Best Investment Strategy

Larry Russell

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Personal investing seems incredibly complex, but the best investment strategy also tends to be a more simple investment strategy

The complexity of personal investment management is driven by the nature of investing in securities that have uncertain and unknowable future values. Nobody — amateur or professional — has a working crystal ball that can predict future asset values. Anyone can have a more or less well-informed outlook and operate with an evolving set of theories as to what might happen.

However, it is what actually unfolds in the future in terms of positive and negative economic, technological, competitive, political, and other developments that will determine the evolution of securities values. And, even as new information becomes known in the future, the value of a particular securities will be always be an amalgamation of currently known information and a forward looking market consensus about the murky future.

In general, it is this very uncertainty that provides investors with opportunities (however unpredictable) to earn over time more or less than a market return on their invested assets. Investing involves varying degrees of risk and participants in real time securities markets buy securities at what they perceive to be a discount against their expectations for higher future values. They sell when they think current market prices exceed the future opportunity.

Thus, the uncertainty about the future drives much of the inherent complexity of investing. Everybody wants a magic system to beat the market and to do better than the other guy, but when you take the time to think about it, you realize that the future cannot be known until it arrives and that there can be no magic bullets, reliable systems, or sure bets with investing.

Nevertheless, the inherent complexity of investing is greatly exacerbated by the proliferation of investment products and services aggressively promoted by a securities and financial services industry that purports to serve your best interests. However, this proliferation of complex investment products most often seems only to serve the financial self-interests of the securities industry itself. Averaged across all retail investors, the high fees of the financial service industry dramatically reduce rather than help to increase retail investors’ net assets.

Personal investing can be simplified greatly by focusing only on valid strategies that have support in the investment research literature. This personal investment planning summary is intended to help you to understand that you can manage your investments using strategies that have a demonstrated basis in the research literature.

When one pursues strategies that are designed to focus solely on the fiduciary interests of individual investors, the vast majority of investment products promoted by the industry can simply and easily be eliminated from consideration. They cost far more than they are worth. Aggressive investment cost control is not a magic bullet to beat the market, but it is a very effective way to avoid being the rube who gets fleeced by the fast talking slick suit.

Once you have committed to a durable long-term investment strategy, you can manage by yourself relatively easily the details of investment implementation. You do not need to pay high costs for something you can do yourself.

You can build an easy-to-manage, do-it-yourself, lifetime investment strategy based upon these principles:

Most people waste a great deal of time on investment activities, tactics, and strategies that are more likely to reduce rather than increase their investment portfolios.

Very low cost, professional index fund managers can manage your money far more efficiently in terms of much lower costs, far greater diversification, better returns, lower taxes, and significantly less time than you can ever realistically hope to do as a personal investment portfolio manager. Do yourself a favor and decide to fire yourself as a personal investment manager in favor of a handful of index fund managers running very broadly diversified, low cost funds.

Despite these factors, some people just cannot resist the personal investment management game. If you simply cannot resist the temptation to play personal investment portfolio manager, then understand clearly that this is likely to be one of the most costly hobbies that you could have. If you are anything like the average investor (and you probably are), then your self-managed personal investment portfolio is highly likely to cost you money through inferior returns, higher costs, and inadequate diversification. Moreover, this hobby is extremely likely to waste a significant amount of your valuable time over your lifespan.

However, if you must play investment manager, then never play with the rent money, the baby’s milk money, or the money that you are relying upon for your retirement, your kids education, or other important obligations. Since investment portfolio self-management is not likely to be a value-added activity, never allocate more than 10% of your overall investment assets to this hobby. Invest the remaining 90+% in accordance with the investment methods summarized above.

In addition, learn how to track carefully and accurately your investment performance relative to appropriate passive benchmarks, so that you do not fool yourself into thinking you have more skill than you actually do. Everybody is an investment genius in a rising market, if they do not track performance relative to appropriate passive market benchmarks. Academic research clearly demonstrates that individuals most often achieve significantly sub-optimal investment results relative to passive benchmarks, while simultaneously they carry higher and unnecessarily risks due to non-diversified self-managed portfolios.

You investments should work for you rather than you working for them. Avoid all the financial industry games designed to make money off of your assets and to keep you moving assets around chasing performance gains that have already passed you by. Instead, simplify your investment program, and use your financial assets to enrich and protect your life and the lives of those you love.

OK — So How Does One Go About Doing This?

