In 16 years of advising hundreds of clients on their personal investment and financial planning, I've yet to find a single prospective client who could provide me a concise description of a well-structured investment process which they follow consistently. Rather I've heard “I follow Money Magazine recommendations” or “Jim Kramer's trading strategies work for me”. Neither of which qualify for consistent or well-structured, both of which qualify for ignorant and futile.
The fact is without a solid foundation – you'll never have a successful investing experience. A recent Dalbar study (March 2011) using analytics and data from Lipper and the Investment Company Institute proved once again that investors do more more harm to themselves than they realize. The data shown the average equity mutual fund INVESTMENT returned 9.90% for the period 1991 to 2010. The average INVESTOR enjoyed a return of just 3.80% over the same time period.
How could that be you ask? Simple. Investors do the wrong thing at the wrong time. The sell low and buy high. They chase yield over total return. They speculate rather than invest. They watch too much CNBC (everything on CNBC is short term in nature – not long term) and react to news too often. They make a slew of bad investment decisions, and do so primarily based off fear and greed – two incredibly powerful emotions.
Every year Dalbar puts out that same study, each year the gap is roughly the same though the numbers do change slightly. This illustrates that as investors, we're simply not wired to “get it right”. The fact is all you had to do was buy the average equity fund and put it in a shoebox (so to speak) to enjoy those near double-digit returns for the last 20 years. Instead of the only thing consistent about the average investor strategy is it reduces investment returns.
It's ironic how most investment strategies will assume an 8% rate of return, yet the average equity investor scarcely earns half that amount as proven by Dalbar. So we absorb more, get less, then wonder what happened.
I'm here to tell you it does not have to be that way. You do not have to be behind the curve financially in retirement, you do not have to settle. You DO however need a sound investment process consistently applied throughout your investment lifetime.
Whether you're a DIY investor, or prefer using an expert for help, you need to have a basic mind in place starting with the hierarchy of decisions. The fact is most investors focus on the LEAST important things when they should be focused on the MOST important things.
Here's a quick list of what really matters to you when it comes to investment strategy and asset allocation:
# 1 What is the time horizon of your investment strategy? By far the most important investment planning decision is the time horizon of your strategy. This is most appropriately determined by expectations of future cash flow needs. However, just because you retire in 10 years does not mean your plan stops. To the contrary, your investment plan should continue on for decades as you enjoy retirement.
# 2 What asset classes will be considered for your plan? Stocks, bonds, cash, and commodities are the primary asset classes. But will you utilize large stocks, international stocks, gold or emerging market bonds? There are four major asset classes, yet dozens of sub-asset classes. Take time, do your research. The important part is selecting major asset classes which will allow you to effectively diversify your portfolio.
# 3 What asset allocation will be selected for your investment portfolio? Nearly tied with asset class selection on the priority list is the mix of those asset classes into an appropriate asset allocation plan. The percentage of stocks vs. bonds and cash etc. is going to determine over 90% of your investment portfolio returns – NOT what stock you pick or when you trade the markets. There are several tools online that are efficient at creating an optimized portfolio (meaning the best mix of asset classes to meet your financial needs); however, there are always intangibles and meeting with a qualified fee only financial advisor to create your asset allocation can be worth it's weight in gold!
# 4 Who's going to manage the asset classes you selected in step 3? The fact is the overwhelming majority of investors have no business trading stocks and bonds. It just does not make sense on so many levels. Rather it's far more prudent to select high quality investment managers of mutual funds and exchange traded funds (ETF's). There are great analytical tools available online including data from Morningstar and Lipper, yet this part gets far more technical and tricky than the first 3 steps. Fortunately, it's the least important of the four steps!
Can you invest successfully on your own? Yes – it is possible, yet the odds of success are clearly against the average investor. History has shown us that it's incredibly hard to do so and the costs of failure can be staggering. If you do decide to invest on your own start with these four simple steps, with the appropriate importance placed on each one.
If you hire a professional advisor – which I recommend for most investors – I highly endorse NAPFA (National Association of Personal Financial Advisors) registered financial advisors nationwide. With NAPFA you'll find completely unbiased and independent advisors who truly have your best interests at heart.