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Copyright © 2015 by Wesley R. Gray, PhD, Jack R. Vogel, PhD, and David P. Foulke. All rights reserved.
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Library of Congress Cataloging-in-Publication Data
Gray, Wesley R.
DIY financial advisor : a simple solution to build and protect your wealth / Wesley R. Gray, PhD, Jack R. Vogel, PhD, and David P. Foulke.
pages cm. – (Wiley finance series)
Includes index.
ISBN 978-1-119-07150-1 (cloth) — ISBN 978-1-119-12491-7 (epdf) – ISBN 978-1-119-12490-0 (epub)
1. Portfolio management. 2. Families–Economic aspects. 3. Wealth–Management. 4. Investment advisors. I. Vogel, Jack R., 1983- II. Foulke, David P., 1966- III. Title.
HG4529.5.G736 2015
332.024–dc23
2015013795
Cover Design: Wiley
Cover Images: Investment charts with laptop © Nonwarit/Shutterstock;
Market graph, dollars and calculator © iStock.com/Niyazz
For those investors looking to get empowered through education.
—Wes, Jack, and David
This book is a synopsis of our research findings developed while serving as a consultant and asset manager for large family offices. By way of background, a family office is a company, or group of people, who manage the wealth a family has gained over generations. The term family office has an element of cachet, and even mystique, because it is usually associated with the mega-wealthy. However, practically speaking, virtually any family that manages its investments—independent of the size of the investment pool—could be considered a family office. The difference is mainly semantic. For example, the term individual investor is often a reference to the head of a household who manages a family's assets. This “individual investor” is a de facto family office—no matter whether this individual investor manages a $10,000 portfolio or a $5,000,000,000 portfolio. The goal is the same as for even the largest family office.
There are benefits and costs to being a family office. The key advantage a family office or, by extension, any individual investor, has over so-called “institutional” investors, is the ability to make long-term investment decisions that maximize after-tax, after-fee risk-adjusted performance, without fear of a misalignment of incentives—those who own the money are the best stewards of the money. By contrast, a professional institutional investor, or “hired gun,” is crippled by a misalignment between the incentives of the owners of capital and those of the investment manager, who has a separate incentive to keep his job, which can create a shorter-term perspective that can conflict with a long-term perspective. The decision that maximizes the after-fee, after-tax, risk-adjusted returns on capital, while optimal for the owner of capital, is not always the optimal decision for a third-party investment manager.
The key disadvantages for a family office, or an individual investor, relative to an institutional investor, are the effect of taxes and a knowledge gap that is sometimes more closely related to perception than reality. But fear not; this book is meant to fill the knowledge gap by providing the reader with the tools to be successful and the confidence to minimize the use of “experts.” And taxes, while challenging, can be minimized by limiting trading activity, engaging in smart planning, and by following some of the simple rules we outline in this book.
Perhaps you are skeptical that you can manage your own wealth. After all, legions of wealth managers have probably told you repeatedly that you cannot. We are here to tell you that you can. We have been lucky to work with and learn from some superb family offices, and the people that run their organizations. The main finding from our experience is that complexity does not imply value—especially when talking about investments.
Many less wealthy investors are told that the mega-rich benefit from their access to arcane strategies, hedge funds, and private equity investments. We are here to tell you that this popular and widespread meme has been propagated by salesmen, not by evidence: access to overpriced, opaque, complex, tax-inefficient exposures typically managed by egomaniacs is not an advantage—it is a serious disadvantage!
What matters in investing are avoiding psychology traps and sticking to the FACTS (fees, access, complexity, taxes, and search), a framework we describe in Chapter 5. These simple concepts apply to everyone, not just the ultra-wealthy. The findings of this book are therefore applicable to the middle-class as well as to the mega-rich. Attempting to maintain and grow wealth accumulated over a lifetime is a task that is equally daunting for both individuals and for big name family offices.
Our natural inclination is to succumb to the challenge of portfolio management and let an “expert” deal with the problem. For a variety of reasons we discuss in this book, we should resist this urge to go with our gut instinct. We suggest that investors maintain direct control, or at least a thorough understanding, of how their hard-earned wealth is managed.
Our book is meant to be an educational journey that slowly builds confidence in one's own ability to manage a portfolio. In our book, we explore a potential solution that can be applicable to a wide-variety of investors, from the ultra-high-net-worth to middle-class individual, all of whom are focused on similar goals of preserving and growing their capital over time.
We have had enormous support from many colleagues, friends, and family in making this book a reality. We thank our wives, Katie Gray, Meg Vogel, and Eliza Foulke for their continual support and for managing our chaotic kids so we could write our manuscript. We'd also like to thank the entire team at Alpha Architect, for dealing with the three of us while we drafted the initial manuscript. Tian Yao, Yang Xu, Tao Wang, Pat Cleary, Carl Kanner, and Xin Song—we are forever indebted! We'd also like to thank outside readers for their early comments: Sam Lee at Morningstar, Ben Carlson at AWealthofCommonSense.com, and Sam Taylor at Fidelity Investments. Finally, Edward Stern and his team at Hartz Capital, and Bob Kanner and his team at PUBCO, have been invaluable mentors in our endeavor to understand how one should operate a family office.
This book is organized into two parts. Part One sets out the rationale and evidence supporting simple, systematic processes. We begin by questioning society's reliance on “expert” opinion. Highlighting the evidence behind the performance of expert opinion, we explain why experts are self-interested and (surprise) are prone to the same behavioral biases that afflict all human beings. Finally, we highlight that experts often rely on stories, not facts.
Part Two outlines how individual investors, managing from $50 thousand to $5 billion, can beat the experts. We outline the reasons why a do-it-yourself (DIY) approach makes sense. Next, we outline various asset allocation frameworks and explain why a simple approach is probably most effective. Next, following this discussion, we explore simple evidence-based risk-management concepts, which help a DIY investor avoid large losses when investing his capital. Next, we outline ways in which a DIY investor can develop a systematic approach to add value to his equity portfolios by incorporating simple value-based and momentum-based security selection techniques. We then highlight techniques to implement approaches to momentum-based security selection processes. We move on to simple asset allocation frameworks, and we end with a discussion of simple, evidence-based risk-management concepts. Finally, we end Part Two by integrating the knowledge discussed on asset allocation, risk-management, and security selection into a full-fledged investment program with an overview of what we believe to be a reasonable DIY Financial Advisor solution.