Here are some ideas to get you going:

1) On the “Retirement Investment Calculator” front page of this website, you can read about VeriPlan, which is an automated personal financial planning and retirement savings calculator software tool that individuals and families can use to do their own lifetime financial plans. This lifetime savings and investment calculator is the most sophisticated and high quality financial planning software that you can buy at a great bargain price. VeriPlan automates all of the tedious calculations needed to do fully integrated lifetime financial planning in a manner that is customized to reflect your particular financial situation, all your financial resources, and all your financial life goals and objectives.

Furthermore, VeriPlan also provides very extensive and absolutely objective personal financial planning documentation that helps you to understand the lifetime financial planning process and how to use VeriPlan’s automated and fully integrated IRA investment calculator, 401k investment calculator, mutual fund investment calculator, and saving for retirement calculator functionality. While VeriPlan hides the complexity of millions of inter-related financial investment calculator operations, it also treats you like an adult!

VeriPlan was designed with the firm belief that smart, well-educated adults need and want well-designed financial decision support tools with sophisticated future value investment calculator functionality. If you are going to invest the time needed to plan your family’s financial future, you need a financial planning software “power tool” to help you. It must be highly functional and robust, while it also provides useful and entirely objective financial information.

2) In parallel with checking out VeriPlan, you might also want take a look at this “Financial Planning Reading List.” This reading list compiles the top 60 or so personal financial planning and personal investment management articles from the many hundreds that the designer of VeriPlan has published on various personal finance websites across the web. All of these “Financial Planning Reading List” articles were personally researched and written by the designer of VeriPlan. If you want to judge whether VeriPlan could be right for you, then these articles might help you with your decision. Furthermore, the more articles on this reading list that you read, the better prepared you will be to manage your own family financial planning and personal investment portfolio over your lifetime.



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3) I do believe that it is a virtue to engage in a lifelong effort to understand economics and investments, because of the significant impact of economics and investing on our lives. Personally, I believe that this knowledge provides a very long-term economic perspective and allows one to rise above the constant pressure from the industry and the media to change something – change anything – with ones investments, without any rational reason other than to generate more revenue and profit for the industry, yet not for you.

The more one learns, the less one is inclined to jump from one currently popular investment strategy to the next. Stability, constancy, passivity, broad diversification, risk control, and very low costs have been the hallmarks of the most successful personal investment programs of the past. I have found nothing that makes me believe that these viewpoints should ever change.

Given these viewpoints, I have also determined that I will not pay additionally for any “special insights” from industry professionals. Paid insights are no better that the abundance of free insights. However, since they cost more, one is likely to end up poorer for having paid.
Therefore, I have decided that I will only use free resources. Everything I do relies upon free public information or at least information that is very, very low cost. One just has to learn how and where to look. Of course using only free or extremely low cost public economic and investment information, means I may have to wade through a lot of rubbish to find things that are useful and valid. However, that is far better than wading through a lot of rubbish for which I have paid very dearly.

4) Recommended journals and books

In addition to materials that I have published, here is a short list of my investment reading recommendations concerning other sources that I consider worthwhile. The online sources are all free. You could buy the books inexpensively on Amazon.

A) Journal of Indexing — http://indexuniverse.com/index.php/publications/journalofindexes.html  Back issues can be read online.

B) John Bogle’s book “The Little Book of Common Sense Investing” Go to “John C. Bogel’s Blog.” You can read the first chapter of his book online on his blog. http://johncbogle.com/wordpress/

C) “Capital Ideas: The Improbable Origins of Modern Wall Street” (1993) or “Capital Ideas Evolving” (2007) by Peter Bernstein. These books chronicle of the intellectual development of modern investing.

D) Investment research papers via Google Scholar (To find investment research papers via Google Scholar, go to Google, click “more”, click “Scholar” and enter a search term. This takes time, but researching personal finance via Google Scholar can be very informative. For example, if you want to learn about forex trading online, (which is not a good idea for individual investors), just type in that phrase. With this example, you get about 2,700 research papers on foreign exchange and related forex topics. Once you get results, you can use Advanced Scholar Search to specify searching within particular subject matter categories and you can select particular authors who have many citations, among other search refinements. Look for most cited papers. Read abstracts, intros, and conclusions.)

After these recommendations, I have few additional recommendations, although I track and read a very wide variety of sources. The next book I would recommend is Ben Franklin’s Autobiography. I do not recommend many investment books, because I think that much more objective materials can be found in research papers on the websites of financial academics.

Comprehensive investment calculator and personal financial planning software is needed to develop a fully personalized family financial strategy

This free “financial freedom guide” on how to invest is just a part of our web site about how to develop a personal family financial plan. The personal finance plan essays on this free site supply important ideas to individuals and families about financial planning program and financial strategy subjects that should taken into consideration. These postings help in understanding how to establish a life time personal finance planning strategy. Also, to generate a really useful long-term money management strategy depends upon you using the best retirement savings calculator and personal financial planning software with a high quality stock investment calculator and the leading long term investment calculator software features.

