CLICK HERE TO READ THE SKILLED INVESTOR’s OTHER ARTICLES ABOUT THESE “10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION
Given the extremely large number and variety of available securities, investors need a rational basis to select among them. Without rational selection criteria and a good understanding of which factors are more or less likely to increase risk-adjusted returns, investors will make decisions based on false assumptions.
The Skilled Investor has concluded that all forms of active management that cannot be cost justified should be driven out of personal investment strategies. Individuals need to choose a comfortable, 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 securities that can be acquired economically and held inexpensively for an extended period.
Markets blend the speculative, future-oriented value assessments of a wide variety of investors of differing outlooks and opinions. The current price of a security represents the market’s risk-adjusted consensus about its potential future value, given the various advantages and disadvantages that all investors see in holding or selling that security.
Three key concepts are important to consider when deciding on a rational basis for choosing investments.
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 the market price, a wide array of investors with differing predictions and varying concerns essentially “vote” on the expected or likely future value of a security through the 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.
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 is 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 expected returns and expected risks into prices means the situation is subject to a wide range of either insightful or specious observations. The movement of historical 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 some selected data in support. The only reliable way to sort through what is true or false about such predictions is to rely upon the studies of highly disciplined academics who carefully test these theories against historical market data.
The Skilled Investor has concluded that individuals will probably be better off, if they ignore concerns about whether markets value a particular security fairly.
If there is a reasonably large and liquid market where investors interact through “arms length” transactions, then individual investors should accept the market price and avoid the usually futile exercise of second-guessing it.
Instead, 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 risk tolerance and choosing a risk appropriate asset allocation
- 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.
The Skilled Investor provides a variety of articles that can help individuals to understand rational investment selection criteria.
For example, see these articles on investment fund selection:
Personal Financial Planning
- Can you really beat the stock market? (
You are not likely to beat the stock market, despite all the cheer leading from the securities industry and the financial media.
When you try to beat the public securities markets, unfortunately you are more likely to trail the market’s return, because of extra costs, taxes, and investment mistakes.
The idea that investors can beat the market [...])
- Determine the Savings You Need for Your Lifetime Financial Goals (You cannot invest without savings. How much savings are enough? ... too little? ... too much?
Currently, the U.S. is experiencing a savings crisis. The net personal savings rate is zero or slightly negative, despite a healthy and growing economy. This situation is a prescription for millions upon millions of future personal financial disasters. (See: [...])
- If Personal Finance is Difficult – Carefully Hire a Good Advisor (
If personal finance is difficult for you, carefully hire a good financial and investment adviser
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 plan. A stable set of [...])
- 10 Lower Cost S and P 500 Index Mutual Funds (10 Lower Cost S&P 500 Index Mutual Funds
Regular readers know that The Skilled Investor advocates a very boring, low cost, broad market, passive index investment strategy. Costs less. Gets the broad market return -- whatever that will be. Narrows the range of outcomes and therefore the risk to your long-term personal financial plan. Takes far [...])
- Excessive Investment Expenses Take 2% of Individual Investor Assets Every Year (Excessive investment expenses take 2% of individual investor's assets every year
Year after year, millions of people lose large amounts of money on unnecessary and unproductive investment costs and investment expenses.
The typical investor loses about 2% of portfolio assets every year by paying too much and getting too little in return.
This wasted 2% is not a [...])
- American Funds – AMCAP Fund – Class A Shares (AMCPX) fetch a +1 Fund Authority Score (The table below in this article presents The Skilled Investor's Fund Authority Score and other information for the American Funds - AMCAP Fund - Class A Shares.
The diversified investment fund strategy of the American Funds - AMCAP Fund - Class A mutual fund shares (AMCPX)
According to its prospectus filing on the U.S. Securities and Exchange [...])
- How many stocks are needed for a well-diversified portfolio? (Industry rules-of-thumb often state that 15 to 30 stocks are enough for a well-diversified portfolio. This can be very misleading.
Recent studies point out that industry rules-of-thumb on the number of stocks needed for a well-diversified portfolio are simply not adequate. These rules-of-thumb most often state that 15 to 30 stocks are enough. “The Truth About [...])
- Fund Authority Scores for Stock ETFs and Mutual Funds – Historical investment performance (
Fund Authority Scores rate stock mutual funds and ETFs on the most important economic factors affecting long term diversified equity investment fund performance. This article explains how historical fund performance is calculated.
<<-- Go to Part 1
Go to Part 3 -->>
Part 1 of this article discussed direct and hidden investment costs, the most heavily weighted factors [...])
- 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 [...])
- Vanguard Institutional Index Fund (VINIX) captures the Best +10 Fund Authority Score (The table below in this article presents The Skilled Investor's Fund Authority Score and other information for the Vanguard Institutional Index Fund.
The diversified investment fund strategy of the Vanguard Institutional Index mutual fund (VINIX)
According to its prospectus filing on the U.S. Securities and Exchange Commission EDGAR system, the investment strategy of the Vanguard Institutional Index [...])
- Commentary on How Many Mutual Funds are Needed for a Well-Diversified Portfolio (
For holding periods of many years, diversification improves dramatically, when you hold multiple actively-managed mutual funds in an investment portfolio.
In "How Many Mutual Funds Constitute a Diversified Mutual Fund Portfolio?," Professor Edward O'Neal of the University of New Hampshire at Durham tackled the important question of how much an investor could improve on diversification by [...])
- Pay Lower Investment Expenses To Get Higher Investment Returns (
Pay Lower Investment Expenses To Get Higher Investment Returns - Part 1
Excessive investment costs are a plague on your personal financial planning.
Excessive investment expenses are one of the most significant barriers to lifelong family financial security. While financial services industry sales people tell you that you need to pay more to get more, the correct [...])
- 15 Value-Added Individual Investor Activities (Before estimating the investment value that you might add or take away from your portfolio, you first need to determine whether your strategies are or are not likely to lead to optimal risk-adjusted investment returns.
This value estimation is separate from any hourly opportunity cost related to spending time on your investments versus an alternative use [...])
- Allocate investments across the primary asset classes – Step 5 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
Appropriately setting your personal investment asset allocation in line with your personal investment risk tolerance is a critical decision for every individual investor.
Because the average risk-averse investor holds the average portfolio asset allocation, this becomes the starting [...])
- Passive Personal Investment Strategies are More Time Efficient with Better Returns and Risk Control (
The scientific investment literature indicates that passive investment strategies usually are more time efficient, while they also increase returns and add more value to your investment portfolio.
For example, given the diversification imperative, it is highly questionable whether the vast majority of individual investors should own any common stocks or bonds directly. Instead, they can achieve [...])