How We Select Investments

When introducing evidence-based investing, we like to begin by explaining why we feel it’s the right strategy for those who are seeking to build or preserve their wealth in wild and woolly markets. Of course sensible strategy is best followed by practical implementation, so it’s also worth describing how we select the funds we typically employ.

Round One: Speculative vs. Evidence-Based Strategy
Our selection process is like a highly personalized, single-elimination tournament. We still consider the entire mutual fund universe and its thousands of possible contenders. But it’s relatively easy to eliminate the vast majority of them in the early rounds, with only the strongest surviving as viable candidates. In the first round, we want to eliminate speculative fund managers who are playing an entirely different game from what we have in mind.

Speculative: Speculative strategists try to forecast the upcoming performance of securities, sectors or markets and trade accordingly. Individuals may do this by gazing at funds’ “star” ratings or acting on seemingly hot tips from any number of sources. Fund managers may hire well-heeled analysts to probe the universe for secrets about to unfold, and issue buy, sell or hold recommendations accordingly. Either way, these are not exercises that are expected to beat the market, especially after the costs involved in trying.

Evidence-Based: Instead, you and your fund manager can simply hold the universe and be part of its expected expansion. Speculative fund managers may be working very hard at what they’re doing, but it’s an exercise that is more likely to detract from than benefit your goals of building and preserving durable wealth in volatile markets. (See my previous blog for more details on the importance of working with the markets)

By eliminating those who are engaging in speculative tactics from our recommended playlist, we can readily knock out a wide swath of would-be fund selections in the opening round.

Round Two: Indexed and Evidence-Based Strategies (A Complimentary Combination)
Once we disqualify speculative fund managers, that still leaves a relatively large (and growing) collection of funds that seek to efficiently capture various dimensions of the market’s expected long-term growth without engaging in seemingly fruitless and costly forecasting.  In this category, you’ll find two broad types of funds:

  1. Index Funds: Index funds track popular benchmarks such as the S&P 500 or the Barclay’s Global Aggregate, which in turn track particular market asset classes such as U.S. large-cap value stocks or global bonds.
  2. Evidence-Based Funds: Evidence-based funds seek to wring the highest expected returns with the least expected risk out of similar market asset classes in a more flexible, but still rigorously disciplined manner.

The goals of each are similar, mind you, making it harder to choose among these second-round contestants. Each emphasizes the importance of minimizing wasted efforts and maximizing the factors we can expect to control.

Still, all else being equal we typically favor evidence-based funds for the core of our clients’ portfolios. We feel they are structured to do an even better job at participating in relatively efficient markets over time. By being freed from slavishly following a popular index benchmark and similar restrictive parameters, they can focus directly on the fund management factors that matter the most according to what the evidence has to say on the matter. This includes most effectively capturing markets’ expected returns, while aggressively managing for market risks, minimizing trading costs and dampening some of the noisy volatility along the way.

Round Three: You AND Evidence-Based Strategy
Once we’ve narrowed down our fund choices to a manageable group, the final step is to match the best funds with the most important factor of all: you and your individual goals.

The specific fund choices and combination of funds depends on the specifics of your situation and in consideration of taxes, transaction costs and asset placement.

Bottom line, our final round typically involves forming the remaining contenders into a unified team that is optimized to reflect your unique goals and risk tolerances. Then, you must stick by your carefully constructed portfolio, not just for a game or two, but over the seasons of your life.

When we talk about fund selection, we deliberately emphasize the qualities that decades of empirical and practical evidence have indicated are worth pursuing over time. We explicitly downplay the more typical “play by play” reactionary antics. Star performers – their glittery victories and agonizing defeats – may be interesting to read about and may seem important. But we believe that the best investment selections are the ones that help you achieve your own hopes and dreams by keeping your financial footing on solid, evidence-based ground.

For more information about our investment philosophy, please follow this link to our Evidence-Based Investing Center or feel free to email me with questions.

 

 

1. Registration with the SEC should not be construed as an endorsement or an indicator of investment skill, acumen or experience. 2.This communication may include opinions and forward-looking statements.  All statements other than statements of historical fact are opinions and/or forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”).  Although we believe that the beliefs and expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such beliefs and expectations will prove to be correct.  Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements. 3. Historical performance is not indicative of any specific investment or future results.  Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss of income and/or principal to the investor. 4.Investment process, strategies, philosophies and allocations are subject to change without prior notice. 5. Nothing in this communication is intended to be or should be construed as individualized investment advice.  All content is of a general nature and solely for educational, informational and illustrative purposes. 6. Any references to outside content are listed for informational purposes only and have not been verified for accuracy by the Adviser.  Adviser does not endorse the statements, services or performance of any third-party author or vendor cited.

 

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES