09 Dec 2016 Your Resources Are Limited – Manage Them Efficiently
One of the most overlooked and yet most important aspects of long term investing is efficiency. The concept of efficiency touches our everyday lives in so many routine ways we take it for granted. We set the thermometers down or up when we are away to conserve money and energy use. We recycle to reduce the waste going to landfills and slow the drain on our natural resources. We are more gentle on the accelerator when gasoline prices are high. We might even think to remove unnecessary weight of stuff on the seats and in the trunk that serve no purpose in our daily commute.
Investing efficiency is loosely comparable to the examples above in that it refers to maximizing results with minimum inputs. But there are two other components that are illustrated above – risk and alignment. There is speculative investing, and there is conservative long term investing. Speculation has very little to do with the concept of efficiency. It is all about being in the right place at the right time with sufficient knowledge and skill to balance the risk against potential rewards. Speculative investing should be treated as a full-time, not a part-time vocation.
Rather, the kind of investing I’m referring to is what we typically refer to as college, retirement, and other long-term goal-oriented savings. Efficient investing here happens when our resources are optimally aligned to achieve the best results in three critical areas – dollars, time, and risk. It seems everybody advertises it, but few deliver. So how is efficient investing done?
First, let’s understand that there’s theoretical efficiency and there’s practical efficiency. We won’t get into the theoretical side other than to say that we believe the capital markets efficiently value stocks and bonds as news changes. We also believe that our model portfolios are efficiently designed to deliver maximum returns for each point along the risk continuum.
Today, I’m more concerned with the kind of efficiency that has a direct impact on our lifestyle, both today and in the future. So let’s take the critical aspects in order. There are three areas of investing that measured in dollars where efficiency is achievable: expenses, taxes, and under-performing benchmark capital market returns. But because of a huge philosophical divide between active and direct investing, many are precluded from achieving these relatively simple paths toward efficiency.
Direct investing is the most efficient way to harness the earnings potential of the stock and bond markets, known as the capital markets. Some refer to it as index investing, passive investing, or evidence-based investing. We call it direct investing because investors are able, through the purchase of exchange traded funds (ETFs), to invest virtually directly in huge numbers of companies and bonds with minimal management, at very low expenses and no unnecessary taxes. These funds are generally tied to large indexes or benchmarks that are reported on by CNBC and the evening news.
Active investing holds the premise that intelligent managers can concentrate their positions within the capital markets, getting into winners and out of losers before the crowd. There are several problems from an efficiency standpoint with this management style. Higher expenses are guaranteed to pay middle men and women to make decisions to move your money around along with the expenses of those transactions. Higher taxes are guaranteed for investments held outside of IRAs and 401Ks. Additionally, studies show that only 30-35% of managers actually beat their benchmarks over ten-year periods. And to make matters worse, winning managers are rarely the same each year. In short, investors employing the active style sacrificed the sure gains of efficiency in the hopes of out-performance – out-performance that must exceed higher costs, just to break even.
The next two components of investing efficiently, time and risk, require a good financial plan for measurement. Financial goals are targets (ranges really of acceptable to ideal) in our lives against which we weigh various inputs of resources to achieve maximum or optimal results. Simply put, one cannot measure efficiency in terms or timing or risk without measurable goals.
Timing in financial planning has many applications. One example might be the timing of savings. A young family generally has to focus scarce savings dollars on items of both physical and chronological importance – food, shelter, and perhaps some entertainment. Scarce savings dollars are likely devoted first to educating their children. There will be more income later as salaries rise and the kids are out of the house and sufficient time to meet retirement and other later-in-life goals.
As time marches on, our lives, values, and circumstances change. Without a plan with its defined goals and timing of them, there is no way to measure the impact of changes on the plan’s overall efficiency toward reaching not just the new goals, but all of them.
The final and perhaps most vital element of investing efficiency is risk. There’s lots of technical mumbo jumbo to define investment risk, like standard deviation, volatility, and correlation and the like, but our purpose today is to focus on practical risk. A plan is not efficient if the holders are going to be frightened out of it by misbehaving stocks and bond markets. A great financial plan integrally includes risk as a ‘resource’ that can be spent or reserved in combination with other resources like working longer or less, saving more or less, changing the timing or size of other important goals in order to achieve more important ones. We give our clients the ability to experience the impact, in real dollars, that varying degrees of risk will have on their portfolio during upcoming market downturns as they weigh using or withholding risk against other options.
Like any vehicle on a journey, once purpose and direction have been established, management of efficiency and confidence become the most important components of great financial planning and investing. You would be amazed to see what huge benefits you can realize in your future lifestyle with relatively modest tweaks today. In fact, that’s not a bad idea. Come and see.
Have a great weekend.
