Investing: Is it an art or science? Or can financial planning be both?
Is investing an art or a science? This is an issue that vexes many individual investors and professionals alike.
If you view investing as being completely art, then you may see no clear path to successful investment returns. In that case, you might as well throw up your hands and view yourself as being subject to immeasurable, unpredictable and unknowable forces. According to this view, success would come to the lucky or the divinely inspired.
On the other hand, if you view investing as a science, you will likely end up disappointed that you couldn't control or predict outcomes as precisely as you could, say, chemical reactions in a laboratory. As a result, unexpected events cost you a lot of money.
So, the best answer to this unanswerable question is that investing is both art and science. It's science because there are good — but not foolproof — ways to identify factors affecting investment potential. If you have to pay high fees to investment managers or you fail to do adequate tax planning regarding your gains, these issues will always cut into total investment returns. Whether you will have gains, however, is another matter.
Investing would be more scientific if there were only one way to reach a given objective, but there are many routes to success with a given asset class. In this sense, investment is an art. For example, you can capture market gains through the right index funds or the right exchange-traded funds. Which is best depends on what other investments you own and how these investments fit into your overall strategy. These decisions require judgments that rely on creative insights.
Yet, unlike Da Vinci's "Mona Lisa," you don't want to bet your future on temporary inspiration. Don't be so artistic that you deviate from your long-term financial plan, because in investing, careful planning is everything — even if things don't always go according to plan.
Nor do you want an investment adviser to be too artistic with your life's savings. You want to know that financial science, not hype and hope, guides their recommendations regarding asset allocation and controlling risk.
Actually, controlling risk is a misnomer. You can't control or manage risk, only your exposure to it. Controlling risk is like controlling the weather; it's impossible.
This is an apt metaphor, because many issues in investing can be compared to the weather. Market movements can't be reliably predicted like the weather, and weather forecasts (viewed as a science) are themselves highly flawed for many of the same reasons that market forecasts are. Chief among these is that all factors can't be known, and if they were known, they couldn't be measured.
Like some weather, markets are ultimately random. If they weren't, they would be more or less predictable and, hence, investing could be viewed purely as a science. In that event, we'd be hiring market scientists instead of investment advisers and financial planners. And, with the certainties of science guiding their analyses, there would be an awful lot of successful investors. (This would be the opposite of the current state of affairs, in which many unsuccessful investors are effectively delivering wealth to the few successful ones.)
Scientific investment managers would be hitting the ball out of the park every day instead of the longstanding reality that the overwhelming majority fail to hit their benchmarks and, thus, don't earn their exorbitant fees.
But this doesn't mean that astute financial planners and individual investors can't find objective, time-tested ways to protect themselves from negative effects of the markets' randomness. Indeed, they can, by using institutional passive investments or generic index funds to capture the overall return of the market while decreasing their portfolios' risk by spreading their investment money over a wide variety of asset classes.
Another way to help improve total returns and address risk is to hire an investment manager who is a true fiduciary — one who has pledged, and is legally required, to advance your interests without even the appearance of a conflict of interest. Fee-based advisers collect fees and commissions from selling financial products. However, fee-only advisers are paid only for their advice and service to clients. Because they sell no products, such conflicts of interest don't exist.
Hiring a fee-only fiduciary adviser is a prudent choice that could be viewed as scientific. But the ways such advisers can build your portfolio involve creativity, insights, subjective judgment and objective analysis that can only be described as both art and science.
Tim Decker, a fee-only financial planner, is president of ISI Financial Group in Lancaster. He is the author of "The Sleep-Well-At-Night Investor" and host of the radio program "Financial Freedom," which airs at noon Saturdays on WHP-AM 580. Contact him at www.isifinancialgroup.com.
This content is based upon information believed to be accurate by ISI Financial Group Inc. However, it should not be relied upon for legal or accounting purposes. Past performance is not indicative of future performance. Investments involve risk, including the possible loss of principal. Always seek professional advice before making any financial or legal decisions.