Also, our financial freedom web site enables you to find the top all-in-one saving for retirement calculator software program for home PC use, and it includes the best retirement investment calculator tool, the best personal budgeting software, and a high quality mutual fund investment calculator for your personally customized lifetime financial planning. It also automates the long-term analysis of debts that you have, which could include mortgage debts, educational loans, credit card debt, business credit, or whatever other credit obligations you wish to analyze individually or jointly. Furthermore, it has an automated tool to assess an interest rate for your choice in situations where your financial assets are projected to have been exhausted, and you would use your other real estate or business assets as collateral for the personal or business credit loan you would need.

Diversification and the credit crisis

Larry Russell

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The best personal investment and financial planning practices are durable and should not change because of market cycles and financial crises.

Less diversified active strategies tend of be sub-optimal, involving greater portfolio volatility and risk accompanied by higher costs in term of expenses, taxes, time commitment, and stomach acid. The best investment strategy is to seek complete market diversification at the lowest investment cost using passively managed and globally diversified index mutual funds and ETFs.

Nothing that has happened in the credit crisis changes the value of broad market diversification. Some uninformed post-crisis commentary has questioned the wisdom of diversification, which only indicates a failure to understand what diversification can and cannot do for you. Diversification across a portfolio can and does mitigate volatility over time.

However, when systemic factors across asset classes are in motion in the securities markets, then there is nowhere to hide, as occurred with the credit crisis. As over-leveraged investors (professional speculators “managing” other people’s money amped up with borrowing – AKA hedge funds) across a variety of asset classes scrambled for liquidity, selling pressure increased broadly and asset values crashed generally, albeit, not uniformly. Those who were very broadly diversified felt less pain, but they still felt pain.

If you really like the potential for a lot more pain, then don’t diversify. Sooner or later, that pain is much more likely to come to an ill-diversified investor’s portfolio compared to the portfolio of a broadly diversified investor. Of course, ill-diversified investors chasing tactical and active strategies are always hoping for outsized returns for the added risk.

Sadly, only a minority of active investors will get lucky, and it is largely luck (of the lack thereof) that is at play here. The percent of the lucky minority achieving excess returns tends to diminish with time — as excessive fees and taxes eat away at illusory excess returns — proving the foolishness of active strategies.

Diversification is really not an option, if your goal is optimized, risk-adjusted personal investing.

Diversification is not an optional part of family investment strategy, if that family wants to sleep well at night. When you are less than fully diversified, every day that you wait exposes you to investment risks that the securities markets tend NOT to compensate through better returns. When you are less than fully diversified, your investment portfolio risks are higher than they need to be without a reasonable expectation of getting any likely additional returns.

When you:

then you are much more likely to lose than to win. This is simply because the road you are taking is unnecessarily rough and unnecessarily winding, and you have less certainty that you will reach your goals.

You might overshoot in performance, if you are lucky. However, you are much more likely to under-perform, because of the various higher expenses and costs that continually drag down active strategies. The longer your time horizon is, then the greater the chances that you will fall behind a passive, lowest cost, market investment strategy.

A passive strategy targets a market return and can still be a bumpy ride — especially if you are not fully diversified globally and you have not adopted an asset allocation that is appropriate to your tolerance for investment risk. Nevertheless, the attendant risks are lower and potential variations are narrower than active strategies.

Furthermore, passive strategies that drive down investment costs and expenses to the bare minimum are not continually burdened by repeatedly having to pay the financial services industry a much larger and undeserved share of your returns. It is hard enough to finish a marathon without carrying water for the financial securities industry at the same time.

Full global investment diversification using the broadest, cheapest, most passive index mutual funds and exchange traded funds (ETFs) is the most optimal strategy for the individual investor.

Few in the industry will tell you this, because a lowest cost, global and passive diversification strategy is the least profitable to the financial services industry. The securities industry looks upon you as a naive “retail investor.” The industry trains its representatives to sell to you the most profitable products that it can at “retail” prices. If you tell a commissioned financial advisor that you want to pursue such a strategy, expect to be told directly or indirectly why you are an idiot.

Through visible and hidden fees and other costs, “retail” financial services product prices are heavily marked up to compensate the industry and its very highly paid sales force. Who do you think is paying for all those tall buildings, brass fittings, mahogany tables, woolen suits, and expensive silk ties? Who pays the industry’s huge salaries and bonuses? Does the money just come out of thin air, or does it come out of your investment assets and your investment returns?

