This week's question is:
I read many experts who seem smart and advocate a particular strategy. The problem is I
don't know whom to believe. What experts do you follow?
In answering your question, first I have to admit that I recently had a revelation
(something that
doesn't happen very often -- maybe once a year, or twice in leap years). The revelation
was that I
am a dummy.
This happened at what may seem an odd place: a conference for investment advisors, where I
was
on a three-person panel speaking about asset allocation. To my left was a man I will call
Kevin, and
to my right was a man I will call Bob (I will call them that because those were their
names).
Kevin was well prepared with a cornucopia of statistical information suggesting that
investors should
diversify out of larger, "growth-oriented" (meaning high price-to-earnings)
stocks and into other
investments, such as international, real estate, and bonds. When he was talking he seemed
very
smart.
Bob had no statistics, but he had a vision (and people with vision always seem smart to me
-- that's
probably why I spend so much time calling the Psychic Friends Network). Bob's vision was
that
investors should put ALL of their money in larger, growth-oriented stocks. When he was
talking he
seemed more than smart.
When it was my turn to speak, I said things that in isolation may have sounded good, but
in
retrospect could be best summed up in two words: "I dunno." That's when I
realized that I am a
dummy.
Confessions of a Dummy
I often hear people like Kevin and Bob articulately defending some policy or other that
dictates
putting one's money in a specific type of investment. Of course, unlike Kevin and Bob,
most of them
have a bias (when was the last time the World Gold Council advised people to sell all of
their
precious metals?). But even the impartial experts don't agree with each other, so I am
forced to
make a choice. But I can't. Faced with two diverging opinions, my honest opinion is
"I dunno."
So I make the "dummy's" choice -- I diversify widely across several categories
of investments: large
companies, small companies, growth stocks, "value" stocks, international
investments, and,
potentially, bonds. I do this for two reasons:
1.I think this strategy will provide me with the greatest return over the long run.
2.Since I don't know what will be the best and worst performing asset classes, broad
diversification provides the greatest safety.
Portfolio Envy
I also read about the hot stocks to buy. I must read about 50 "sure-winner"
stocks per week --
either in a newspaper or magazine, or in a professional research report. If I bought every
stock that
was recommended to me and held onto it for a year, I would own 2,500 securities and my
friends
would suffer from portfolio envy.
But it would be impractical -- at best, I could only own 50 or 60 stocks without getting
chewed up
by commissions. So I am forced to choose among these well-founded recommendations, but
(here
we go again) my overriding thought is, "I dunno." So I make the choice for
dummies -- I pick a few
mutual funds that have established track records, solid management and reasonable fees,
and let
managers who are better informed and probably smarter than I am make those stock-buying
decisions.
Talking Heads
Finally, I often see experts on CNBC or CNN saying that now is the time to take my money
out of
the stock market (because it's definitely, definitely going down), or that now is the time
to put all of
my money into stocks (because they are definitely, definitely going up). The problem is,
they are
making these recommendations at the same time. So I need to make a choice, which leads me
to
say … well, by now you know what I say. So I make the choice for dummies -- I do
neither. I
follow the strategy I started with -- broad diversification with a degree of risk that's
comfortable for
me. I do this with the knowledge that oscillating around a strategy can increase risk by
as much as
50% relative to sticking with a consistent investment policy.
Dumbness is Power
So there you are -- the investment strategy for dummies. Diversify broadly, let fund
managers do
your stock picking, and maintain a consistent direction. The odd thing is that research
shows that
investors who follow these dumb principles tend to achieve higher returns with less risk
than their
smarter counterparts. I think I feel a new slogan coming on -- "Dumbness is
Power!"
 Lummer's
Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
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