Investment Philosophy

Individuals who receive assistance with their 401(k)s earn 3.32% higher annual returns. Our 401(k) includes an automated investing service (optional) so employees can earn more for retirement and avoid confusing investment decisions. *Based on a 2014 study by Aon Hewitt and Financial Engines

Our investment philosophy follows best practices rooted in decades of academic research and espoused by the world's leading financial economists.
Investment advice provided by Captain Advisors LLC, an SEC registered investment advisor.

Invest today and take a long-term view

The Theory

The easiest path to wealth is to start investing early and consistently. Because of the power of compound interest, when you start investing can be as important as how much you invest. Someone who starts investing $390/month at age 25 can retire a millionaire — however, someone who starts investing at age 35 will need to save $825/month to achieve the same result ($1900/month for those starting at age 45).

Once you start saving, you should continue doing so regularly. The best way is to make it automatic — ideally by deducting savings directly from your paycheck so that the money is already invested before you have a chance to spend it (a concept called "paying yourself first").

It also helps to take a long-term view on how you invest the money you save. As we'll explain below, the investments with the highest long-term expected returns also vary the most from year to year, even losing money in some years. In order to maximize your investment gains, you must ignore short-term movements (even years in which you lose money) and instead focus on the long term.

“The amount of capital you start with is not nearly as important as getting started early. Every year you put off investing makes your ultimate retirement goals more difficult to achieve.”

Burton Malkiel, former Chairman of the Princeton Economics Department

How Captain401 applies this
  • Captain401 has chosen 401(k) accounts as our area of focus. Not only is 401(k) the most popular investment account, but it's also the easiest way to save regularly via an automatic deduction from your paycheck. In addition, 401(k) participants are encouraged to take a long-term view, due to penalties for early withdrawal.
  • When crafting an investment recommendation for you, Captain401 focuses on long-term performance, rather than recent results.
  • In the future, Captain401 will develop tools to help individuals save and invest more of their income.

Take an appropriate amount of risk

The Theory

Assuming a well-diversified investment portfolio (we'll talk more about diversification below), an investment's expected rate of return will generally correspond with its level of risk. For example, the U.S. stock market has returned an average of 11% per year over the past 30 years — but in any given year, has gained as much as 37% (1995) and also lost as much as 37% (2008). In contrast, the U.S. bond market has only returned an average of 7% per year over the past 30 years, but its biggest yearly loss was only -3% (in 1994). This relationship between risk and return is captured by the Nobel Prize-winning Capital Asset Pricing Model.

One of the most important decisions an investor makes is how to balance the tradeoff between risk and return — in other words, how much to invest in stocks (which are riskier but have higher returns) and how much to invest in bonds (which are safer but have lower returns). Older people nearing retirement should allocate a greater percentage of their investment portfolio to bonds, because they need that stability to protect themselves from losing their retirement savings. In contrast, younger people should allocate a greater percentage of their portfolio to stocks, because they want their money to grow faster and have time to recover from short-term drops in the market.

A prudent investor should also avoid taking on any unnecessary risk. While some forms of risk are necessary to achieve higher returns, other forms of risk do not provide any extra benefit. Owning individual stocks (such as your employer's stock) — as opposed to the entire stock market (such as the S&P 500) — is an example of this. Individual stocks are subject to enormous risk, yet don't reward investors with proportionally higher returns. For example, consider the Enron employees who held most of their 401(k) money in company stock.

“The most fundamental decision of investing is the allocation of your assets: How much should you own in stocks? How much should you own in bonds?”

John Bogle, founder of Vanguard

How Captain401 applies this
  • Captain401 calculates an appropriate level of risk based on your age and time horizon, and makes sure you hold the right proportion of stocks and bonds.
  • For young people, our investing strategy carries a strong bias towards stocks, due to their historical outperformance over the long term.
  • We help reduce any unnecessary risk that may be caused by holding individual stocks or investing in multiple funds in the same asset class.


The Theory

By dividing your investments across different asset classes (ex. bonds, U.S. stocks, international stocks) rather than putting all your eggs in one basket, you can reduce risk by letting one part of your portfolio cushion the blow if another part goes down. Getting this right is the most important decision you can make, since it will be responsible for 90% of your investment portfolio's risk and return.

Earlier, we discussed how bonds and stocks have different risk/reward characteristics. It turns out, though, that because stocks and bonds don't always move in the same direction at the same time (one often rises when the other one falls), investing in both can actually reduce your portfolio's overall risk without sacrificing expected return. In fact, adding stocks (which are normally very risky) to an all-bond portfolio can counterintuitively increase returns and reduce risk!

The same principle of diversification applies within stocks and bonds as well. There are many types of stocks (such as large-company, mid-cap, small-cap stocks, and international) and there are many types of bonds (such as government and corporate). Each of these asset classes can behave differently from the others — the famous Callan Periodic Table of Investment Returns shows that the best performing asset class one year is rarely the same as the next, and there is seemingly no pattern between past and future performance. Therefore, the prudent course of action is to diversify and own multiple asset classes, thereby capturing the long-term returns of the entire global market while decreasing risk. The mathematical model underpinning this principle is known as the modern portfolio Theory, and several of the theory's creators were honored with a Nobel Prize for their insights.

“Since you cannot successfully time the market or select individual stocks, asset allocation should be the major focus of your investing strategy, because it is the only factor affecting your investment risk and return that you can control.”

William Bernstein, financial theorist and best-selling investment author

How Captain401 applies this
  • Our investing strategy chooses investment funds that cover as many of the major asset classes as possible.
  • We use modern portfolio theory to calculate the optimal proportions of asset classes that will maximize expected return and minimize risk.

