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. 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?

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 individual investor.

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See: Registered Investment Advisor Pasadena >>>

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Larry Russell, Managing Director

MBA – Stanford University, MA – Brandeis University, and BS – M.I.T.

Lawrence Russell and Company Pasadena, California 91103

(626) 399-9579

A California Registered Investment Adviser — Certificate 133101

KNOWLEDGE — OBJECTIVITY — HONESTY — DILIGENCE — SATISFACTION

A truly independent financial planner and fee only investment advisor

(Regarding how I am compensated, I provide financial planning services only on a hourly fee or fixed fee for service basis, and only under a contract that we agree upon. You will not have to pay any asset fees. Furthermore, to avoid all conflicts-of-interest, I do not accept compensation or commissions of any kind from the industry.)

Start a conversation today — Send a message using this contact form

Registered Investment Advisor Pasadena

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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 Pasadena Financial Planners Sitemap link at the top of this page. You can reach us by using the contact form below. Please enjoy reading this article. Thank you!

Investment diversification is a genuine financial “free lunch.” Diversified investment funds are key contributors to optimal investment risk management.

Diversification has become an axiom of personal investing, because the specific risks of businesses and other investment entities can be reduced or eliminated from a portfolio without reducing expected returns. When you hear that you should diversify your investments, this means that you should diversify your investments completely and globally – now and always. The investment research literature repeatedly demonstrates that a fully diversified, low cost investment strategy is superior. Get diversified. Stay diversified. Be globally and fully diversified all of your life.

Post-Credit Crisis Commentary Concerning:

Diversified Investments

NOTE: Best personal investment and financial planning practices are durable and wouldn’t change because of market cycles. The article below was written years ago and doesn’t need to be revised. In light of the more recent financial market crisis, the additional comments in this colored box were published recently to emphasize the durable wisdom contained in the detailed article below.

The best investment strategy is to seek complete market diversification at the lowest investment cost using passively managed and globally diversified index mutual funds. You can reduce the volatility of your personal portfolio significantly and track the return of the market with relatively small investment costs. Other strategies tend of be sub-optimal, involving greater portfolio volatility and risk — and accompanied by higher costs in term of expenses, taxes, time commitment, and stomach acid.

Nothing that has happened in the credit crisis changes the value of broad market diversification. Some uninformed post-crisis commentary has questioned the wisdom of diversification, which only indicates a failure to understand what diversification can and cannot do for you. Diversification across a portfolio can and does mitigate volatility over time. However, when systemic factors across asset classes are in motion in the securities markets, then there is nowhere to hide, as occurred with the credit crisis. As over-leveraged investors (AKA speculators) across a variety of asset classes scrambled for liquidity, selling pressure increased broadly and asset values crashed generally, albeit, not uniformly. Those who were very broadly diversified felt less pain, but still felt pain.

However, if you really like the potential for a lot more pain, then don’t diversify. Sooner or later, that pain is much more likely to come to an ill-diversified investor’s portfolio compared to the porfolio of a broadly diversified investor.

Of course, ill-diversified investors chasing tactical and active strategies are always hoping for outsized returns for the added risk. Sadly, only a minority of active investors will get lucky, and it is largely luck (of the lack thereof) that is at play here. The percent of the lucky minority achieving excess returns tends to diminish with time — as excessive fees and taxes eat away at illusory excess returns — proving the foolishness of active strategies.

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Diversification is really not an option, if your goal is optimized, risk-adjusted personal investing. Diversification is not an optional part of family investment strategy, if that family wants to sleep well at night. When you are less than fully diversified, every day that you wait exposes you to investment risks that the securities markets tend NOT to compensate through better returns. When you are less than fully diversified, your investment portfolio risks are higher than they need to be without a reasonable expectation of getting any likely additional returns.

When you chose an active management strategy versus a passive one, try to time the markets versus staying put, buy individual securities versus funds, favor certain economic sectors versus full domestic and international diversification, etc., then you are much more likely to lose than to win. This is simply because the road you are taking is unnecessarily rough and unnecessarily winding, and you have less certainty that you will reach your goals. You might overshoot in performance if you are lucky, but you are much more likely to under-perform, because of the various higher expenses and costs that continually drag down active strategies. The longer your time horizon the greater the chances that you will fall behind a passive, lowest cost, market investment strategy.

A passive strategy targets a market return and can still be a bumpy ride — especially if you are not fully diversified globally and you have not adopted an asset allocation that is appropriate to your tolerance for investment risk. Nevertheless, the attendant risks are lower and potential variations are narrower than active strategies. Furthermore, passive strategies that drive down investment costs and expenses to the bare minimum are not continually burdened by repeatedly having to pay the financial services industry a much larger and undeserved share of your returns. It is hard enough to finish a marathon without carrying water for the financial securities industry at the same time.

