We believe that successful investing requires a sound investment philosophy. Elroy Dimson of the London Business School once defined risk as “more things can happen than will happen”. We are very fond of this simplified definition because we look at the investment world as a continuum of possibilities and probabilities. We believe the goal of portfolio construction should be to prepare a client’s portfolio for an uncertain future with many potential paths. Building a sound investment philosophy gives investors the focus and confidence to maintain their strategy when markets go haywire. Below are some of the major tenets of our philosophy:
- Time Frames are Critical – We believe that investments should be allocated based on goals-based time-frames. Being forced to sell equities to generate cash-flow for spending needs at a market trough can have a significant negative impact to future income. Therefore, we recommend allocating a portion of your portfolio to stable asset classes (i.e. – fixed income) to support short-term spending needs. On the other end of the spectrum, having a significant allocation to stable asset classes for long-term spending needs can significantly hamper long-term compounding returns. We believe that by projecting cash-flow needs, we can better allocate your portfolio with a focus on both protecting your portfolio over the short-term and maximizing growth in your portfolio over the long-term.
- Less Asset Classes can be More – We believe that each asset class in a portfolio should have a defined purpose. We are opposed to a portfolio filled with a hodge-podge of investments in the name of “diversification”. At a high level, the three primary functions of investments are protection, growth and diversification through non-correlated returns. We believe that, in general, bonds should provide downside protection, equities should provide growth and alternative investments should offer non-correlated performance. We believe that any additional asset class must offer a compelling and well-defined value to the portfolio. Otherwise, capital will be diverted from the more efficient asset classes depriving the portfolio of its optimal allocation.
- Less Managers can be More – Again, we believe that each investment in a portfolio should have a defined purpose. We believe both passive strategies and active strategies can play an important role in portfolio construction. However, we believe that active managers should be used in moderation, should have a specific role and should complement the core strategies. Otherwise, with too many holdings, active managers get over-diversified and end up looking like a very expensive index fund. Core strategies should be the low-cost and tax-efficient diversifiers.
- Tax-Efficiency is Key – Investors only get to keep their after-tax returns, so we are always cognizant of an investment’s tax efficiency. For example, we typically recommend and employ tax location by investing less tax-efficient assets in tax-sheltered portfolios. However, this can play havoc on withdrawal strategies unless managed correctly. We believe having a dynamic withdrawal strategy that combines tax location with proper ordering of portfolio withdrawals can add significant value over time.
- Don’t Forget to Rebalance – We believe disciplined investing requires regular rebalancing. Rebalancing is a mechanical way to sell high and buy low. Studies continuously tout the benefits of rebalancing, but selling “winners” to buy more of the “losers” can be a difficult “pill to swallow” – both in rising and declining markets. Rebalancing can be the ultimate test of trusting one’s investment philosophy, but it also has the potential for the most long-term reward.
Anyone can have great returns when the markets are heading higher. We believe, however, disciplined investors who apply sound investment philosophies are more likely to have success over the long run where markets do what they do best – move up, down and sideways. Connect with us to learn more about what we can do for your portfolios.