An extensive body of research supports passive and index investing as a proven, reliable long-investment strategy. Here we offer a brief overview of how this research applies to investors.
How Markets Work
Worldwide financial markets historically reward investors for the capital they supply. According to financial theory, capital markets in a free market economy accurately set securities prices so investors receive reasonable rewards for taking long-term risks.
While markets have grown more complex and sophisticated, they continue to offer a simple and powerful way for people to exchange value and improve their financial well-being. Entrepreneurs and investors meet in the capital markets. Investors supply capital with an expectation of receiving a reasonable return for its use, and this capital in turn fuels economic activity. Businesses compete for capital by offering higher returns, and investors compete with each other to find the most attractive returns. Competition quickly drives prices to fair value, ensuring that companies must offer returns in line with perceived risk.
When markets work properly, no investor can expect greater returns without bearing greater risk. These rewards do not come from choosing the right stocks or selecting the best time to enter and exit the market. Rather, investors are rewarded over the long-term with appropriate compensation for the level of risk they are willing to bear.
Passive Investment Strategy
For Cardiff Park Advisors and others committed to passively-managed index fund and ETF portfolios, the burden of creating returns is the responsibility of the market. This stands in opposition to active investment managers, who rely on research to predict market behavior and recommend specific investments.
Passively managed investment portfolios are built on the understanding that the market sets prices to compensate investors for the risks they bear. Passive portfolio management is a smarter strategy because it eliminates guesswork. It acknowledges that returns come from risk, and at least some risk is essential for long-term gain, but not all risks carry a reliable reward.
Cardiff Park Advisors counsels clients to diversify broadly through index funds and selected ETFs, taking only risks that bear compensation while avoiding those that don't generate expected return. Risks that can be eliminated may include holding too few securities, betting on particular countries or industries, following market predictions, or speculating based on rating services.
The idea is to hold as many stocks in as many industries and as many countries as reasonably possible. Index funds provide broad market coverage and promise optimal exposure to reliable dimensions of expected return at minimal cost to the portfolio. Certain costs of asset allocation are unavoidable, including transaction expenses, taxes and tracking error. With little to no trading once a portfolio is established, passive and index mutual fund and ETF portfolio managers like Cardiff Park Advisors offer a superior way to invest by reducing costs that penalize long-term expected returns.
Index mutual fund and ETF managers design strategies to closely approximate the performance of well-recognized market benchmarks. They buy and hold stocks in the same proportions as they exist in the market or particular market sub-category; for instance, the S&P 500 index (large U.S. companies), the Russell 2000 Index (small U.S. companies) or the Morgan Stanley “EAFE” index (large international companies). Other well-known indexes measure small company stocks, high-book-to-market company (value) stocks, emerging market stocks, foreign stocks, real estate securities, precious metals, gold, commodities and an array of taxable and tax-exempt fixed income strategies.
Passive and index mutual fund and ETF investment advisors build portfolios based on proven principles of asset allocation, using low-cost index funds. Index funds offer the advantages of low operating and trading expenses, excellent diversification within asset categories, and broad access to all segments of the market. The result is a portfolio with hundreds or even thousands of securities.
The tremendous growth in the use of index funds serves as tangible evidence that money management today is being transformed, moving away from attempts at market timing and stock selection to the wider and more important context of asset allocation and diversification. Rather than trying to out-research other market participants, passively managed index fund investors look to asset class diversification to manage uncertainty and to position for long-term growth in the capital markets. For passively managed index mutual fund and ETF portfolio managers like Cardiff Park Advisors, the objective is to devise appropriate long-term strategies that will move investors toward their financial goals with the least amount of risk. These strategies do not fight the capital markets with the goal of trying to beat them. Instead, they work intelligently with capital markets to appropriately manage risk and build long-term wealth.
For more information about Cardiff Park Advisors please review our brochure at https://adviserinfo.sec.gov/firm/summary/126752 or visit www.cardiffpark.com