Few will tell you this fundamental truth about the superiority of cheap, passive, fully diversified broad market investing. Everyone in the industry gets paid somehow, and there is far less profit in promoting a low cost, fully diversified investment strategy. However, there is real money in it for you. In the end, you will tend to save more money, to save more time, and to save yourself from emotional consternation, when you use a very low cost, fully diversified passive investment strategy.

Complete investment diversification has become an axiom of personal investing, because the specific risks of businesses and other investment entities can be reduced or eliminated with a fully diversified portfolio without reducing your expected returns.

A fully diversified portfolio is an absolute investment necessity. Increased diversification reduces portfolio risk without a corresponding reduction in expected portfolio returns. Diversification is genuinely an investment “free lunch,” and it is a key contributor to improved investment risk management. A very high degree of diversification can be achieved through investing in a variety of low cost passively managed index mutual funds or exchange-traded funds. Such investments are also among the lowest cost investment vehicles available to individual investors in the financial markets. Given that this alternative is easily and cheaply available, the relevant question is never whether a portfolio should be fully diversified. Your investment portfolio should always be as diverse, as is economically practical.

Through investments in broad-based index mutual funds and exchange-traded funds, diversification is relatively easy and inexpensive to achieve. Attempting to become broadly diversified through the self-assembly of a portfolio of a large number of individual securities is far more difficult and much more costly. It is a simple shame that millions of investors listen to the hot stock recommendations of brokers their whole lives, when their brokers cannot know what will actually happen in the future.

Portfolio self-assembly is much more likely to result in higher risk with returns that lag the market. Buying individual stocks and bonds instead of diversified funds provides you with no advantage whatsoever. The industry likes it, because individual securities trading generates fees and keeps the charade of beating the market going. However, when you buy individual stocks and bonds, you are less than fully diversified, and you are exposed to more risk. Plus, you also get to waste your money and time for nothing. Pay more and get less. What kind of value added is that? Ignore that kind of investment counseling and financial advice.

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Retirement tax optimization strategy

Larry Russell

Find VERIPLAN:   Do-It-Yourself Financial Planning Software


Optimal asset “tax location” strategies and drawing down traditional tax-advantaged assets, while delaying Social Security retirement payments

Investment tax location and Social Security tax optimization strategies could improve your lifetime financial plan. To understand how VeriPlan manages the automatic: A) reinvestment of positive annual cash flows from net earned income and other non-asset cash flows and B) withdrawal of assets in years with negative cash flows please refer to the “Transactions timing and priorities for traditional & Roth tax-advantaged accounts” section of the tax-advantaged worksheet.

In general, across your lifetime projections VeriPlan will assume that cash, bond, and stock financial asset withdrawals will be taken first from taxable accounts, then from traditional “avoid-initial-taxes-but-pay-taxes-in-retirement” tax- advantaged accounts, and then finally from Roth “tax-initially-but-not-later” tax-advantaged accounts. This topic is not at all simple, but in general, VeriPlan automates the lifetime asset transactions process for you, while allowing you to evaluate and obtain the benefit of tax-deferral and tax avoidance provided by traditional and Roth tax-advantaged retirement accounts.

Because the computations regarding a series of forward-chained lifetime projections can be very complex for all of what VeriPlan already automates in your projections, there are certain tax optimization strategies worth noting that could not also be implemented practically within VeriPlan projections. Therefore, the information in this section will simply point out that some investors may have the opportunity to improve upon their lifetime financial plans in practice:

1) by implementing optimal tax location strategies and
2) by drawing down tax-advantaged assets to delay their initial receipt of Social Security retirement payments.

Concerning implementing optimal tax location strategies, see: Asset Allocation, Investment Asset Tax Location, and Emergency Cash Management

It can be advantageous for certain people to withdraw tax-advantaged account assets between age 62 and age 70, while not taking Social Security payments until a later age

Regarding drawing down traditional tax-advantaged account assets while delaying the age that Social Security payments are first taken, it can be advantageous for certain people to withdraw tax-advantaged account assets at some points between age 62 and age 70, while not taking Social Security payments until a later age. In particular, when some people do this, they can avoid paying unnecessary income taxes on earlier Social Security retirement payments and instead pay income taxes on withdrawals from their tax-advantaged retirement accounts to meet cash flow short-falls.

By doing this they draw down their traditional tax-advantaged retirement account assets and lower future taxes that would be due on Required Minimum Distributions (RMDs) after age 70 and 1/2. Meanwhile, by delaying their Social Security payments to a later age of first payment, they can increase their payment levels throughout retirement, and receive favorable tax treatment on those payments.

