Investment Philosophy

Let’s be blunt: Over the past thirty years we have studied the conventional wisdom, we have put it to the test, and we have rejected it. Our investment philosophy is based upon reason and academic science. Essentially, we believe that in order to enhance returns, it is best to focus upon the drags to returns that we can control: risks, costs, taxes, and mistakes.

Financial Plan Inc Returns Infographic
  • ⇧ Returns:

    Future investment returns are unknown and past returns are useless as a criteria in investment selection.
    Conventional wisdom tells us that a skilled financial expert who is in tune with the economy and markets can develop a useful market outlook and can have some success in predicting future returns of stocks. Clients expect their advisors to make forecasts, but at Financial Plan we adhere to the the efficient markets hypothesis, meaning that we do not believe that anyone knows the future price direction or magnitude of any security or market. We console ourselves with the fact that neither does anyone else!

    In our professional opinion, the way to enhance returns is to eliminate the factors that drag them down: Risks,  Costs, Taxes, and Mistakes.

  • ⇓ Risks:

    Certain investment risks add to expected long run returns, others do not.

    Conventional wisdom says that the more risk an investor takes, the higher the expected return. We disagree. Although it is true that some risks may lead to increased returns, there are others that do not, and at times the higher risks cause permanent loss. For example, the risks associated with investing in single issue stocks (versus baskets of securities such as mutual funds and ETFs) do not add to expected returns, and can cause permanent and complete loss. The risks associated with market timing and leverage also do not add to risk adjusted expected returns. However, we utilize various dimensions that do indeed add to returns.   To learn about these dimensions of return, read more about the three factor model.

  • ⇓ Costs:

    Certain investment costs are worthwhile, others are a waste of money.  Higher costs correlate with lower returns.

    Active managers trade based upon stock analysis, which can be quite expensive and may erode returns due to high transactions costs and increased expense ratios. Active managers who time the market tend to maintain high cash positions from time to time. A high cash position may erode returns over long time periods, and creates an opportunity cost called cash drag. Read more about active versus passive management. Other financial strategies involve charging commissions for the purchase and sale of securities. Commissions can sometimes create harmful conflicts of interest between advisors and their clients, and in some cases (especially in regard to annuities, life insurance, and limited partnerships) commissions can be extremely damaging. Read more about commisioned security sales versus fee based advice. We believe that it makes sense to pay a fair fee for ongoing financial planning advice if the fee is transparent and the advice is objective. We believe that high costs are a detriment to investors, and every effort should be made to eliminate costs which do not pay for a commensurate benefit.

  • ⇓ Taxes:

    Certain income tax strategies are worthwhile, others are not.

    Investors today do not take advantage of the tax laws to the fullest extent possible. For example, many do not take full advantage of Roth IRA conversion and recharacterization rules and are unaware of the  tax rules surrounding Health Savings Accounts.  Some accountants tend to focus completely upon the current tax return, ignoring the strategies that are designed to reduce taxes in the future. Some investors have not achieved tax balance in their portfolios, thus exposing themselves to high tax bracket risk. Finally, some are paying high taxes because of high turnover in their traditionally managed mutual funds. The turnover in our selected domestic equity funds is much lower than that of tradtional funds.*

    To learn more, read about why we partner with DFA.  We believe that investment decisions should be made only after the tax impacts have been considered, and that a careful evaluation of the various tax strategies is beneficial.

  • ⇓ Mistakes

    Behavioural mistakes are perhaps the biggest drag on returns.  Investors are plagued with cognitive and emotional biases, causing them to make irrational investing decisions.  For example, most investors tend to buy high and sell low.  They follow the herd, they tend to overweigh evidence that comes easily to mind, and to emphasize recent experience too heavily.

    We serve as a behavioral coach to our clients,  helping them to avoid these mistakes and to stay on track.

Efficient Markets Hypothesis

The Efficient markets hypothsis (EMH) is an organizing principle for understanding how markets work and what investors should care about.

Active vs. Passive

Most mutual fund managers and advisors invest with an active approach. The profile of a hypothetical actively managed mutual fund reads as follows:

The Three Factor Model

Market prices reflect the aggregate expectations of market participants.  However, fairly priced securities can have different expected returns.

Sales vs. Fee-Only Advice

To an outside observer, all financial consultants appear to be in the same business. In the sense that they are all competing for the same investment dollar, it is true.

Learn More About our Investment Philosophy

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