We Apply Academic Research to Investing and Investments

At OpelKey Financial Advisors LLC (“OpelKey”), we go beyond conventional wisdom and only use investment strategies that have been proven successful through rigorous academic studies. “Beyond conventional wisdom” is quite appropriate because studies have consistently shown that traditional investing techniques (i.e., "conventional wisdom") tend to yield sub-par results both short and long term.

The strategies we utilize are consistent with the legally recognized Prudent Investor Rule.

To review many of the academic studies upon which the strategies are based, see the articles/papers in the Reading Room.

Below is a discussion of several investing concepts and OpelKey’s stance on them.

Asset Allocation refers to the allocation of a portfolio across asset classes. For example, one could allocate various percentages of their assets to each of the following asset classes: Large US Stocks, Small US Stocks, US Bonds, and International Stocks. Several academic studies have shown that, on average, over 90 percent of the variability of a portfolio’s performance over time is solely attributable to the portfolio’s asset allocation. Further, on average about 100% of the level of a portfolio’s total return (before investing expenses are subtracted) is due to its asset allocation. Therefore, the asset allocation decision is by far the most important in the financial planning process and should be made early in the process. OpelKey considers this decision to be central to selecting an appropriate investment portfolio. See Modern Portfolio Theory.

Diversification refers to spreading your investment over many asset classes and, within each asset class, over many individual assets. The old adage, “Don’t put all your eggs in one basket” applies. In fact, prudently selecting how to spread your portfolio can actually increase your expected long-term returns while decreasing your portfolio’s expected long-term risk/volatility. OpelKey portfolios typically are extraordinarily diverse, often representing tens of thousands of stocks and bonds (indirectly through mutual funds). See Mutual Funds.

Efficient Market Hypothesis ("EMH") refers to an explanation of market pricing. EMH suggests that, in a market where information is free flowing and where there are large numbers of rational, profit maximizing participants, stock prices always reflect all available information about each stock. An interesting corollary is that the market’s best guess at each stock’s future prospects is already “built into” the stock’s current price. Therefore, unless you are either smarter than the rest of the market (unlikely) or more lucky, there is no way of consistently outperforming it through fundamental analysis (or technical analysis — a.k.a., "charting"). That doesn't mean that there are no prudent investing strategies — it just means that fundamental analysis and technical analysis aren't among them. See Individual Asset Selection.

Growth Investing refers to a strategy of buying stock in companies which are expected to grow quickly. Growth stocks tend to be overvalued compared to the “book” value of the company. This is the opposite of value investing. Recent academic research has shown that value investing tends to give superior long term results with less long-term risk/volatility than growth investing. Therefore, OpelKey tends to recommend that growth stocks be somewhat underweighted in most portfolios (indirectly through mutual funds). See Value Investing.

Individual Asset Selection refers to selecting an individual asset to invest in (e.g., a specific stock or a specific bond). Conventional wisdom holds that this is a vitally important part of the investing process. Unfortunately, both theory (Efficient Market Hypothesis) and experience (empirical evidence) preclude the possibility of consistently outperforming a relevant market index.

Indeed, one can only know which stocks would be best to buy after the fact. There is VERY LITTLE CREDIBLE EVIDENCE that it is possible in the long run for anybody to successfully predict which individual investments will produce superior risk-adjusted results in the future. If it were possible, mutual fund managers would certainly be successfully and consistently doing it (i.e., not sporadically due to occasional luck). But the evidence is clearly to the contrary: in the long run, the average non-index mutual fund performs worse than the average equity in its investment universe after fees and expenses.

Buying individual stocks also makes it expensive and difficult, to say the least, to assemble an adequately diversified portfolio. OpelKey does not recommend that individual investors hold ANY individual stocks. See Efficient Market Hypothesis.

Indexing refers to investing in index mutual funds. Index mutual funds are a type of mutual fund which attempts to match its investments to those in an index. As an example, many index funds mirror the S&P 500 index. In other words, those funds invest in substantially all the individual stocks making up the S&P 500 index in substantially the same proportions in which the stocks are represented in the index. Studies have consistently shown that, in the long run, the average mutual fund tends to perform worse than the index which best represents its investment philosophy. This, combined with the fact that index mutual funds tend to be more highly diversified, have lower fees, and may be more tax-efficient than their non-index counterparts, makes them preferred vehicles for investment. Therefore, OpelKey almost exclusively recommends appropriate index mutual funds as the best way to implement an asset allocation in a portfolio. Principal indexes on which mutual funds are based include (but are not limited to): various S&P, Russell, Wilshire, MSCI, and CRSP indexes. See Mutual Funds.

