By Scott Keffer
The hallmark of Stress Free Investing is to be transformed from an emotion-based investor to an information-based investor. Decisions are made based upon how we feel or what we think. Moving from how we feel (emotions) to how we think (factual information) requires time and education. However, the payoff is substantial: peace of mind.
Warren Buffet called the classic bestseller by Benjamin Graham, The Intelligent Investor, “By far the best book on investing ever written.” In the preface he writes, “To invest successfully over time does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
The investment landscape has changed immensely since the 1960s. Then, institutions made only one out of ten market transactions; individuals made the other nine out of ten. Today, it is the absolute opposite. Institutional investors now make nine out of ten transactions; individuals only make one out of ten!
What does that mean? Institutions are no longer competing with you and me, but with other institutional investors like themselves. Even more significant, the 50 largest, most active institutions dominate the market; they make one-half of all the trades at any given time.
Think about it: in order for one “expert” to outperform the other “experts,” someone must discover and take advantage of an error—one institution would have to figure out how to out maneuver the other institutional investors who also dominate the market. Does that make sense? Does it seem possible? Could one institution consistently outthink and outmaneuver the other ones?
The hallmark of the free market system is that information flows freely and quickly. Therefore, it is not possible for one institution to establish a proprietary advantage in anything other than the short run.
Let’s consider an alternative: the investment strategy used by 40 percent of the institutional investors: a disciplined, research-based approach. I call this approach Stress Free Investing, where you transform yourself from an emotion-based investor to an information-based investor. The three keys are:
• Turn off the investment noise.
• Establish and implement a multiple asset class investment strategy.
• Stay the course.
Let’s look at the first key: turning off the investment noise. Noise causes confusion, uncertainty and fear. The problem is, confusion, uncertainty and fear make great news—so the media loves noise. These emotions also prompt us to move money—to try and chase a better return or try and find a better manager—so Wall Street loves noise.
Charles Ellis speaks about moving money and chasing return in his book, “Winning the Loser’s Game” Timeless Strategies for Successful Investing. On Ellis’ book, Peter Drucker commented, “This is by far the best book on investment policy and management.” In it, Ellis writes, “During the fifteen years from 1982 to 1997 mutual funds averaged approximately 15 percent in annual returns. However, mutual fund investors averaged only 10 percent. Because instead of developing an astute long-term investing program and staying with it, investors jumped around from one fund to another.”
Noise is based upon one of two beliefs: the ability to increase return through security selection or market timing. In other words, that it is possible to add value to a portfolio’s return by either picking or timing.
Picking presumes that someone—you, your broker, or the newest “guru”—can consistently discover mispriced securities that others have failed to discover. Securities, by the way, that will out-earn the market.
Timing presumes that someone can consistently identify when the entire market, or a market sector, is mispriced, and then predict when it will move up or down. Had an “expert” been able to successfully time the market by picking the best performing asset class over the 15-year period ending in 1998, the compound annual rate of return would have been 32.19 percent. Do you know of anyone who actually delivered that rate of return?
Picking and timing rely on the belief that someone can out-predict the future or gain by discovering the errors of others. Wall Street firms spend billions trying to out-predict the competition, and trying to convince you that it is possible.
Ellis writes, “For investors, the real opportunity to achieve superior results is not in scrambling to outperform the market, but in establishing and adhering to appropriate investment policies over the long term—policies that position the portfolio to benefit from riding with the main long-term forces in the market.” Further, he adds, “Investment policy is the foundation upon which portfolios should be constructed and managed.”
Which leads us to the second key: establish and implement a multiple asset class investment strategy. As Ellis says, the foundation of this strategy is a written outline of what you want your investments to do for you, called an Investment Policy Statement. Think of it as your flight plan to success. Be sure it includes the following: your objectives for your portfolio, including your desired returns and time horizon; your need for cash flow and lifestyle desires; and your definition of and tolerance for risk.
The next critical step is to use your Investment Policy Statement to design the appropriate mix of asset classes. Different mixes produce different expected returns and different risk levels. Economist and Nobel prizewinner, Harry Markovitz, found that for every given level of risk there was a unique combination of asset classes that produced the highest possible returns. When he plotted out each optimal portfolio on a graph, the result was a curved line called an “efficient frontier.”
The concept is to pick an asset class mix that falls on the efficient frontier, designed to achieve the highest possible return for your given level of risk. Then, hire managers who specialize in each asset class and benchmark their performance to ensure that they are beating the market over time.
Once your strategy has been put in place, except for rebalancing the portfolio on a regular basis, the final key comes into play: stay the course. The power comes by holding the course despite the noise, or news, from the media or Wall Street.
The difference between weather and climate helps me with this concept. Weather is short term; climate is long term. I choose to live in a certain place based on its climate, not its weather. Having chosen a place to live based on climate; I would not change my residence because of last week’s weather, or last year’s. The same should be true of your investment strategy. On this issue, Ellis writes, “After formulating and implementing a sound investment policy, changes should be made very carefully and very infrequently.”
Tired of the noise? Tired of the confusion, uncertainty, and fear? Then, hire a specialist to help you design and implement a multiple asset class investment strategy, chart your course, put it on autopilot and let the long-term forces of the market work for you. Then, close your windows, turn off the noise and enjoy peace of mind and the ride!
Scott Keffer is president and founder of Wealth Transfer Solutions, Inc., a legacy planning company in Pittsburgh.