How Should You Choose Assets? - Part 1
Add comment May 12th, 2008
Amy L. Barrett, MBA, CFA, CFP®, CDFA™
A previous blog dated March 5th provided a short risk tolerance questionnaire to help you, the investor, select a personal and appropriate level of stocks-to-bonds in your investment portfolio. With the right amount of investment risk (stock-to-bond ratio), you can withstand tough times — like current markets — without selling your investments. Armed with the knowledge of your risk tolerance, your next step in order to achieve a solid investment plan is to choose the stocks, bonds, and other assets to fill your portfolio. But, how do you choose your assets? If you are like most of our prospects, your investments are “all over the place” meaning that they are a hodge-podge of investments. Investors often collect assets without a thought of their overall strategy. Ideally, investors should purchase assets so that the portfolio may meet their life goals.
There are two investment philosophies, active and passive investing, that lead to different methods of building a portfolio. Active investors bet that they can pick the best stocks and funds plus they can “time the market” (buy when the market is low and sell when the market is high). Active investors believe their ability to select stocks and “time the market” will allow them to outperform all other investors. On the other hand, passive investing involves buying broadly diversified investment baskets - a broad variety of investments. Passive investors believe that their stock picking ability and market timing are not superior to the average investor’s ability. In fact, passive investors believe they have no more knowledge than average investors do. Though this view is not flattering, the fact is that passive investors routinely get better results than active investors do. A recent Savant analysis found that 70% of the large cap mutual funds (existing for ten years) had lower return than the S&P 500 Index return. After the investors pay taxes (which reduce return), perhaps 80% would fail to beat the index return. These funds fail because most fund managers are not superior at stock selection or market timing. Active investors may win for a while, but consistently winning over a long period of time is nearly impossible.