Investment Time Horizon refers to the amount of time between now and when you expect to use the money from an investment. As an example, if one intends to buy a house in five years, their time horizon for that purpose is five years. Conversely, a 25-yr old person saving for their retirement has a time horizon of at least 35 years for those assets. It is usually appropriate for the amount of risk/volatility in one’s portfolio to be proportional to their investment time horizon. This is because, in the long run, one tends to be rewarded with higher returns if one accepts higher risk/volatility. But if one needs the money soon, one can less withstand the dramatic short-term downturns that are expected from more risky/volatile investments. OpelKey considers investment time horizon to be a central component in assessing an appropriate asset allocation. See Asset Allocation.

Market Timing refers to a strategy of buying stocks and other securities at the “right” time (i.e., when the price is low, ideally at its lowest point) and selling them at the “right” time (i.e., when the price is highest, ideally at its highest point). Unfortunately, one only knows the “right” time after the fact. There is no way of knowing in advance what is going to happen in the future. In fact, studies have shown that investors tend to have a knack for buying and selling at precisely the “wrong” times. There is VERY LITTLE CREDIBLE EVIDENCE that it is possible in the long run to successfully (and consistently) time investments or divestments in order to gain an advantage over other investors. In fact, attempts to do so usually have a detrimental effect on returns. OpelKey does not, therefore, attempt to time investing or divesting decisions in order to take advantage of perceived market-timing opportunities.

Modern Portfolio Theory (“MPT”) refers to an investment technique which suggests that each investment should be considered for its effect on the overall portfolio. A wisely chosen portfolio will tend to maximize expected long-term return for some value of risk/volatility or, equivalently, minimize risk/volatility for some expected long-term return. MPT is a Nobel Prize winning approach to investing (Harry Markowitz won the 1990 Nobel Prize in Economics for it). OpelKey uses MPT to assist in selecting appropriate asset allocations. See Asset Allocation.

Momentum Investing refers to a strategy of buying stock of companies which have performed well in the recent past. Academic research has shown that momentum investing tends to give superior long term results with less long term risk/volatility than investing in "the market". Further, this "momentum premium" tends to have a negative correlation with the "value premium", which makes momentum stocks a good diversifier for value stocks. Therefore, OpelKey is increasingly recommending that value positions be complemented with momentum positions.

Mutual Funds are investment vehicles whereby many investors buy shares in the fund, the proceeds of which are then used to purchase an array of individual investments (e.g., individual stocks or bonds). Mutual funds are the most efficient way for all but the largest institutional investors to achieve a diverse portfolio. OpelKey recommends mutual funds on the basis of their investment philosophy and low fees. If you pay high fees, your return will be less than if you pay lower fees, all else being equal. OpelKey does not recommend ANY mutual funds that charge ANY sales commissions (a.k.a., “loads”) and we avoid funds that charge 12b-1 fees. OpelKey currently recommends various mutual funds from Vanguard and DFA principally, but also selected funds from Bridgeway and others. See Diversification and Indexing.

Risk Tolerance refers to a person’s individual comfort level with various types of and levels of risk/volatility. In general, the investments which return the most in the long run tend to be the riskiest (i.e., they tend to have the highest levels of volatility). But a particularly volatile investment that one person may be completely comfortable with may prevent another person from sleeping at night (e.g., if the investment suddenly went down in value dramatically, as very risky/volatile investments tend to from time to time). Therefore, OpelKey considers assessing each client’s personal level of risk tolerance to be central to determining an appropriate asset allocation. See Asset Allocation.

Small Company Stocks have been shown to perform better over the long term than large company stocks, albeit at somewhat higher risk/volatility. Because of this, OpelKey usually includes small company stocks (indirectly through mutual funds) as a portion of our recommended portfolios.

Value Investing refers to a strategy of buying stock of companies which are undervalued compared to the “book” value of the company. This is the opposite of growth investing. Recent academic research has shown that value investing tends to give superior long term results with less long term risk/volatility than growth investing. Therefore, OpelKey tends to recommend that value stocks be somewhat overweighted in most portfolios (indirectly through mutual funds). See Growth Investing.

Every investor should have a highly diversified portfolio, constructed in order to maximize expected risk-adjusted after-tax long term returns, with risk levels consistent with their investment time horizon and their personal need, willingness, and ability to bear risk.