Match Your Investment Personality with the Corresponding Investment Strategy

Each Investment Personality requires a specific Investment Strategy.

If you have a Hands-Off Investment Personality, you aren’t going to want to read the Wall Street Journal every morning, track the Federal Reserve’s decisions, and perform regular research on your investments. Likewise, if you have a Consumed Investment Personality, there’s no way you’re going to be comfortable reviewing your investments once a quarter or content making an investment decision without doing a sizable amount of research.

Each Investment Personality has a corresponding Investment Strategy. You’ve got to do what’s right for you and what feels most comfortable for you. If your Investment Strategy is inconsistent with your Investment Personality, you will experience anxiety and discomfort and may ultimately feel so frustrated that you quit investing.

Hands-Off Investment Strategy

Summary

If you have a Hands-Off Investment Personality, you need a strategy that provides a simple and straightforward approach to investing. The Hands-Off Investment Strategy uses only Lifecycle mutual funds. These kinds of funds are offered by almost all fund companies including Fidelity, Vanguard, and many others and can also be called Lifecycle, Target Date, or Target Retirement funds (throughout the book, they will be referred to as Lifecycle funds).

A single mutual fund purchase is all that is required for immediate diversification across bonds, stocks, and the various asset classes. Lifecycle funds have target dates that can be matched to your desired goal date. As your goal gets closer, these funds automatically allocate to a more conservative portfolio. The Hands-Off Investment Strategy takes all of the guesswork and research out of investing.

Advantages

• It’s simple. If you think investing is confusing and overwhelming, and you want little to do with it, you are going to be pleasantly surprised at just how easy it can be with the Hands-Off Investment Strategy.
• It’s easy to create. Not sure where to start or what to do? The Hands-Off Strategy is truly that — Hands-Off! All you need to do is buy a Lifecycle fund with a target date that most closely matches your goal. That’s it!
• It’s easy to monitor. Forget about asset allocation, the economy, studying the stock market, rebalancing your account, diversifying, and learning which funds to buy. Setting up and monitoring your investments will take about as much time as it takes you to read this sentence.
• It’s good enough for many investors. At the end of the day, the Hands-Off Investment Strategy is good enough for most investors who don’t have the time, skill, or desire to be more involved in their investments. In fact, even if you want to be more involved, once you learn how easy and straightforward this strategy is you might be hooked!

Disadvantages

• It’s more expensive. The Hands-Off Strategy is not the most cost effective investment strategy. Most Lifecycle funds charge at least 1% of the amount you have invested per year in investment management fees and some charge additional fees.
• You see the lowest possible return. If you use this strategy, there is a good chance that you won’t do as well compared to the Involved or Consumed Strategy. This doesn’t mean that you won’t have good return over time, it simply means you won’t do as well as the others. However, you’ll still probably do better than the average investor.
• It’s tax inefficient. Because of the nature of the Hands-Off Investment Strategy, this approach is the least tax efficient. That doesn’t matter in a tax-deferred account, but it can make a difference in a taxable account.
• It’s the least flexible of the strategies. This strategy offers virtually no investment flexibility. You buy one diversified mutual fund and hang on to it. There aren’t any choices.

If you know deep down you are a Hands-Off investor but aren’t happy with the list of disadvantages to this Investment Strategy, you have a couple of choices. One, you can disregard your Investment Personality and try to use the Involved or Consumed strategies. This is what most investors do and it is a mistake. Not only will you be frustrated and overwhelmed, your investment performance will suffer because your heart (and head!) will not be in it.

A much better alternative is to take advantage of the benefits of the Involved or Consumed strategies by “outsourcing” the work to someone else. There are few alternatives if you decide you want to do this. You can hire an hourly financial planner or a fee-only financial planner.

Involved Investment Strategy

Summary

This strategy provides a great deal of control over the investment allocation, but no control over the investments that make up the allocation. Only low-cost index funds are used to build a portfolio. Instead of buying one fund and having no control over the allocation as in the Hands-Off Investment Strategy, the Involved Investment Strategy has the flexibility to create a customized allocation by purchasing a blend of index funds. You are responsible for creating the right mix of stocks, bonds, and cash in your account for each of your goals. As you get closer to achieving your goals, it is your responsibility to re-allocate to make the accounts more conservative.

This approach requires some initial involvement to create the individual allocations for each account and ongoing participation as you re-allocate over time, but is much less time consuming than the Consumed Investment Strategy because you don’t have to research or compare individual stocks, bonds, or mutual funds since all you will be using are low-cost index funds.

