In addition to subscription-based financial planning, many clients may also want investment management services.
There are many ways to approach investment management. First, you can hire someone to manage your investments.
If you choose that route, it’s important to understand their investment strategy (or approach).
Conventional industry (by industry, I mean primarily brokerage) advice is to invest in mutual funds that are “best in class” funds that consistently beat their index.
Yet numerous studies show that depending on the time period, less than 20% of these types of funds actually outperform the index against which they are compared.
So, why do so many people continue to invest this way?
Three reasons people invest this way
Beating the market was the industry standard for decades. Fortunately, that’s changing. However, much of the advice industry still subscribe to this standard.
Here are three reasons why:
- It’s what they’ve been taught – The brokerage industry and financial media have beaten the drum for decades that to be successful you have to invest in the best funds. I’m going to show you why that’s a bad strategy. CNBC, for one, barks all day long about what the market is doing on a minute by minute basis. They have pundits who advocate how investors can beat the system. If you listen for any length of time, you’re likely to come away more confused than you were when you first tuned in.
- Most advisors don’t have an investment strategy – Sounds crazy, right? It’s true (see reason #2). That’s especially true of advisors who are new to the business. It takes time to learn the business. With that said, it’s true for seasoned advisors as well. My advice to investors interviewing advisors is to ask them what their investment strategy is. If they can’t articulate it, find someone who can. It’s important for you to know there’s a strategy.
- Investors often don’t know the alternatives – Whether it’s not taking (or having) the time to learn, or not wanting to take the time, inertia can keep investors stuck. A good advisor should explain the different investment strategies available and the pros and cons of each. Most don’t. I’ve had clients send me investment recommendation from advisors trying to get their business. It amazes me how little these proposals focus on the client and extol the virtues of what this advisor and their firm can do for them. It’s mostly product drive, rather than client driven.
What is it? How is it different?
Is it better than other investment strategies (market timing, tactical, trading, etc.)?
An evidenced-based investment strategy uses decades of academic research and market data to identify the various dimensions of return. These dimensions are often referred to as factors.
This research has identified several factors where evidence shows investors have achieved market premiums (translation: higher expected returns) by overweighting (translation: putting more money there) into these areas of the market
Basics of evidence-based investing
There are three basic tenets (actually a lot more but I’ll keep it simple) to this strategy as follows:
- Markets are efficient -over long periods of time, the stock and bond markets have provided investors with growth on their capital that exceeds that of inflation.
- Diversification reduces risks – a broadly diversified global portfolio exposes investors to markets around the world and diversifies risks that have no expected return.
- Focus on what you can control – have an investment plan that fits your willingness, ability, and need to take risks. Keep trading costs and expenses low, minimize taxes, and have the discipline to stick to your plan
Portfolios include low cost, broadly diversified mutual funds. The customized mix of stocks, bonds, and cash include an ongoing rebalancing strategy.
Rebalancing keeps the risk in line with each investor’s risk profile.
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