The Most Important Investment Decision is Not What You Think

Conventional wisdom and the popular media perpetuate the notion that to be a truly successful investor you need to be really great at choosing the best stocks (Security Selection) and/or picking the perfect moment to buy and sell (Market Timing).

It turns out that conventional wisdom may be hazardous to your wealth. Let’s begin by considering the first approach (i.e. Security Selection). You can either pick the investments yourself, or hire a professional to do it for you.

Most investors delegate the responsibility of security selection to a professional by purchasing shares in a Mutual Fund which in turn hires a money manager to make the investment decisions.

How have these professional mutual fund managers performed?  According to a recent study, “the number of funds that have beaten the market over their entire histories is so small that the False Discovery Rate test can’t eliminate the possibility that the few that did were merely false positives”1

If the professionals cannot consistently outperform the market by picking the best stocks, perhaps Market Timing is the key to success. As it turns out the average investor only makes the problem worse by attempting to pick the best time to be in or out of the market. According to Dalbar Inc., a Boston-based financial market research company, “an analysis of actual investor behavior over the 20 years ending December 31, 2007, the average equity fund investor would have earned an annualized return of just 4.48% –underperforming the S&P 500 by more than 7%”2

If Security Selection and Market Timing prove to be unhelpful and even harmful to your wealth, then what is the key to successful investing?  The answer is to proactively establish an Investment Policy.

Researchers shook the investment community over twenty years ago with this discovery when they published the landmark study, “Determinants of Portfolio Performance.” The authors showed that, “investment policy explained on average 91.5 per cent of the variation in quarterly total plan returns.”3  Other researchers have confirmed the importance of investment policy which “has a greater effect on the portfolio’s return than either the sponsor or manager, or the transaction costs or timing and selection.”4

According to the Global Fiduciary Standard of Excellence (GFSE), a written Investment Policy should be, “a formal, long-range, strategic plan that allows the Investment Advisor to coordinate the management of each client’s investment program in a logical and consistent framework.”5  This can serve to insulate the client and Investment Advisor from market noise – keeping everyone focused on the client’s long-term goals and objectives.

Feel free to call us for expert help in designing an Investment Plan that helps you to accomplish your goals, and because we are registered as a fiduciary with the SEC, we are required by law to always put your interest ahead of our own.

1) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869748#PaperDownload

2) http://www.qaib.com/showresource.aspx?URI=advisoreditionfreelook&

3) http://www.cfapubs.org/doi/abs/10.2469/faj.v47.n3.40

4) http://www.highwayfinancial.com/Downloads/InvestmentPolicy.pdf

5) http://www.fi360.com/main/resources_download.jsp