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"Generally Accepted Investment Principles"

     Individuals who invest their own money can turn to many sources for investment advice -- such as books, magazines, newspapers, mutual fund companies, and web sites. In an article entitled "Personal Investing: Advice, Theory, and Evidence" that appeared in the November/December 1997 issue of the Financial Analysts Journal, Professors Zvi Bodie, (Boston University) and Dwight B. Crane (Harvard University) examined whether individual investors tend to follow the advice offered in these sources. Bodie and Crane summarize this advice in a set of guidelines which they call "generally accepted investment principles":

  • Investors should establish an emergency fund invested in short-term safe assets and not held in retirement accounts.

  • Retirement funds should be invested primarily in stocks and long-term fixed-income securities.

  • The percentage of assets invested in stocks should decline as an investor ages. A popular rule of thumb is to subtract a persons age from 100 and invest that percentage of total assets in stocks.

  • The percentage of assets invested in stocks should increase with wealth because wealthy individuals can generally tolerate greater risk.

  • In general, tax-advantaged assets (municipal bonds) should be held outside of retirement accounts and only by investors in high tax brackets, while assets that are taxed more heavily should be held in retirement accounts.

  • All Investors should diversify their total portfolios across asset classes, and the equity portion should be well-diversified across industries and companies.

     The authors note that all the sources of investment advice that they consulted recognize that the optimal asset mix for a particular household might differ from the general mix they recommend because of the special circumstances or risk preferences of the given household. Time horizon, risk tolerance, income stability, and other factors influence asset allocation.

     In the study, the authors analyzed data from questionnaires sent to TIAA-CREF members. 4,622 questionnaires were sent and 1,503 responses were received, of which 916 included complete information. The authors concluded that on average, "participants in TIAA-CREF, people who on average are better educated and more experienced at managing self-directed retirement accounts than the general U.S. population," do appear to invest according to generally accepted investment principles.

     The authors state that their "findings suggest that, given enough education, information, and experience, people will tend to manage their self-directed investment accounts in an appropriate manner."

     For examples of the guidelines, the authors refer to the educational materials that can be found at the World Wide Web sites of TIAA-CREF, Fidelity Investments, and The Vanguard Group. The authors also refer to Bogle on Mutual Funds as a "good exposition of practical investment principles in book form."

     The term "Generally Accepted Investment Principles" derives from the term "Generally Accepted Accounting Principles" or GAAP, which refers to accounting standards or rules used in preparing financial statements. GAAP specify the type of information that should be included in financial statements and how that information should be prepared. Accounting standards and GAAP can differ significantly by country and define what accounting practices are acceptable and unacceptable. Professor Bodie coined the phrase "Generally Accepted Investment Principles" and is also one of the authors of INVESTMENTS (the leading investment text).

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