Does it seem like there’s been an extra level of uncertainty lately, threatening your investment plans? Today’s brew of geopolitical threats, inflation trends, rising interest rates, recessionary fears, and lingering COVID concerns can feel especially daunting. The market’s volatile reactions to it all may have left you wondering whether this seemingly heightened risks call for a higher-alert approach to your investment selections.
If you’re seeking clarity, the daily spew of financial commentary won’t help. To cut past the clutter, we’ll revisit our investment selection process over this three-part series. Reviewing the steps involved speaks to the importance of looking past today’s unsettling news in pursuit of your greater goals.
Step One: Eliminate the Ineligible
Chocolate or vanilla? Back in the 1970s, when Vanguard’s John “Jack” Bogle introduced the first retail index fund, there were limited choices available to satisfy an investor’s tastes. For better and worse, the volume and variety of investment flavors has changed over the years, with product providers adding to an ever-growing menu of selections.
Fortunately, we can promptly eliminate most investment products. It’s not about how they’ve been performing lately. Instead, we weed out the speculative, or traditional active product providers who are playing an entirely different game from the one we have in mind.
Speculative, or active investors try to predict what’s going to happen next in markets or to individual securities, and place clever trades ahead of the curve. Be they individual traders or well-heeled analysts, the competition is so fierce and price-setting is so instantaneous, their efforts aren’t expected to add persistent value, especially after costs. They work hard to decipher financial conditions and economic indicators and may even be correct, but that “curve” they’re trying to trade ahead of is always blind to the next price-altering news. Over the long run, this makes it nearly impossible to consistently surpass the prices and long-term expected returns already available in highly efficient markets.
Step Two: Identify the Best of the Best
After we eliminate the speculative product providers, we’re left with a much smaller pool of credible selections where we must narrow the field by identifying the best of the best.
As your advisor, we believe we add considerable value through our upfront and ongoing due diligence. We aim for providers who offer a prudent balance between incorporating important innovations, without creating chaos. This involves identifying the most robust factors, or expected sources of return, and understanding how they interact with one another across various market conditions. To build toward desirable investment outcomes, we favor fund managers who are:
Evidence-based: They harness the same, growing body of evidence we use to create a more reliable investment experience across the market’s “random walk.”
Persistent: They are deliberate, patient, and thrifty, with an eye toward offering more than just a menu of popular products and short-term “pops.”
Visionary: They’ve been around for a while, with a strong track record for capturing known and newly identified dimensions of expected returns.
Collaborative: They specialize in providing sensible, low-cost building blocks for creating and managing solid investment portfolios to facilitate investors’ greater financial goals.
Step Three: Inspect the Product Packaging
Beyond the investments themselves, there are the “containers” in which investment opportunities are delivered. There are traditional mutual funds and ETFs, hedge funds, target-date funds, annuities, separately managed and/or direct indexing accounts, private partnerships, robo-advisors, and more.
Regardless of the wrapper, the initial hurdle remains unchanged: Is the product provider managing your money in an appropriate, evidence-based manner, as described above? After ruling out any speculative action, we also want to review each product’s prospectus or similarly detailed disclosures to avoid packaging that is overly complicated, suspiciously opaque, and/or needlessly expensive. (If there are no details to inspect, that’s a big, red flag in itself.)
Selecting the most appropriate structure—or structures—for your unique circumstances usually involves substantial due diligence, as well as a close look at your individual needs. We’ll cover that next time in Step Four.