"The investor's chief problem -- and even his worst enemy -- is likely to be him self" -- Benjamin Graham (1894 - 1976)
Since there are so many variables to consider in determining a prudent asset allocation, I've broken the conclusion of my "Invest Like a Philosopher" series into three asset allocation model portfolio posts: (1) The "Rote Model," which is for people who want (or need) the most rational, passive approach to investing; (2) The "Balanced Model," which is inspired by the age-old philosophy of moderation on many levels; and (3) The "Socratic Model," which requires active management and is built upon a sophisticated investor's natural tendency to question mainstream thought and popular trends. If you are a student of philosophy, you will notice that the names of my models are based upon philosophical ideals and educational methods of teaching and learning. What a surprise!
In education, The Rote Method of learning is essentially the "memorize and regurgitate" method most teachers use in Kindergarten through 12th grade. For example, the student may be required to memorize dates or mathematical equations. This is definitely not a "self-teaching" approach. Applied to investing, my Rote Model portfolio is appropriate for the average individual because of its simplicity and passive nature. As with the rote method of teaching and learning, there is primarily one "right" answer and no openness to discussion or questioning the method -- the student does as the teacher says.
Most people would not consider themselves as "investors." They consider themselves as "savers." In financial terms, the word investor connotes active management while saver connotes passive management. With that in mind, a philosopher, aware of their own ignorance and need to focus their valuable time and resources on their true passions, will make their investing experience as simple and logical as possible to remove themselves from "active management" of their own portfolio.
My Rote Model portfolio requires no real "allocation," in the true sense of the word, on the part of the individual. The investor will select only one "life-cycle" fund, which is identified by a "target date" or year that is closest to the individual's investment time horizon, which is typically retirement. The individual will invest current and future dollars into that one life-cycle fund, which will, in turn, be allocated by a professional fund manager that will invest the dollars in a way that is appropriate based upon the "target date" of the selected life-cycle fund.
I am partial to Vanguard's Target Retirement Funds because they invest only in index funds -- the ultimate low-cost, passive approach. For example, if a 45-year old investor thought they may retire in 15 to 20 years from today, they would select the Vanguard Target Retirement 2025 fund, which ultimately spreads assets among several index funds representing diverse areas such as foreign and domestic stocks ranging among all capitalization sizes (large, mid, small), as well as bonds and cash. The fund manager will also slowly shift the assets more conservative (toward bonds and cash) over time as the target date approaches and even after that date passes. All the while, the investor never lifts a finger or spends even one minute studying the financial markets! The only decision on the part of the investor is the amount to invest...
Not only does my Rote Model provide the ultimate passive approach, it almost completely removes an investor's greatest enemy (themselves) from the asset allocation process. The most common and most damaging investor behavior is the tendency to buy into strength and sell into weakness. In other words, most investors get the "buy low, sell high" strategy completely wrong because of their human nature to "chase performance." In my personal experience as an investment advisor, I receive the most calls from clients in times of volatility. If they hold six diverse mutual funds, two may be performing extremely well, two may be performing "average," while the other two may be performing "poorly" (as a result of market performance, not management). Naturally, the client will want to move assets from the "poorly" performing funds into the funds performing "extremely well." Without my guidance as their advisor, those clients would most likely do exactly that -- buy high and sell low at precisely the wrong time.
To the contrary, if an investor uses a life-cycle fund, they would not actually see which underlying funds are doing well, average, or poorly -- they only see the aggregate performance of those underlying funds on their monthly statements expressed as one overall net return for one fund; therefore, the volatility (and, hence, the temptation to chase performance) is greatly reduced or even removed.
As you might imagine, I fully believe the average investor is best served by a "fee-only" investment advisor that uses the financial planning process to arrive at an asset allocation that is appropriate for the individual investor's unique risk tolerance, investment objectives, and financial situation. Absent that unbiased advice, an investor choosing to select their own investments should do so in a way that will protect them from themselves...
Stay tuned for the final two asset allocation models from my "Invest Like a Philosopher" series: The Balanced Model and The Socratic Model...
TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston. ACI specializes in retirement, investments, and comprehensive financial planning.
I want to ask about "buying model of investor". I'm a student of Industrial Management and doing graduated seminar, so I need this model to solve my problem. please, help me. Send your answer to my email. Thanks
Posted by: Sarah | September 13, 2007 at 12:16 AM