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The Weekly News Source for Wyoming's Ranchers, Farmers and AgriBusiness Community

Prudent Investment Strategies

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By Chris Nolt, Solid Rock Wealth Management

The definition of prudence is shrewdness in the management of affairs and using skill and good judgment in the use of resources. 

There is an endless list of investment options to choose from today. Having so many options can make it difficult to decide which is best.

One source of investment advice is the media. Unfortunately, a lot of what we read and hear in the media about investing isn’t good advice. 

Much of what we hear in the media centers around active management. The truth is, there is no scientific basis for many of the most highly touted beliefs, including the idea that value is added through the techniques of active management – stock selection and market timing. 

Once we understand the goals of the media and Wall Street are to entertain, to sell advertising and to move money, we will look to other sources for investment advice. 

An alternate source of investment information is independent academic research, which normally promotes asset allocation, diversification and a long-term plan. 

One of the most famous academic studies on investing was published in 1986 by a prestigious pension fund consulting firm named Brinson, Singer and Beebower. The firm analyzed the performance variations of 91 large pension funds. Their report analyzed the three primary investment strategies that determine variations in portfolio performance:  Market timing, security selection and asset allocation.  

What they found is the two strategies which have the least impact on variations in returns are market timing and stock selection.   

Market timing and stock selection rely on attempts to predict the future. Most stockbrokers’ recommendations are based on these two strategies. Wall Street spends billions of dollars each year trying to outguess the competition in these two areas. 

On average, these two strategies do not add value. In most studies, not only do they not add value, after management fees, they significantly under-perform the market.

The third strategy, asset allocation, has the largest effect on portfolio performance variation, and it is the simplest of the three to use. 

Asset allocation accounts for over 90 percent of a portfolio’s performance. An asset class can be defined as groups of securities – stocks, bonds and/or real estate – that have common risk and return characteristics. Asset allocation is how we allocate our money between the different asset classes.

Investing in index funds is an effective method for allocating our money among asset classes. There are indexes representing most asset classes, and there are index funds one can invest in for these indexes.  

Index funds comply with specific and clearly defined sets of rules of ownership, which are held constant regardless of market conditions. Index funds do not employ the tactics of stock picking and market timing, but rather buy and hold the securities within an index such as the S&P 500, Russell 2000, etc.  

Companies are purchased and held within the index when they meet the index parameters. Stocks are sold when they move outside of these parameters and no longer meet the index rules of construction. 

When it comes to index fund investing, one can invest in mutual funds or exchange traded funds (ETFs). Two of the most reputable companies advocating an indexing type approach are Dimensional Fund Advisors (DFA) and the Vanguard Group. 

Although DFA’s funds are similar to index funds, they create their own asset classes and are not restricted to traditional index rules of ownership. Instead, they retain the flexibility to make trading and portfolio construction decisions that add value.  

This flexibility offers them some advantages over traditional index funds.  In fact, from 1999-2018, 85 percent of DFA’s funds outperformed their index benchmark.  Although DFA is the fifth largest mutual fund company in the world, we may not have heard about them because they do not advertise, and they only offer their funds financial advisors by the company to sell their funds.

Conclusion

Using the techniques of active management and relying on the media to make our investment decisions can lead to inferior results. A prudent choice for investing money is to buy and hold a globally diversified portfolio of stock and bond index funds that is matched to our investment goals and tolerance for risk. 

How we allocate our money among different asset classes is a key decision. An independent, fee-only registered investment advisor can be very helpful in determining the appropriate asset allocation for us.

Chris Nolt is an independent, fee-only registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement.  

To order a copy of Chris’s new book Financial Strategies for Selling a Farm or Ranch, visit Amazon.com or call Chris at 800-517-1031. For more information, visit solidrockproperty.com and solidrockwealth.com.

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