Tuesday , 25 October 2016

What Are Your Investment Default Settings? Don’t Forget These Crucial Ones

There is a crucial component of the investment process that gets surprisingly littleinvesting-7 attention:  our investment default settings.  We can use them when we aren’t sure what to do, when we’re deciding what to do, when our circumstances have changed but our plan hasn’t (yet), or when we’re just starting out. Here they are.

So says Bob Seawright (rpseawright.wordpress.com) in edited excerpts from his original article* entitled Establishing Your Top 10 Investment Default Settings.

[The following article is presented by  Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com and www.munKNEE.com and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]

Seawright goes on to say in further edited excerpts:

The idea here is that we all have default settings — known and unknown, acknowledged and unacknowledged — and that those defaults greatly influence how successful we are and become…

What follows are my suggested default settings:

1. Save

One of the keys to overall success is the ability to delay gratification.  Saving is crucial to developing that ability and imperative for anyone who wants to acquire and grow wealth.

As investors, we tend to spend far more time on rates of return than savings rates.  We shouldn’t.  Beginning to save early, doing it consistently, and saving more are far more important over the long-term….As shown below, 15% seems to be a bare minimum savings rate with respect to retirement assuming 30 years of work.  I suggest 20-25% as your default savings rate.  I recognize that there are often multiple goals for saving (e.g., retirement, a house, children’s education) that are often in tension with each other and I also recognize that saving aggressively isn’t easy, but living with the consequences of not saving is far rougher.  Investment success requires saving, saving consistently and saving aggressively.


2. Invest

…In the aggregate, cash generally produces negative real returns, thus holding more cash than would be needed as an emergency fund represents a major opportunity cost…”[i]n an ideal world, we could meet our future financial needs by investing in safe, liquid, short-term assets. Unfortunately, we don’t live in that world. To generate real returns, an investor needs to take on some risk.” …Have an investment plan, implement it and stick to it.  Even if you don’t have a good plan yet, don’t wait to get invested.

3. Invest Passively

In the aggregate, passive investing will outperform active investment on account of lower fees.  Passive outperforms active more specifically too and, in any given year, roughly 65% of active managers underperform…I believe that active management has a place, even a very important place in an investor’s arsenal of weapons, but the numbers suggest that passive investment be your default setting.  Indeed, the vast majority of investors would improve their lot considerably by switching to a passive portfolio of low-cost index funds and sticking with them.

4. Invest 60/40 in Stocks & Bonds

Asset allocation is a really big deal.  Your asset mix — how you spread your money across stocks, bonds, other investments and cash — has a far greater impact on long-term returns than your individual investments.  For many years a portfolio consisting of 60% stocks and 40% bonds has been seen as the traditional or typical portfolio.  An American investor with a 60/40 allocation (there are many ways to do this, of course) has received an average annual return of around 8.5% historically.

Advisers have been increasingly turning away from the 60/40 portfolio in favor of less traditional asset allocations…[as the] performance of the 60/40 portfolio over the next 10 years will likely underperform on account of high stock valuations and low bond yields today…[In addition,]research examining the performance of various assets…shows [in the past] that nearly all asset classes posted losses at the same time that stocks were plunging…but the raw data supports the idea that maintaining a basic 60/40 portfolio works well as an appropriate default setting, especially when effectively implemented.

5. Invest in Funds With Low Fees

It is axiomatic that all other things being equal, lower fees are better for investors than higher fees.   Indeed, ranking investment funds according to fees (with lower fees being more highly rated) provides the best indicator we have of future performance.  Fees matter, sometimes a lot.  Cheaper should always be the default option.

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6. Invest Tax Efficiently

Experienced money managers routinely argue that you shouldn’t “let the tax tail wag the investment dog”  and it’s true that a poor investment isn’t often salvaged by good tax treatment.  However, the difference between having a $1,000 gain taxed at the long-term capital gains rate of 20% versus the income tax rate of 35% would save the investor $150 before considering state taxes and without even using the top income tax rate or noting that other new provisions could hit investment income as well…

Taxes matter a great deal.  Moreover, tax efficiency has not generally hindered performance.  According to Lipper, for example, over the 10 years ended December 31, 2012, tax-managed large cap core stock funds returned an annual average of 5.82% after taxes while the entire category (which includes hundreds more funds) returned 5.71% after taxes.  Tax efficiency is the appropriate default setting.

7. Re-balance Your Portfolio

Re-balancing works and to a surprising degree.  Doing so as a matter of regular practice should be de rigueur.

8. Keep Your Investment Strategy Simple

…A simple, albeit less than optimal, investment strategy that is easily followed trumps one that will be abandoned at the first sign of under-performance. Keeping things simple should be an obvious default setting.

9. Stay the Course

We are all prone to behavioral and cognitive biases that impede our progress and inhibit our success.  We are prone to flitting hither and yon chasing after the next new thing, idea, strategy or shiny object.  Don’t do it.  One way to deal with these biases is to require a really good, data-based reason to change course. In a related matter…

10. Re-think Making Changes

Don’t be in a hurry to make changes even when you are convinced that they are warranted.  Losses on account of delay will almost always be out-weighed in the aggregate by more careful and thoughtful analysis keeping you from taking action too soon and without sufficient reason.


Your investment process should include:

  • intellectual curiosity,
  • the ongoing pursuit of knowledge,
  • the courage to communicate your views and findings openly,
  • remaining amenable to constructive criticism, and
  • a willingness to move in a different direction if and when the evidence demands it (but not before) and especially if the truths uncovered are at odds with conventional wisdom.

Starting with the appropriate default settings can help you get started and keep you headed in the right direction.

Do you have other or different investment defaults to suggest? Comment below.

[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]

* http://rpseawright.wordpress.com/2013/02/05/establishing-your-top-10-investment-default-settings/

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