Clients often come to us not knowing exactly how they are invested. They have some knowledge of investing, but don’t have the time or inclination to dive into how markets work or the details of an exchange traded fund.
This is where we help.
We are here to help clients understand how their portfolios work, and educate them on markets and products.
Much of portfolio theory and investment research is based on what a rational person would do. The “rational person concept” helps us build portfolios by assuming that investors act in their own interest, make logical decisions, and have access to relevant information.
Let’s focus on the rational side of creating a portfolio.
Goal Based Strategy
We have always been a “planning first” firm. To us, this means that we create a financial plan first, and then determine the products or investments needed. This step-by-step process allows our clients a sense of financial wellness and gives them clarity to see how products and investments fit into their overall picture. Having the big picture prevents clients from being “sold” products that are not the right fit.
Understanding your core values allows you to live your fullest life. When your finances match your ideals, you can live in alignment with the things that are important to you. Your values match your goals, and your goals match your passion and the life you want to lead. All of this is captured in your financial plan.
Having a portfolio that aligns to your goals and values gives you more assurance that you can meet your near term and long-term goals, while not sacrificing your family’s safety. This focus grounds your investing. When news is bad or things change, you can always go back to your plan and know that your investments have been factored in your overall direction.
Our younger clients are investing for retirement. This important goal is far in the future, and they understand the value of investing for their future life. For many of us, it’s drilled into our head – save, save, save.
Our retired clients, on the other hand, focus on the dual goals of not running out of money during retirement and minimizing taxes. This requires a different mindset, as well as a different type of portfolio.
Each of these circumstances has clients investing differently to meet their goals, so their overall plan affects their portfolio construction.
Low-Cost Investing
When thinking of low-cost investing, most people immediately equate it with passive investing. While passive investments are inexpensive, it is not a “set it and forget it” solution.
While the passive investing approach hints at an index approach—like the S&P 500 or the Bloomberg Aggregate Bond Index—it doesn’t mean that there are never any changes to the portfolio or to the individual investments. While the individual investments may rebalance securities anywhere from one to four times a year, each fund may need to be replaced depending on markets, management, or your personal needs.
Choosing and Maintaining Low-Cost Investments
There is actually a lot that goes into selecting and maintaining a low-cost type of portfolio:
- We start with the rational process of creating the right asset allocation mix, which is done during the planning process.
- Next, we choose appropriate investments, such as mutual funds or ETFs, which meet your goals.
- We then allocate the right type of investments to the right type of accounts, known as asset location, to maximize growth and minimize taxes.
- We monitor your account over time and make asset allocation adjustments as needed.
We believe that the average person cannot outguess the market, which is why holding an index of funds for the long term is important. Markets tend to be efficient and move based on known information, so it’s extremely difficult for a person to make trading decisions that out-guess the market. By the time you know the information, it has already been factored into market prices.
While we always start with a core set of passive investments, (often index funds,) we may use active satellite investments to boost performance. These funds may hold fewer, more targeted securities, which may be traded more often depending on the goal of the fund. Low fees are a hallmark of passive index funds. Active funds often have greater costs to account for greater management and trading fees. These funds can produce outsized returns depending on their purpose and structure.
Remember: the lowest cost funds do not always make the most efficient portfolio for your needs.
Diversification
There are multiple levels of diversification, which is a fancy word for “don’t put all your eggs in one basket.”
First is your asset allocation. This is dividing your funds between stocks, bonds, and cash.
Next, each piece of your asset allocation is divided into smaller pieces. For example, stocks can be divided into US and International. US stocks can be further divided into asset classes of growth stocks, value stocks, mid-cap, and small cap.
By the time you get to the level of individual stocks, your overall pool of money is diversified across multiple asset classes and individual securities. You want to diversify across the investment universe.
Diversification does not mean having multiple accounts at different banks and brokerages. That is just spreading money around and can be more expensive to track and maintain. It also does not mean purchasing investments that are unfit. If gold or bitcoin are not a fit for your plan because they are too risky, then you don’t need them for your portfolio to be diversified.
When a stock market index, such as the S&P 500, decreases, a diversified portfolio of 60% US and Foreign stocks along with 40% US and Foreign bonds will perform differently than the index. For example, this chart shows that when the S&P 500 was down 3.26% over a four-month period, a diversified 60 / 40 portfolio was up 0.24%:
Taking a diversified approach to investing allows you to take advantage of market upswings while having protection when markets are down.
Discipline
Creating a portfolio that works for your personal situation is a thoughtful, rational process to meet your personal goals, reduce costs, and diversify across multiple investment categories. This is the first step, which then needs to be balanced with the emotional side of investing.
Maintaining your portfolio requires discipline to stay on track when times are uncertain and markets are volatile. Having a rational portfolio that fits your risk comfort level is the first side of the equation. Maintaining the discipline to keep your investing on track over time is more difficult, as it means taming our emotions during periods of exuberance and turmoil.
Keeping the rational and the emotional balanced is the key to success.
Pamela J. Horack, CFP® of Pathfinder Planning LLC provides personal financial planning advice and investment management for a simple fee to young adults and working families in North and South Carolina through group classes, one-on-one planning, and ongoing advice.