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My investment philosophy is quite simple.

Most investors should utilize a passive investment strategy, with an emphasis on cost minimization and optimal portfolio diversification.

We have covered my reasoning for this in many posts leading up to today.

In short:

Passive Management

Most investors lack the expertise and experience of professional investors. Compounding this, the average investor does not have the time, access to information, and financial tools to compete against those who manage money for a career.

If it is extremely hard to beat the professionals, why bother?

Now you can hire professionals to manage your capital. But that can be expensive. Further, it is questionable whether professional money managers are able to outperform the market.

So why pay for asset management that probably will not add value?

These are the key arguments to invest passively.

Unless you have expertise in the investment field, or you possess specialized knowledge concerning niche markets, it is probably most prudent to take a passive approach.

Cost Minimization

Under passive management, the objective is to match market returns as closely as possible.

Part of the return relates to how closely the investment tracks the market. Tracking error, style drift, window dressing, and other factors can cause actual gross returns in the investment to deviate from the market’s return.

You need to monitor gross asset returns to ensure that it actually matches the market.

Part of the return relates to the costs associated with the investment. A market does not have costs associated with it. Its gross and net returns will be the same. But your investment may have a variety of costs. These include expenses for operations, transaction costs, interest, marketing, taxes, etc. The greater the level of costs, the lower the asset’s net returns, and the worse the asset’s performance as compared to the benchmark index.

Costs tend to be problematic for investors when attempting to match market returns. You always need to find the most cost-effective solutions for your investment needs. This relates to brokerage accounts, debt (if you are leveraging), transaction costs, and costs associated with the actual investment. It also relates to taxes owing on investment income.

Every dollar that is lost to third parties, is a dollar than cannot be reinvested on your behalf. As we saw in our discussion on compound returns, seemingly small amounts can grow significantly over time. Do not let your money grow someone else’s wealth.

Maximize your own capital by minimizing your investment costs.

Portfolio Diversification

A well-diversified portfolio will provide risk reduction benefits to your capital without degrading your expected returns.

How you diversify will be the result of the asset allocation.

Your asset allocation will be unique for you. It will be based on your comprehensive investor profile. Something that takes into consideration such issues as: life cycle phase; financial situation, investment objectives and personal constraints; risk tolerance, time horizon.

In addition to decisions on diversifying between asset classes, you also need to diversify within each class. This is because the risk-return profile of assets within a specific class may vary substantially from the general risk-return characteristics for the asset class as a whole.

Investments

Today there exists a multitude of low-cost passive investments that provide excellent diversification potential.

No-load index mutual funds and exchange traded funds are simple ways to achieve low-cost diversification.

The bulk of the investment portfolio should be in the core asset classes: cash equivalents; fixed income – bonds and preferred shares; common shares.

Within each core class there are many subclasses and investment styles to consider. Many of these will deviate from the general risk-return profile for the class as a whole. How you invest within a class will be based on your investor profile as well.

There are many other asset classes to consider. Often, these alternative assets can further diversify your portfolio. We will discuss a few of these assets in the future.

Next Steps

That covers where we are to date.

Hopefully it makes some sense by now.

Next we will start a look at how to construct a diversified portfolio.

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