The Investment Answer

January 18th, 2015

The Investment Answer by Daniel C. Goldie and Gordon S. Murray front cover

In this quick 90-page primer for beginning investors, Daniel C. Goldie and Gordon S. Murray present five key decisions you need to make when starting out. They are:

  1. The Do-It-Yourself Decision
  2. The Asset Allocation Decision
  3. The Diversification Decision
  4. The Active versus Passive Decision
  5. The Rebalancing Decision

Should I do it myself or seek professional assistance?

With the first decision, the authors give examples of investor psychology at work, exhibited in bouts of overconfidence, attraction to rising prices, herd mentality, and fear of regret. They also expand upon the distinction described in Helaine Olen's Pound Foolish between brokers working for their firm, and fee-only advisors working for their clients, including revealing that a broker — not an advisor — may "change hats" when recommending different products, switching roles from faux advisor to broker — and therefore interests — at the drop of a hat. Outrageous!

Goldie is president of a registered investment advisory firm, and Murray accumulated 25 years of experience of Wall Street. As such, it's no surprise that they quickly arrive at the conclusion that individual investors need the services of professional money managers in order to survive in the market:

In today's world of global markets and complex financial instruments, professionals have access to superior resources. It is difficult for an individual investor to effectively put together and maintain an efficient portfolio that is properly diversified, minimizes fees and taxes, and avoids overlapping assets.

I strongly disagree. In my opinion, this disinformation will lead impressionable inexperienced investors, to whom this book is specifically marketed, toward professionals whose services are often overpriced and unnecessary. For instance, by investing in index funds, individual investors can easily maintain a diversified portfolio without overlapping assets, while simultaneously limiting fees and taxes.

How should my assets be allocated?

You can reduce your risk by investing in different kinds of asset classes, and the authors examine the concept of standard deviation and the impact of price fluctuations on returns.

Goldie and Murray limit themselves to discussing stocks and bonds. Later in the book, they actively discourage investors from delving into alternatives such as hedge funds, private equity, and commodities, due to the additional risk involved. Examining these in depth would probably only bewilder the beginning investor, so I feel they made the right choice here.

There's mention of inevitable years of 20 or 30 percent market declines, but no discussion of how one might alleviate some of the emotional strain caused by these setbacks, say through dollar cost averaging.

How do I diversify my investments to reduce risk?

Within each asset class, you can further reduce risk by spreading your investments based on company size, business sector, geography, etc, and using correlation to your advantage.

Some stocks are positively correlated, meaning when one goes up in price, the other usually does as well. An example would be the relationship between the stocks of Coca-Cola and PepsiCo.

Conversely, when the prices of two securities consistently seem to move in opposite directions, they are said to be negatively correlated. A company specializing in sun cream would be highly negatively correlated with an umbrella manufacturer.

Should I attempt to beat the market with an active approach, or mirror the market returns by going the passive route?

Active fund managers try to beat the market through timing and stock picking, bringing with it increased manager expenses. Additionally, repeatedly selling and buying securities results in the double whammy of increased turnover fees and imposing taxes upon any realized gains. As a result, the active manager must achieve gross returns considerably higher than those of the passive manager in order for their net returns to be equal.

In my opinion there's no reason to hire a professional to tell you something you can easily discover on your own using the Internet, especially when, as the authors themselves say, most fund managers fail to beat their benchmarks. Most of the useful tools available to money managers in today's digital age, are just as easily accessed by the individual investor on their own. You'd be better off educating yourself and cutting out the middleman.

When and how should I rebalance my portfolio?

Your securities going out of balance constitutes a threat to your investment strategy. Some rebalance at fixed intervals, eg. in January of every year. Others review their balance once a year but only take action if a position has strayed far enough to warrant rebalancing.

Rebalancing ensures that your portfolio continues to reflect your previously determined risk tolerance, but is psychologically difficult for investors because it involves selling your winners and putting money in the losing column. The authors present a nice alternative way of thinking about it:

Rebalancing is an automatic way to buy low and sell high, without your emotions getting in your way.

Conclusions

Here's a succinct, easily digestible manual which can be read in a few hours. The authors' points are eloquently presented and limited to the things the budding investor should concentrate on, nicely complemented by regular though not overabundant tables and graphs.

My one big caveat concerns their eagerness to steer beginning investors towards professionals. While the last four decisions are relevant whether you take the DIY path or put your trust in an advisor, the authors do multiple times allude to the necessity of consulting your advisor when making decisions, instead of making them yourself.

My advice would be to read the book for its clear advice on asset allocation, risk reduction, and rebalancing, but be wary of the direction in which the authors try to push you.

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