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DIY Investing

January 29, 2009 by  


By Bob Wood, MMNS

As we look back on how stock markets around the world have fared, 2008 was a pretty dismal year. Investors suffered the worst round of losses on record since the 1930s. Traditional investing principles did little to mitigate the damage, yet those theories, still considered the best available, are used by most professional advisors, possibly even those who manage your portfolio. Are there better alternatives to consider?

The debate rages on about which investing methods work best over long time periods. Discussions tend to focus on the differences between active portfolio management and passive investing, which uses index funds. John Bogle, founder of the fund firm Vanguard, was heartened to see again in 2008 that index funds outperformed the majority of those with active managers.His victory was tempered, though, since index funds simply lost less money than actively managed funds.

Over longer time periods, index funds do hold advantages for investors; they have lower costs from management fees, lower tax costs from less buying and selling and, frankly, fewer manager mistakes. How many active managers chased financial stocks lower during 2008, only to watch them go much lower, as in shares of Citigroup, AIG, Bank of America and others?

I won’t discuss here the massive accidents endured by investors in hedge funds that cratered, such as Bernard Madoff’s fund that proved nothing more than a scam. Other highly acclaimed active managers like Bill Miller and Ken Heebner also experienced very bad years, with Miller’s performance erasing years of prior gains in just a few short months.

In addition, many other professional fund managers, those advisors who sell their asset allocation expertise, also suffered nasty falls in the past year. With the S&P 500 now sitting about where it was in mid-1997, what can we assume about their performance over that time, given the dearth of those professionals who beat the market in any one year — or even any 10-year period?

What have investors gained by paying fees and commissions for performance they could have matched or beaten themselves, using a passive approach? Is there another way for investors like you to manage their life savings?

Considering the poor performance records over time of most active managers and those who espouse asset allocation, perhaps you should just fire those “professionals” and do the job yourself! If that sounds like a daunting task and one you’d rather not take on, consider these facts. Plenty of tools are available, and — here’s the best part — they cost little, if anything, to use.

Better yet, this investment stuff is easier to understand than you might think. Nothing is so esoteric, complex or mystical about asset allocation that it should scare you away. Your broker or advisor simply learns the theory and implementation of diversifying an investment portfolio, and so could you. And that’s all I’m suggesting.

Diversification lies at the heart of Modern Portfolio Theory (MPT) and asset allocation. By spreading your risk among several different asset classes, you gain the same benefits planned by your professional advisor when he/she builds and manages your portfolio.

One of the worst aspects of hiring professional advisors lies in how they make diversifying sound much more complicated than it really is. But it is really nothing new, since asset allocation and MPT have been around since the 1950s. The methods are well understood, and you can learn as much about the subject as your professional advisor knows by reading just one book on the subject!

My personal favorite, logically enough, is Asset Allocation by Roger Gibson. Everything you need to know is there, and little, if anything, has been discovered to enhance the contents of this book, even though it’s almost 20 years old!

My main objection to using asset allocation and MPT, as described in this and many other books, is that, while these methods are fine for long-running bull markets, they fail badly during long-running bear markets such as the one now miring our advancement. But investors can rather easily work around that disadvantage by adding bear market mutual funds to the list of ‘’core’’ funds normally used for dividing up investment capital.

Other resources are available to help you take control of your own investments. Virtually all of the no-load mutual fund companies offer advice, though it may not add anything to what you’d already know after reading a book on asset allocation. Nonetheless, all the help you need is available.

You can also visit the web sites of Fidelity, Vanguard, T. Rowe Price, Index Fund Advisors and others to see samples of model portfolios, which consider your tolerance for risk. These will look almost identical to those built by your professional advisor. Surely, most use computer software programs that arrive at similar conclusions after the user inputs basic parameters such as risk tolerance, age and the amount to be invested.

For a more personal approach, you could even call and speak with advisors at those fund firms, rather than going it alone. Doing your own investing need not involve sitting isolated and alone, wondering if you’re doing the right things while following directions on a computer screen.

Fund sellers like Fidelity also offer funds from other companies, so you are not limited to only in-house funds. And sticking with mutual funds is likely the best option to pursue. While so many individual stocks blew up on their way to single digit prices in 2008, very few mutual funds suffered similar losses.

Other resources include the ubiquitous chat rooms, found on many financial web sites. The Morningstar site offers several forums, including the “Vanguard Diehards,” who seem eager to offer advice on properly building a portfolio using low cost funds. And I think their acumen on asset allocation and diversification would match that of most investing professionals I have met.

However, if you currently work with a manager or a mutual fund whose performance merits your respect, don’t change what you’re doing. Today’s advice pertains only to those whose investing results have been underwhelming for too long and where the costs of professional advice have not been justified by the end results.

But if your current advisor has been disappointing, what good does it do to find another who is more than likely using the very same methods? If one is only as good as another and none have impressed you for this many years, your best option might be to assign the task of managing your savings to the one person whose self interest is most aligned with your own. you!

You can do this, and taking some time to research asset allocation theory and implementation will be worth the time, if only for the peace of mind you gain from knowing that you are not flying blindfolded – and without instruments.

Have a great week.
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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