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The Elements of Investing

Simple Indexing

Simple Indexing has been around for more than three decades. It is now as common as pizza

The vast majority of us will do better owning index funds because index investing will give us a higher return than most of the more expensive managed alternatives. Eureka!

Skeptics should visit Standard & Poor’s Web site. If you do, you can download its regular SPIVA report, otherwise known as the Standard and Poor’s indices versus active funds scorecard. In a recent report, its analysts found that over the trailing five-year period, a majority of active equity and bond managers in most categories failed to beat their benchmark indicies.

Managed funds fail to beat simple index funds. Time and time again.

While the percentages change from quarterly report to quarterly report, the pattern is constant. Don't bet your future on picking fund managers. If so… you're playing a loser’s game. We invite you to play a winner’s game.

Simple Diversification

Let’s talk about simple diversification. Better known as “don’t put all your eggs in one basket.”

You’ll do better in a variety of assets because one will surely be going up when another is going down. Yes, successful investing requires more than taking risks to get an expected return. It also means reducing risks that aren’t working

Avoidable risks include holding too few securities, betting on countries or industries, following market predictions, speculating on “information” from rating services, and chasing returns. To all these, diversification is the antidote. It washes away the random fortunes of individual stocks. It positions your portfolio to capture the returns of broad economic forces. It is the smarter investor’s play.

Adding simple diversification into our portfolio’s design means that the positive performance of some investments will neutralize the negative performance of others.

The portfolio that holds both has not only provided a higher historical return than either alone, but it has done so with fewer negative quarters.

Smart Indexing

Researchers Eugene Fama and Kenneth French have shown that we can get higher returns if we build portfolios with value stocks (priced at low price-to-book-value ratios). They also found we get higher returns with small-capitalization stocks. According to Ibbotson Associates, for instance, large-company stocks returned 10.4 percent, compounded annually, from 1926 through 2005. Small-company stocks provided 12.4 percent.

The higher return was not a free lunch: You got it only by surviving some catastrophic declines.

A tilt toward value stocks does much the same. Over the long term, the bargain hunters have always prevailed over the hyper-ventilators. Today, smart index funds are abundant, either as mutual funds or exchange-traded funds (ETFs). (We have chosen to use Dimensional Fund Advisors, a fund organization founded on the very best academic research.)

Smart Asset Allocation

The first three elements are pretty easy. No rocket science required. The fourth step, Not so easy.

It is constructing a portfolio that gives you the highest return with the least risk. It can be done with a technique called mean variance optimization, which is close enough to rocket science to have won its creator, Harry Markowitz, a Nobel Prize in 1990.

Today, a number of software venders sell optimization packages. Unfortunately, having the tool and getting reasonable results isn’t the same thing. Ah, the difference between a salesmen and a scientist. Many would do better with an Ouija ™ board than with an optimizer. Yes, many advisory firms talk about optimizing. But few actually do it.

We've got this down to a science.

Drumroll please… our value proposition to you. It’s a pre-constructed, risk-measured portfolios based on your risk tolerance, time horizon, investment needs and goals. Together, let’s select the smart one for you.