Are Your Financial Planning and Investing Strategies Scientific?
Your financial planning and investing strategies should have a scientific basis
A previous article, “The Solution – ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient,” suggested that individuals are much better off with a well-considered financial viewpoint. A stable set of financial beliefs can help you to keep focused and on track throughout your life. This follow-up article discusses the need for these beliefs to be based upon financial practices that have been established scientifically.
Without a scientific basis for personal financial decision-making, you have no way to distinguish a valid financial planning and investment strategy from an industry marketing sideshow or a trip to Las Vegas.
Regarding best practices in personal financial planning and investing, objective information about what tends to work and what tends not work can be found. However to find this objective information, you must know where to look.
Academic specialists in finance and economics do most of the objective theoretical and statistical research on subjects that directly or indirectly affect the financial affairs and well-being of individuals. The scientific finance literature that they produce exists in bountiful quantities and is the source of the best practices that The Skilled Investor uses. (See: How does The Skilled Investor find and summarize scientific investment information?)
Most of this objective and enlightening information is “hidden” in academic journals and working papers. With the Internet, however, much of this information is now “hidden in plain sight.” One of the primary objectives of The Skilled Investor is to do much of the required digging and synthesis for you. (See: What is The Skilled Investor and who will find it useful?) However, if you would like to do some searching yourself, see this article on one way to get started: Using Google Scholar to find scientific finance articles.
Scientific finance and its limitations
When you decide how to plan financially and how to invest, you ought to be able to point to the high quality research work of some honest, objective, highly-educated, skillful, well-respected, and thoughtful people regarding financial best practices. These people should have: a) developed theories, b) done their homework, c) run the numbers, d) published their findings, and e) had their publications stand up to peer-level criticism. This is a crude summary of the scientific method applied to finance. (See: What is investment science?)
Some readers, particularly those with physical sciences or engineering backgrounds, might read this and say that financial planning and investing is not really a science. They might contend that science and the scientific method require observable, measurable, and repeatable phenomena, explanatory hypotheses, and verifiable experiments conducted by objective analysts who publish their methods and findings for others with similar expertise to critique.
One can always quibble about the degree to which the social sciences, which include economics and finance, can implement properly the scientific method. Unlike the fundamental sciences, which are focused on the study of natural and repeatable phenomenon, finance and economics are really a quantification of history, which is time linear, lacks repeatability, and can only be proven statistically. There will always some small to large level of statistical uncertainty in the findings of finance studies. Furthermore, as time marches forward, a horde of economic, social, political, demographic, technological, and other possibly influential variables keep shifting their relationships in the background. This shifting backdrop can raise reasonable questions about whether findings established using historical data will remain valid in the future.
However, the financial and investment science of the past several decades has been built on an increasing wealth of historical securities market data and on extensive survey research data. These data sets have been sliced, diced, and analyzed statistically by thousands of researchers. When studies looking at different data sets or at the same data from different perspectives reach similar conclusions, then it is reasonable to pay attention to the findings of these studies. It is also reasonable to call them scientific, while taking into account the associated uncertainties.
Without scientifically based financial information, there can be no valid or invalid financial guideposts. However, even with the abundant availability of scientifically based financial information, those who do not do their homework or have ulterior motives will continue to make vacuous financial assertions. Therefore, you need to make choices about whom and what you will listen to and what proof you will require, before you commit your money.
Tags: financial strategies
Personal Financial Planning
- Schwab S&P 500 Index Fund – Select Shares (SWPPX) capture the Best +10 Fund Authority Score (
Fund Authority Scores rate mutual funds and exchange traded funds (ETFs) on the most important economic factors that influence individual investors' net long term diversified investment fund performance. The Skilled Investor developed the Fund Authority Score system to provide individual investors with concise, objective, and realistic summaries of mutual funds and ETFs for comparisons within [...])
- Understand the Confusing Securities Market Motion Picture (
Securities markets are usually very quick to adjust prices to reflect new information. However, this price adjustment process may take longer and be more volatile, if the new information is ambiguous.
At any point in time, market participants will already have used more or less rigorous valuation methods to judge their expected risk-adjusted value of securities. [...])