Full global investment diversification using the broadest, cheapest, most passive index mutual funds and exchange traded funds (ETFs) is the most optimal strategy for the individual investor.

Few in the industry will tell you this, because a lowest cost, global, and passive diversification strategy is the least profitable to the financial services industry. The securities industry looks upon you as a naive “retail investor.” The industry trains its representatives to sell to you the most profitable products that it can at “retail” prices.

Through visible and hidden fees and other costs, these “retail” prices are heavily marked up to compensate the industry and its very highly paid sales force. Who do you think is paying for all those tall buildings, brass fittings, mahogany tables, woolen suits, and expensive silk ties? Who pays the industry’s huge salaries and bonuses? Does the money just come out of thin air, or does it come out of your investment assets and your investment returns?

Few will tell you this fundamental truth about the superiority of cheap, passive, fully diversified broad market investing. Everyone in the industry gets paid somehow, and there is far less profit in promoting a low cost, fully diversified investment strategy. However, there is real money in it for you. In the long run, you will tend to save more money, to save more time, and to save yourself from emotional consternation, when you use a very low cost, fully diversified passive investment strategy.

Complete investment diversification has become an axiom of personal investing, because the specific risks of businesses and other investment entities can be reduced or eliminated with a fully diversified portfolio without reducing your expected returns.

A fully diversified portfolio is an absolute investment necessity. Increased diversification reduces portfolio risk without a corresponding reduction in expected portfolio returns. Diversification is genuinely an investment “free lunch,” and it is a key contributor to improved investment risk management. A very high degree of diversification can be achieved through investing in a variety of low cost passively managed index mutual funds or exchange-traded funds. Such investments are also among the lowest cost investment vehicles available to individual investors in the financial markets. Given that this alternative is easily and cheaply available, the relevant question is never whether a portfolio should be fully diversified.

Through investments in broad-based index mutual funds and exchange-traded funds, diversification is relatively easy and inexpensive to achieve. Attempting to become broadly diversified through the self-assembly of a portfolio of a large number of individual securities is far more difficult and much more costly.

Portfolio self-assembly is much more likely to result in higher risk with returns that lag the market. Buying individual stocks and bonds instead of diversified funds provides you with no advantage whatsoever. The industry likes it, because individual securities trading generates fees and keeps the charade of beating the market going. However, when you buy individual stocks and bonds, you are less than fully diversified, and you are exposed to more risk. Plus, you also get to waste your money and time for nothing. Pay more and get less. What kind of value added is that? You are better off ignoring that kind of investment counseling and financial advice.

Also, see these articles for more about the value of diversification: “The value of diversification to individual investors” and “What is the cost to individual investors of sub-optimal portfolio diversification?” These articles are published on The Skilled Investor, and they report on important investment research studies on asset diversification. Note that The Skilled Investor is one of our sister publications, and it is the longest running of our family of websites.

A significant portion of a investment portfolio may sometimes become concentrated in a single investment security, which dramatically increases the overall risk of a personal investment portfolio.

While generally undesirable, there sometimes are unavoidable reasons for investment concentration. Unavoidable reasons for lack of diversification can include owning a private business or being a key member of a company management team who is required to own company stock by an employment agreement with the company. In such circumstances, you should seek expert guidance on possible ways to mitigate the risk associated with your concentrated investment position.

Nevertheless, for 99.9+% of investors, there is absolutely no good reason to maintain a high level of concentration in an individual security. Immediate steps should be taken to reduce the exposure. How many failed public companies like Enron and WorldCom do investors need to see crash and burn, before they realize that excessive concentration does not pay and can lead to very significant personal financial peril?

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See: Investment Advisors in Pasadena California >>>

.

.

Larry Russell, Managing Director

MBA – Stanford University, MA – Brandeis University, and BS – M.I.T.

Lawrence Russell and Company Pasadena, California 91103

(626) 399-9579

A California Registered Investment Adviser — Certificate 133101

KNOWLEDGE — OBJECTIVITY — HONESTY — DILIGENCE — SATISFACTION

A truly independent financial planner and fee only investment advisor

(Concerning compensation, I provide financial planning services only on a hourly fee or fixed fee for service basis, under a contract that we agree upon. You do not have to pay any asset fees. In addition, to avoid all conflicts-of-interest, I never accept compensation or commissions of any kind from the financial industry.)

Start a conversation today — Send a message using this contact form

Pasadena Financial Planners

The best fee only investment advisor for clients in the Pasadena area, including these towns South Pasadena, South San Gabriel, Studio City, Sun Valley, Sunland, Tujunga, and Pasadena.