The years when this tactic would tend to most useful are the years after retirement when earned income falls off and total income tax rates decline before age 70. Retirees can weigh the benefits of pursuing this tax optimization strategy, when they get to that point in their lives and before they decide to accept initial Social Security retirement payments. This decision will require some careful thought.

First, an optimal lifetime “tax location” strategy can influence the relative balances of taxable and tax-advantaged account assets that would be held at this early point in retirement — and thus taxes due associated with RMDs. Second, one’s asset allocation strategy will influence whether this strategy is more advantageous, since people who hold an asset allocation skewed more heavily toward cash and bonds would be likely to receive more benefit.

Third, getting this decision right before accepting initial Social Security retirement payments has become even more critical, since in December of 2010. That is when the Social Security Administration effectively eliminated the “do-over” strategies of repaying all Social Security payments and restarting payments at a higher level. In December 2010, the Social Security Administration began to restrict do-overs to one time during one 12-month period with no repeats.

To understand more about this tax optimization strategy of accelerated tax-advantaged account withdrawals versus delayed Social Security retirement payments decisions, Dr. Shelby Smith has written a detailed white paper that discusses this strategy. Reading this white paper can be a bit of tough sledding, but for those nearing retirement the potential financial advantages could make reading this paper quite profitable.

Find a link to Shelby Smith’s “Guide to Social Security”

The Value of Future versus Current Consumption

Larry Russell

Find VERIPLAN:   Do-It-Yourself Financial Planning Software


These are some thoughts that I provided to a client couple struggling to live within their means, while also saving and investing for their future:

The most important long-term topic we discussed was how you as a couple can find a way to balance current consumption, which presently exceeds your dual incomes, against the need to save for the future. This will require a significant modification of behaviors and the development of some techniques for you both to reinforce each other’s intentions to save and invest for the future — perhaps in a similar, but opposite manner, to which you have said you tend to reinforce each other’s desires to splurge and to break into the weak locks on the “savings lock boxes” that you currently have.

We discussed the idea of you both having money taken out of your paychecks and invested into your 401k/403b plans, and then living on the net check without allowing yourself to use a credit card except in dire emergencies. We discussed the idea that those in their mid-40s need to save and invest at least 15% to 20% to prepare to maintain their lifestyles in retirement using their Social Security full retirement ages.

There are multiple ways to approach this, but fundamentally it means that, when making decisions about consuming now versus saving and investing for the future, you need to find ways to value your “future needs” above your “current wants that are not really needs.” There are a variety of techniques to do this, but among other things one needs to:

A) find mechanisms to automatically save and invest to remove the temptation to over consume (e.g. 401k, 403b, automatic deposits from paychecks into taxable accounts that you never touch, etc.)

B) understand the potential long-term value of investments (See my free book, “Lifetime and Retirement Financial Planning and Investing” which is available on this website. Focus on the investment chapters. There is a lot of material, but reading some should be helpful.)

C) find a means to identify with your future selves over a long lifetime

D) strive to increase income while holding consumption in check (for example, the idea of committing to invest 100% of a bonus or 75% of a raise rather than thinking about how to spend it)

E) find ways to systematically cut repetitive expenses and convert the expense reduction into savings and investments. (For example your residence refinance to reduce both costs and interest rate risk)

Just for your reference, we talked about the idea of the modest $40 dollar “upscale fast food” dinner” versus the $80 splurge dinner, which is eaten out on a regular and frequent basis — and the idea that the $40 saved could buy multiple future $40 dinners. While it is difficult for any human being to be entirely rational on almost anything, the rational mind needs to wrestle with current desires. The $80 dollar dinner will always win over the $40 dinner without some frame of reference about the $40 saved, if that $40 is truly saved for the long-term.

Here is an example of long-term investment appreciation. Long-term historical investment returns indicate that a 5% constant purchasing power, real dollar, annual compounded return is a reasonable middling expectation. So what happens with $1 saved over the decades with a 5% return? After 10 years, the dollar becomes $1.63. The math is just 1.05 multiplied by itself 10 times, but it implies that $40 saved today buys about 1 and 2/3 equivalent $40 dollar meals ten years from now or $40 saved now buys one $65 meal in 10 years. ($40 x 1.63 =$65.16)

The math of compounding accelerates with time, and since it is reasonably possible/probable for one partner of a middle-aged couple to live into their 90′s, it makes sense to look at the numbers up to 5 decades out. Here they are:

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