- How to Lie with Statistics – Investment Performance Charts (How to lie with statistics: Investment performance charts - A Tip from The Skilled Investor
Darrell Huff wrote a short and very informative book, "How to Lie with Statistics," which was first published in 1954 and was amusingly illustrated by Irving Geis. This book is still in print and remains very popular (Amazon book rank #2,040 [...])
- The John Bogle Blog and His Financial Article About ETFs (John C. Bogle's Blog and his article about ETFs
This article is a heads-up to people interested in investment blogs and personal finance blogs.
John C. Bogle, the founder of The Vanguard Group, Inc., has a blog called The Bogle eBlog. (If you are wondering about "eBlog," it is an anagram of Bogle.) Mr. Bogle just posted [...])
- The Economics of the Financial Investment Advisory Industry (Everyone has similar, yet distinct, financial planning needs regarding their families' financial futures.
While more wealthy people (think millions of dollars) have greater complexity to their financial affairs (caused largely by our incredibly convoluted U.S. personal tax codes), everyone needs sophisticated financial lifecycle planning. Whether wealthy or not yet wealthy, families need a personalized way to [...])
- Diversify To Avoid Investment Fraud (Another kind of investment diversification that individual investors should consider important relates to the failure or corruption of the financial industry intermediaries and fiduciaries that hold individual investors’ securities.
This meaning of diversification has nothing to do with scientific investment principles related to optimal portfolio diversification. However, it is still very important. Prudent investment practices would [...])
- Advisor Costs and Strategies Determine Your Return on their Services (Financial advisor costs and the value of their investment strategies determine your return on investment from these investment advisor services
A previous financial article, “The Solution - ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient,” suggested that investors are much better off with a well-considered financial [...])
- Set a Minimum Portfolio Size Threshold for Mutual Funds and ETFs (
Choose mutual funds and ETFs with a minimum economical portfolio size
If you are going to invest in actively managed funds, then you should want them to have a sufficiently large asset base to fund the necessary research.
If an active fund is too small, then fund management quality can suffer or fees could grow. Index funds [...])
- No Financial Planning Software or Calculator Can Predict the Future (No financial planning software and no investment growth calculator can predict the future
The future is simply not predictable, even with automated financial planning software.
A previous financial article, “The Solution - ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient,” suggested that investors are much better off [...])
- What Works Financial Newsletter – October 2011 (
October 2011 Newsletter
Identity Theft Protection and Prevention
As a threat to your financial security, you should take the potential for identity theft very seriously. Identity theft sometimes entails a loss of your money. However, whether or not you lose money, identity theft usually takes a very large amount of your time to rectify. To prevent an [...])
- Where’s Waldo? – The illusion of superior professional mutual fund manager performance. (If investment mutual fund managers were truly skilled at beating the market, then you would expect mutual fund manager performance prowess to persist over time.
Unfortunately, the evidence indicates that superior past professional performance among mutual fund managers tends not to persist. Past superior mutual fund performance is simply not a predictor of future superior mutual [...])
- Rational Mutual Fund and ETF Screening Rules (Scientific mutual fund and ETF screening criteria: a summary
Scientifically based selection criteria are rational methods to screen mutual funds and ETFs.
Recently, The Skilled Investor Blog published a series of articles on scientifically based selection criteria for mutual funds and exchange traded funds (ETFs). These screening rules help you to winnow down the thousands of available [...])
- Efficient Market Pricing in the Investment Securities Markets (
Efficient market pricing is the theory that all known information is already reflected in current securities prices.
Efficient securities market pricing has become very widely accepted within the investment community. The preponderance of evidence is that securities markets are efficient and tend to reflect available information. Whether you believe markets are efficient is very important to [...])
- Risk-Free Investment Money Is Fantasy Money (
For Individual Investors Risk-Free Investment Money Is Fantasy Money
Securities with low investment risk and high investment returns are just fantasies.
No "risk-free" investment money is consistently and reliably available to individuals. Luck dominates skill in the securities markets. Clever investment selection is vastly over-hyped, and only the promoters tend to benefit. On average over long periods, [...])
- Insure against risks economically – Step 8 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION
While value, affordability, risk exposure, and risk tolerance should affect insurance purchase decisions, insurance is often sold and purchased emotionally. Yet, insurance premium payments reduce personal funds that might otherwise be available for additional investments. Many people [...])
Comments are closed.