Advantages

• It’s low cost. Because you are only using low-cost index funds, this approach is the least expensive. Most index funds charge an annual expense ratio of less than 0.50%.
• It gives you more flexibility. This strategy lets you have complete control over the investment allocation for each of your accounts. You can overweight small-cap stocks if you think they are going to do well and underweight international bonds if you think they are overvalued.
• It’s tax efficient. The Involved Investment Strategy is tax efficient for two reasons. First, index funds naturally have a low-turnover ratio (percentage of investments in the fund that are bought and sold in year). This helps limit and avoid short-term and long-term gains. Second, you are able to tax-loss harvest throughout the year.
• It’s easy to compare performance. Since you are using index funds that aim to match an investment benchmark, the performance for each asset class should be the same investment return as the “market.”

Disadvantages

• It’s more time consuming to create. Greater control requires a greater commitment of time from you. To create individual allocations for each of your investment accounts, you need to determine an appropriate blend of stocks, bonds, and cash.
• More ongoing work is required. This is not a buy and hold strategy—it requires regular rebalancing and re-allocating to a more conservative mix of stocks, bonds, and cash as you get closer to achieving your goal. If you neglect the ongoing work, it can derail your chance of achieving your goals.
• It’s impossible to beat the market. Since you are only using index funds that match a benchmark, you can’t, by definition, do better than the market.

Like the Hands-Off approach, if you are not happy with the disadvantages of the Involved Investment Strategy or just don’t have the time to dedicate, you really only have two options. One, you can disregard your Investment Personality and try to use the Consumed strategy. This is what most investors do and it is a mistake. Not only will you be frustrated and overwhelmed, your investment performance will suffer because your heart (and head!) will not be in it.

A much better alternative is to take advantage of the benefits of the Involved or Consumed strategies by “outsourcing” the work to someone else. There are few alternatives if you decide you want to do this. You can hire an hourly financial planner or a fee-only financial planner.

Consumed Investment Strategy

 Summary

This strategy provides the greatest amount of control over the entire investment process. Not only do you control the investment allocation, but you also control the specific investments that make up the allocation.

Like the Involved Investment Strategy, you are responsible for choosing an appropriate mix of stocks, bonds, and cash for each of the accounts initially and for re-allocating the accounts as you get closer to reaching your goals. Unlike the Involved Investment Strategy where the only investment options are index funds, the Consumed Investment Strategy uses both low-cost index funds and actively managed mutual funds.

The use of actively managed funds adds a whole new level of commitment and responsibility. There are thousands of actively managed mutual funds from which to choose. Where do you start? For the Consumed Investment Personality, this is what it’s all about. It takes a significant time commitment, but you have the ability to do better than the Hands-Off or Involved Investment Strategy.

Advantages

• You get the best possible return. This strategy has the greatest chance to produce the best return because it uses actively managed funds. This advantage is what drives the Consumed Investment Personality.
• It provides the greatest flexibility. The Consumed Investment Strategy provides the greatest degree of control—both the investment allocation and the investments are under your complete control.
• It’s tax efficient. Like the Involved Investment Strategy, this approach can be highly tax efficient for the same two reasons. You’re using index funds with low-turnover ratios (percentage of investments in the fund that are bought and sold in year), which helps limit and avoid short-term and long-term gains and you’re able to harvest losses throughout the year to offset gains.

Disadvantages

• It’s the most difficult to create. You can’t get something for nothing. The high amount of control and flexibility comes with a price. This strategy is the most time consuming because you have to create the overall allocation between stocks, bonds, and cash for each account and have to select the individual investments for each asset class.
• It’s the most time-consuming to monitor. The “buy it and forget it” approach that works so well with the Hands-Off Investment Strategy does not work with the Consumed Investment Strategy. To do this well, you must continuously monitor the actively managed mutual funds against dozens of criteria. In addition, you have to rebalance and re-allocate each account as you get closer to reaching your goals.
• It’s not the most cost-effective. This strategy is not the cheapest. Using actively managed mutual funds increases the overall cost because they charge a higher investment expense fee. According to Morningstar, the average actively managed stock mutual fund costs 1.40% of the amount invested per year compared to the average stock index fund of 0.85%. Of course, if you choose good actively managed mutual funds, you can make up for the higher fees with better performance.
• Bad habits may affect your investment return. The more control you have over your investments, the greater the potential for problems such as trying to chase hot asset classes or funds, trying to time the market, over trading, or making investment decisions based on emotional reactions.

What do you do if you really want to be involved but just don’t have the time? I suggest reading the Hands-Off and/or Involved Investment Strategy, which might be better for someone that is as time-constrained as you.

Again, one strategy isn’t better or worse than another. The best strategy is the strategy that most closely matches your Investment Personality. Don’t get caught up in the advantages or disadvantages of each strategy, just focus on the strategy that applies to you. 

The proceeding blog post is an excerpt from The Six-Day Financial Makeover: Transform Your Financial Life in Less Than a Week!, available now on Amazon.