Choose index funds

The Theory

Most investment funds available in 401(k) plans can be categorized as either actively-managed mutual funds or index funds. Mutual funds are baskets of different stocks and/or bonds, chosen by a fund manager that tries to pick wisely in order to beat the market. Index funds, on the other hand, are baskets of stocks or bonds chosen by a computer to exactly match the market, thus guaranteeing the market return.

Mutual funds tend to be very expensive due to their overhead, charging an average of 1.1% per year, which is deducted directly from the fund's investment returns. Index funds, on the other hand, charge a mere fraction of that (ex. Vanguard index funds average 0.2%). Because of this cost difference, mutual funds need to do better than index funds by almost 1% per year in order to outperform them after fees.

It turns out mutual funds are rarely able to achieve this — multiple academic studies have discovered that mutual funds consistently underperform index funds. The exact stats vary by time period, but studies have shown that anywhere from 67% of mutual funds to 97% of mutual funds get beaten by index funds, and the rare mutual fund that does better in one time period is unlikely to do so again in subsequent periods. One study found that stock mutual funds underperformed the S&P 500 index fund by an average of 2.1% per year over a 20-year period.

The Efficient Market Theory explains why it's so difficult for a mutual fund manager to consistently beat the market, even before costs are taken into account. While mutual funds are extremely profitable for Wall Street due to their high fees, the academic research is clear — you're better off sticking with index funds.

“Most investors will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”

Warren Buffett, legendary investor

How Captain401 applies this
  • When selecting investment funds appropriate for you, Captain401 chooses index funds wherever possible.
  • This is especially important in 401(k) plans, which are usually laden with high-fee mutual funds and don't clearly label the mutual funds from the index funds.
  • We select index funds that cover as many of the major asset classes as possible, in order to achieve maximum diversification.

Reduce unnecessary costs

The Theory

Financial institutions would like you to believe that they've discovered the secret to picking investments that will yield higher returns. In fact, as explained earlier, no such secret exists, and even professional fund managers can't beat index funds the vast majority of the time. There is, however, a single factor that's been shown to be correlated with higher returns — low fees.

A study conducted by Morningstar concluded that the expense ratio (or annual cost) of a fund is the only dependable predictor of future performance, even more so than Morningstar's own popular star rating system. In fact, "in every asset class over every time period, the cheapest quintile produced higher total returns than the most expensive quintile."

Intuitively this makes sense, since every dollar you spend in fees is a dollar that's being deducted from your returns. So why do financial institutions continue to insist that you pay them extravagant fees to manage your money? Simply, because it's in their self-interest — financial institutions profit from extracting high fees from its customers, and the financial press needs to churn out 24/7 information and advice in order to attract more eyeballs.

Ultimately, these perverse incentives are bad for individuals — unnecessary costs can add up over long periods of time. According to the Department of Labor, excessive fees can rob as much as 28% of your retirement assets. You are better served implementing the long-term, optimally diversified, risk-balanced strategy that's backed by academic research, rather than paying high fees to "experts" trying to guess what will happen to the market.

“Perhaps no other issue…has as much direct impact on investors' returns than the level of fund fees. While fund performance is unpredictable, the impact of fees is not.”

Arthur Levitt, former chairman of the SEC

How Captain401 applies this
  • Captain401 chooses the lowest cost fund that makes sense for a given asset class. Besides explicit costs, we also consider hidden costs like the fund's level of trading activity, which generates transaction costs that can decrease returns.
  • We won't include an asset class if the costs to owning that asset class outweigh the diversification benefits.
  • Captain401 is wary of high-fee target date funds. While the best target date funds provide automatic, low-cost diversification within a single fund, the target date funds commonly found in 401(k) plans carry excessive fees.

Avoid performance chasing and other behavioral biases

The Theory

One of the most common mistakes that investors make is choosing investment funds based on their past performance. While it seems intuitive that funds who did well previously will do well in the future, studies have repeatedly shown that this is not the case. One oft-cited study published in the Journal of Finance concluded that "individual funds do not earn higher returns from following the momentum (persistence) strategy in stocks. The only persistence not explained is concentrated in strong underperformance by the worst-return mutual funds." In fact, another study even found an inverse relationship between past and future performance, noting that "funds that finished the first five years in the top quintile were the least likely to finish in the top half over the next five years."

Another common mistake investors make is trying to time the market or adjust their investments in reaction to short-term market news. Numerous academic studies have shown that this behavior can cost an investor between 1.5% and 4.3% per year, because individuals are notoriously bad at predicting the market even if they don't realize it. By attempting to time the market, investors usually end up buying high, selling low, and trading too frequently, leading them to worse performance than if they had done nothing at all. This phenomenon is so prevalent that it now has a term — the "behavior gap", coined by author Carl Richards.

In contrast, an investing strategy that reacts to market movements in a mathematical, emotionless manner has been shown by Yale's Chief Investment Officer, David Swensen, to increase returns by 0.4% per year. This strategy is known as rebalancing, and it involves periodically adjusting your investments to return them back to their pre-set proportions as market movements cause the winners to encompass an ever-larger part of your portfolio. Unlike market timing, this strategy forces you to buy low and sell high, which is why it boosts returns.

“Buying funds based purely on their past performance is one of the stupidest things an investor can do.”

Jason Zweig, personal finance columnist for The Wall Street Journal

How Captain401 applies this
  • Captain401 de-emphasizes recent performance when choosing the best investment funds for you. We pay closer attention to expense ratio — which is a better predictor of future performance — as well as the long-term expected returns of the fund's asset class composition.
  • Our automated investing service makes all the investing decisions for you and maintains an optimal strategy. This eliminates the behavior gap and ensures you'll achieve maximum expected returns.
  • Our automated investing service rebalances your investment portfolio whenever markets shift.