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The Optimal Investment Strategy for Individual Investors

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The Solution – ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient

A previous article, “The Problem – Straight answers about personal financial and investment planning are difficult to find,” summarized important reasons why individuals may experience difficulties, even if they are intent upon doing better with their personal financial planning. This article summarizes some general decision rules to address those problems. This article also introduces a series of additional articles, which will discuss these decision rules and related financial practices in more detail.

In general, individuals will benefit greatly and get more enjoyment out of their financial affairs, if they decide ONLY to follow financial and investment strategies that are: a) scientifically grounded, b) completely passive, c) thoroughly diversified, d) savings focused, e) risk adjusted, f) cost effective, and g) tax efficient. While this might seem very challenging to do, in reality all these factors are interrelated. In fact, when you choose financial strategies with these characteristics, your financial life tends to become less complicated. When the complications of personal finance diminish, you can get on with living. You can plan to live and not live to plan.

First, you should always demand that your financial strategies be scientifically valid. Far too many financial and investment strategies have no objective basis and are in fact contrary to what has been established in the financial science literature. Second, the more passive your strategies are, the better they are. Motion without real purpose in finance wastes both your money and your precious time. Motion in finance is futile, because asset price setting is generally very efficient, and the costs of making changes push you backward.

Third, thoroughly diversified strategies eliminate unnecessary risk. In addition, fully diversified strategies usually are completely passive, and they tend to have lower investment risk. Fourth, by earning more and spending less, most people will have much more impact on their future financial well-being than they ever could by trying to be more clever investors. Investment cleverness tends to be counter-productive for individual investors. In contrast, another dollar saved is another dollar to invest. (See: What is the cost to individual investors of sub-optimal portfolio diversification?)

Fifth, investing is about risk-adjusted asset returns. Securities markets tend to pay a premium for risk taking, but only for market-oriented risk taking. Securities markets tend not to compensate for the risks associated with holding the securities of individual companies. Individuals need to understand this. There is no risk free money in investing.

Sixth, your financial and investment practices need to be cost effective. Cost reduction is the single most important factor that will improve investment returns for most people. In addition, when you cut out investment costs, you also cut out the incentive for someone to sell something to you. When you stop listening to financial sales people and start looking proactively for low cost, passive, risk adjusted, and fully diversified investments, you simplify your choices. You will still have plenty of investments options. Furthermore, the scientific evidence indicates that these choices will be the most favorable to your interests. Finally, greater tax efficiency simply tends to be a by-product of following the other decision rules listed above. More risky, poorly diversified, active strategies tend to incur higher taxes.

To cover these decision rules and some related subjects in more detail, The Skilled Investor intends to publish sequentially, the eighteen “viewpoint” articles listed below. These financial planning and investing articles will give you a better understanding of why you should ONLY follow financial and investment strategies that are: a) scientifically grounded, b) completely passive, c) thoroughly diversified, d) savings focused, e) risk adjusted, f) cost effective, and g) tax efficient.

As these articles are published, we will add links to the list below. If you do not yet find a link below and you wish to be informed when these articles are published, you can stay tuned by selecting our RSS feed from the side column.

Forthcoming financial decision rule articles from The Skilled Investor:

1) Your financial and investment strategies should have a scientific basis.

2) Your personal earnings, expenditures, and savings are the most important determinants of your family’s long-term financial wealth.

3) There is no such thing as risk-free money from investing for individual investors.

4) You need to allocate your financial assets in a manner that reflects your relative tolerance for investment risk. You need to stay in the securities markets to earn market risk premiums.

5) Build asset buffers to protect yourself from market volatility.

6) You should always completely diversify your portfolio.

7) Own investment funds and not individual securities.

8} Spending your valuable time on the wrong financial activities is just plain bad for you.

9) Passive, index-oriented investment strategies tend to be superior, because they narrow the range of outcomes, and thus, they reduce the total investment risk associated with your portfolio.

10) Unfortunately, you cannot reliably identify beforehand professional investment managers who will deliver superior performance in the future, and you cannot hire them at a price that is lower than their potential value-added.

11) Never invest solely because of superior past performance.

12) Tax-advantaged investing is very good for most people at most times.

13) Excessive visible and hidden investment costs can reduce the potential value of your portfolio unnecessarily and dramatically.

14) Direct and indirect advisory costs and the expected value of the strategies that you are encouraged to use will determine your total return from advisory services.

15) If financial behavior control is difficult for you, then carefully hire a good advisor.

16) Do not ignore other risks that could destroy your best-laid financial plans.

17) Your portfolio assets are simply your evolving estate. You need to prepare appropriately for the day, when your assets become your estate.

18) Nobody and no tool can predict the future.

You might also want to take a look at a book on low cost mutual fund and ETF investing that I have written. To find this investment book summary, just click on the “best books on investing” link in the next sentence. I call it one of the best investing books not just because of pride of authorship, but because it is based on my years of reading the university investment research literature to sort out what actually works for do-it-yourself investors. After you read about this book, you also might agree that this is one of the best books on investing that an individual investor can find for straightforward do-it-yourself no load mutual fund investing and low cost ETF investing.


Personal Financial Planning

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