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Rising Above The Noise
 

 
Investing can seem confusing at times, especially with the constant jargon and advice coming from investment professionals and the media. In reality, though, investing is not that complicated. It is simply a matter of making decisions under these basic guidelines:
  • you either believe in the ability to select superior investments or you don’t; and
  • you either believe in the ability to time markets or you don’t.

These guidelines can be used to identify an “investment decision matrix” comprised of four distinct “belief systems” of investors. Each investor subscribes to one of these belief systems as the basis for making investing decisions. Let’s explore further and talk about which system you should follow as a prudent investor.

The following table shows the investment decision matrix as four quadrants.
 
                              The Investment Decision Matrix

 

 

Market Timing

 

 

Yes

No

Security Selection

 Yes  

            1. Noise Quadrant        
  • Most individual investors
  • Financial journalists

 

2. Conventional Wisdom Quadrant

  • Financial planners
  • Stock brokers
  • Most mutual funds

No

3. Tactical Allocation Quadrant

  • Pure market timers
  • Asset allocation funds

4. Information Quadrant

  • Academics
  • 40% of institutional investors
 
 
The Noise Quadrant
 
Quadrant 1 is the noise quadrant. It’s comprised of investors who believe in both market timing and supe­rior investment selection. These individuals think that they (or their favorite financial guru) can consistently uncover mispriced investments that will deliver market-beating returns. They also deem it possible to determine when entire market segments are mispriced and predict when these segments will turn up or down.
 
The vast majority of investing approaches based on these beliefs fail to even match the market, let alone beat it, particularly after costs are considered. Despite this poor track record, most investors are in the noise quadrant. The quadrant is popular mostly because the media promote this way of think­ing in their drive to sell newspapers, magazines and television shows. For the media, it’s all about convincing you to return to them time and time again for information.
 
The Conventional Wisdom Quadrant
 
Quadrant 2, the conventional wisdom quadrant, is where most of the financial services industry resides. Most investment professionals know they can't predict broad market swings with any degree of accuracy, and that making incorrect predictions usually means losing clients. But they believe they can add value for their clients by relying on market analysts and portfolio managers with research staffs to find under-valued securities.
 
In an efficient capital market, this methodology adds no value on average. The results of study after study reveal that capital markets work. Competition drives prices to their fair value, making it difficult—if not impossible—for an investor to earn greater returns without bearing greater risk. Attempting to beat the market by finding pricing "mistakes" and predicting the future is generally costly—and futile.

The Tactical Allocation Quadrant
 
Quadrant 3 is the tactical allocation quadrant. Investors in this quadrant believe that, even though individual securities are priced efficiently, they (and only they) can see broad mispricing in entire market sectors. The quadrant 3 approach entails buying when a market is undervalued, then waiting until other investors recognize their mistake, and then finally selling when the market is fairly valued once again.
 
At Grand Wealth Management, we believe it’s inconsistent to believe that individual securities are priced fairly, but that the overall market, an aggregate of the fairly-priced individual securities, is not. Prudent investors don’t belong in quadrant 3.
 
The Information Quadrant
 
Now we come to quadrant 4, the information quadrant. This is where most of the academic community can be found, along with about 40 percent of institutional investors. Individuals in this quadrant dispassionately research what works and then follow a rational course of action based on empirical evidence.
 
Academic studies indicate that average net returns of the three other quadrants are lower than the overall market return. This is due to high fees and turnover, which results in additional trading costs and higher taxes.
 
Turnover is lowest in quadrant 4. In fact, quadrant 4 is where you’ll find most prudent investors—and it’s where we believe you should be. At Grand Wealth Management, we can help you make smart decisions about money—decisions that can lead you to permanent residency in quadrant 4 and maximize your chances of achieving your financial goals.
 
 
This article is adapted from our white paper, The Informed Investor: Making Smart Investing Decisions in Today's Volatile Market. The investment decisions matrix was developed by CEG Worldwide, LLC.


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