industry personnel will say or suggest practically anything, if they think it will help to close the sale more quickly.
There are many investment advisors and investment counselors who provide good advice. Unfortunately, it is often very difficult to tell good advice from not-so-good advice. Most securities industry personnel are trained to sell and are not trained to make the best investment decisions on your behalf. They are trained to inspire trust and develop a rapport with you. Many simply do not know how to provide advice that is in the best interests of their clientele. If they are just trained to sell to you, why should they know what is in your best interests?
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In addition, there is also an incredible amount of historical performance chasing and unnecessary investment risk taking that goes with individuals’ investment money. Unwittingly or otherwise, many investment counselors and individual investors pursue highly inferior personal investment management strategies.
There is not reason to guess or to wing it, when your investment money and future retirement is at stake. There is a very large body of statistical investment research that can instruct any interested person about what tends to work and what tends not to work with personal investment strategies.
If you can not find scientific evidence to verify a personal investment management strategy, then just do not do it. Do your research and find out what works and what does not. For more information about scientifically based personal investment strategies, see these articles on “Personal Investment Management.” These articles are published on our sister website, The Skilled Investor.
The best investment strategy for lifetime personal finance and retirement planning
To cut to the chase about what tends to work best with investment strategy and retirement planning, The Pasadena Financial Planner has concluded that all forms of active management that cannot be cost justified should be driven out of personal investment strategies. Individual investors need to choose a comfortable, very low cost, low tax, risk-adjusted market investment strategy and let it run over time. Maintenance should be minimal and low cost, and the urge to chase “beat the market” mirages should be heavily restrained. Investors’ strategies should focus on broad-based, market-oriented investment funds securities (mutual funds and ETFs) that can be acquired economically and held inexpensively for an extended period.
Buy the cheapest, most broad based investment mutual funds and exchange traded funds (ETFs). Buy and hold them. Otherwise get on with your real life. For more information about scientifically based personal investment strategies, see these articles on “7 Ways to Pick the Best Noload Mutual Funds and ETFs.” These articles are published on our sister website, Best No Load Mutual Funds.
Three key concepts are important to consider when deciding on the best investment strategy for your personal investment portfolio.
First, the current price of a security represents the market’s consensus about its potential future value, given the various advantages and disadvantages that all investors see in holding or selling that security. As such, the current security price is a weighted average valuation forecast of events that might or might not occur. Market prices are the best available assessment of forward-looking, risk-adjusted fair market value.
Through securities market prices, a wide array of investors with differing predictions and varying concerns essentially “vote” on the expected or likely future value of a security through its current price. Investors’ evaluations of the value of securities may vary widely. What one person might see as a great bargain, another might consider grossly overpriced. Without this divergence of opinion over current securities values, there would be no trading of securities. Given the immense volume of securities trading that occurs daily across the world’s securities exchanges, it is clear that there is no shortage of significant differences of opinion about current market values.
Second, securities prices represent the current valuation consensus on a risk-adjusted basis. Risk refers to the expected size and likelihood of future up or down price variations or volatility. As such, not only do prices reflect expected returns, they also reflect the panoply of concerns, optimism, risks, and euphoria about how a wide range of factors might affect the price in the future.
Third, given this highly speculative, future-oriented, and risk-adjusted valuation process, there are bound to be very significant price fluctuations as time goes on. This variability is the natural side effect of the market’s communal, self-interested valuation process and is neither good nor bad. It seemly means that speculation about future investment value has been, is, and will always be subject to risk and uncertainty.
The problem with trying to predict future securities market values is that the future is fundamentally unknowable, until it arrives.
While history can be instructive about what might be more or less likely in the future, history tends not to be predictive. Securities prices exhibit only a very tiny level of predictability within a very large range of random fluctuations. The blending of expectations about future returns and risks into current securities prices means that the situation is subject to a wide range of either insightful to specious predictions. Unfortunately, you can only guess which predictions are insightful or specious, until after the fact.
The volatility of prices across time provides an opportunity for just about anyone to develop a supposedly predictive theory on how the markets actually work and to offer selected data to support their arguments. The only reliable way to sort through what is true or false is to rely upon the investment research studies of highly disciplined academics who carefully test these theories against market price data that is unbiased.
Individual investors are usually better off, when they ignore concerns about whether the securities markets fairly value investment securities.
If there is a reasonably large and liquid market where investors interact through “arms length” transactions, then individual investors should simply accept current market prices and avoid the usually futile temptation to second-guess current values and try to beat the market. While some securities prices will eventually be shown to have been either too high or too low relative to their subsequent prices, the reasons almost always have nothing to do with current market pricing mistakes by the securities markets.
Current securities market prices do a pretty good job of reflecting information that is already know. Statistical studies demonstrate that errors tend to cancel each other leaving little opportunity of investors - especially amateur individual investors - to identify, trade, and profit on these current pricing errors. In effect, especially among individual investors, those who appear to have done better than the market were largely lucky and those who did more poorly were simply unlucky.
Instead, prices tend to change over time due to unpredictable future events which occur and cause the securities markets to revalue securities. New information continually changes forward-looking expectations about expected future investment values. Since this new information becomes known only if and when it happens, there is no way to have reliably predicted it. Speculation about a range of possible future events will influence current prices, but only time will tell what actually will happen.
Some full-time professional investment managers and professional securities analysts might be able to discern when a security is more likely to be under-valued or over-valued. On average, before their added costs and taxes are considered, active professional mutual fund managers have been shown to deliver performance that is modestly better than passive index benchmarks. However, across all professional investors there is no evidence that they can consistently beat the markets, after their added costs and higher taxes are taken into consideration.
Unfortunately, the average professional investment fund manager charges several times his added-value through increased investment fees, costs, and taxes.
For the individual investor trying to identify and hire only “superior investment managers,” this effort is highly uncertain, usually futile, and subject to a great deal of error and dumb luck. Except for cost reduction, there are no reliable metrics to predict superior investment fund performance and to identify superior money managers before the fact.
So, where are all the perennially superior traditional money managers who can be hired economically to manage your money and that of thousands of others for a superior return? They are not to be found. Individual investors spend an excessive amount of time and money looking for investment mutual fund managers who will almost all turn out not to be the next Warren Buffett in the long run.
The lowest cost investments will always mean adopting a passive index benchmark investment strategy. The logical decision of individual investors is to avoid all costly activism and not to pay a substantially more for a very poor chance of winning versus a much larger chance of losing. Instead of trying to beat the market or trying to find a mutual fund manager who will beat the market net of his substantial added costs, individual investors should focus their efforts on:
- becoming better educated about investing rather than just relying naively upon advisors to do the right thing for them
- earning income and saving adequately to fund their investment program
- understanding their relative investment risk tolerance and choosing an investment asset allocation that is appropriate for their personal risk profile
- using rational selection methods to acquire a low cost, low tax, broadly diversified, passive market-based portfolio
- applying time and energy to investment activities that tend to increase personal financial welfare, while eliminating time spent on activities that undermine it.
Invest passively in very low cost, very broadly diversified index funds across the world. Save more to build your assets. Do something else that you actually enjoy, instead of wasting your time and money playing amateur investor.
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See Step 7 — Investment Management Fees >>>
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Larry Russell, Managing Director
MBA — Stanford University, MA — Brandeis University, and BS — M.I.T.
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Lawrence Russell and Company Pasadena, California 91103
A California Registered Investment Adviser — Certificate 133101
KNOWLEDGE — OBJECTIVITY — HONESTY — CONFIDENTIALITY — DILIGENCE — EFFICIENCY — SATISFACTION
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