Investing Strategies for Dummies

By Scott Lummer
401k Forum Chief Investment Officer

This week's question is:

I read many experts who seem smart and advocate a particular strategy. The problem is I don't know whom to believe. What experts do you follow?

In answering your question, first I have to admit that I recently had a revelation (something that doesn't happen very often -- maybe once a year, or twice in leap years). The revelation was that I am a dummy.

This happened at what may seem an odd place: a conference for investment advisors, where I was on a three-person panel speaking about asset allocation. To my left was a man I will call Kevin, and to my right was a man I will call Bob (I will call them that because those were their names).

Kevin was well prepared with a cornucopia of statistical information suggesting that investors should diversify out of larger, "growth-oriented" (meaning high price-to-earnings) stocks and into other investments, such as international, real estate, and bonds. When he was talking he seemed very smart.

Bob had no statistics, but he had a vision (and people with vision always seem smart to me -- that's probably why I spend so much time calling the Psychic Friends Network). Bob's vision was that investors should put ALL of their money in larger, growth-oriented stocks. When he was talking he seemed more than smart.

When it was my turn to speak, I said things that in isolation may have sounded good, but in retrospect could be best summed up in two words: "I dunno." That's when I realized that I am a dummy.

Confessions of a Dummy

I often hear people like Kevin and Bob articulately defending some policy or other that dictates putting one's money in a specific type of investment. Of course, unlike Kevin and Bob, most of them have a bias (when was the last time the World Gold Council advised people to sell all of their precious metals?). But even the impartial experts don't agree with each other, so I am forced to make a choice. But I can't. Faced with two diverging opinions, my honest opinion is "I dunno."

So I make the "dummy's" choice -- I diversify widely across several categories of investments: large companies, small companies, growth stocks, "value" stocks, international investments, and, potentially, bonds. I do this for two reasons:

1. I think this strategy will provide me with the greatest return over the long run.
2. Since I don't know what will be the best and worst performing asset classes, broad diversification provides the greatest safety.

Portfolio Envy

I also read about the hot stocks to buy. I must read about 50 "sure-winner" stocks per week -- either in a newspaper or magazine, or in a professional research report. If I bought every stock that was recommended to me and held onto it for a year, I would own 2,500 securities and my friends would suffer from portfolio envy.

But it would be impractical -- at best, I could only own 50 or 60 stocks without getting chewed up by commissions. So I am forced to choose among these well-founded recommendations, but (here we go again) my overriding thought is, "I dunno." So I make the choice for dummies -- I pick a few mutual funds that have established track records, solid management and reasonable fees, and let managers who are better informed and probably smarter than I am make those stock-buying decisions.

Talking Heads

Finally, I often see experts on CNBC or CNN saying that now is the time to take my money out of the stock market (because it's definitely, definitely going down), or that now is the time to put all of my money into stocks (because they are definitely, definitely going up). The problem is, they are making these recommendations at the same time. So I need to make a choice, which leads me to say … well, by now you know what I say. So I make the choice for dummies -- I do neither. I follow the strategy I started with -- broad diversification with a degree of risk that's comfortable for me. I do this with the knowledge that oscillating around a strategy can increase risk by as much as 50% relative to sticking with a consistent investment policy.

Dumbness is Power

So there you are -- the investment strategy for dummies. Diversify broadly, let fund managers do your stock picking, and maintain a consistent direction. The odd thing is that research shows that investors who follow these dumb principles tend to achieve higher returns with less risk than their smarter counterparts. I think I feel a new slogan coming on -- "Dumbness is Power!"

Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment Officer, is a recognized expert in the investment field. He has conducted extensive research on asset allocation, international investing, risk management, mutual fund analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook. He wants to know what's on your mind, so feel free to send him your questions about the stock market! He'll answer as many as he can in his weekly column.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Investing Strategies for Dummies

By Scott Lummer
401k Forum Chief Investment Officer

This week's question is:

I read many experts who seem smart and advocate a particular strategy. The problem is I don't know whom to believe. What experts do you follow?

In answering your question, first I have to admit that I recently had a revelation (something that doesn't happen very often -- maybe once a year, or twice in leap years). The revelation was that I am a dummy.

This happened at what may seem an odd place: a conference for investment advisors, where I was on a three-person panel speaking about asset allocation. To my left was a man I will call Kevin, and to my right was a man I will call Bob (I will call them that because those were their names).

Kevin was well prepared with a cornucopia of statistical information suggesting that investors should diversify out of larger, "growth-oriented" (meaning high price-to-earnings) stocks and into other investments, such as international, real estate, and bonds. When he was talking he seemed very smart.

Bob had no statistics, but he had a vision (and people with vision always seem smart to me -- that's probably why I spend so much time calling the Psychic Friends Network). Bob's vision was that investors should put ALL of their money in larger, growth-oriented stocks. When he was talking he seemed more than smart.

When it was my turn to speak, I said things that in isolation may have sounded good, but in retrospect could be best summed up in two words: "I dunno." That's when I realized that I am a dummy.

Confessions of a Dummy

I often hear people like Kevin and Bob articulately defending some policy or other that dictates putting one's money in a specific type of investment. Of course, unlike Kevin and Bob, most of them have a bias (when was the last time the World Gold Council advised people to sell all of their precious metals?). But even the impartial experts don't agree with each other, so I am forced to make a choice. But I can't. Faced with two diverging opinions, my honest opinion is "I dunno."

So I make the "dummy's" choice -- I diversify widely across several categories of investments: large companies, small companies, growth stocks, "value" stocks, international investments, and, potentially, bonds. I do this for two reasons:

1. I think this strategy will provide me with the greatest return over the long run.
2. Since I don't know what will be the best and worst performing asset classes, broad diversification provides the greatest safety.

Portfolio Envy

I also read about the hot stocks to buy. I must read about 50 "sure-winner" stocks per week -- either in a newspaper or magazine, or in a professional research report. If I bought every stock that was recommended to me and held onto it for a year, I would own 2,500 securities and my friends would suffer from portfolio envy.

But it would be impractical -- at best, I could only own 50 or 60 stocks without getting chewed up by commissions. So I am forced to choose among these well-founded recommendations, but (here we go again) my overriding thought is, "I dunno." So I make the choice for dummies -- I pick a few mutual funds that have established track records, solid management and reasonable fees, and let managers who are better informed and probably smarter than I am make those stock-buying decisions.

Talking Heads

Finally, I often see experts on CNBC or CNN saying that now is the time to take my money out of the stock market (because it's definitely, definitely going down), or that now is the time to put all of my money into stocks (because they are definitely, definitely going up). The problem is, they are making these recommendations at the same time. So I need to make a choice, which leads me to say … well, by now you know what I say. So I make the choice for dummies -- I do neither. I follow the strategy I started with -- broad diversification with a degree of risk that's comfortable for me. I do this with the knowledge that oscillating around a strategy can increase risk by as much as 50% relative to sticking with a consistent investment policy.

Dumbness is Power

So there you are -- the investment strategy for dummies. Diversify broadly, let fund managers do your stock picking, and maintain a consistent direction. The odd thing is that research shows that investors who follow these dumb principles tend to achieve higher returns with less risk than their smarter counterparts. I think I feel a new slogan coming on -- "Dumbness is Power!"

Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment Officer, is a recognized expert in the investment field. He has conducted extensive research on asset allocation, international investing, risk management, mutual fund analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook. He wants to know what's on your mind, so feel free to send him your questions about the stock market! He'll answer as many as he can in his weekly column.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.