We believe that successful long-term 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 the 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 individual time-frames. Being forced to sell equities at the bottom of a market to generate cash-flow for spending needs can have a very significant negative impact to future income. Therefore, we recommend having a large enough bond portfolio to meet many years of spending. On the other end of the spectrum, having a significant amount in bonds in a long-term portfolio can significantly hamper long-term compounding returns. We believe that by projecting cash-flow needs, we can better allocate a client’s portfolio in an attempt to protect assets in the short-term and maximize growth 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, high-credit bonds should provide the downside protection, equities should provide the growth and alternative investments should offer the 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
We believe that each investment in a portfolio should have a defined purpose. We believe both passive management and active management can play an important role in portfolio construction. However, we believe that active managers should be used sparingly, should have a specific role and should compliment the passive strategies. Otherwise, with too many holdings, active managers get over-diversified and end up looking like a very expensive index fund. Passive managers should be the low-cost 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. We use tax location by investing less tax-efficient assets in IRA portfolios, but this can often play havoc on withdrawal strategies. We believe that 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 that 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 good times and in bad. Rebalancing can be the ultimate test of trusting one’s investment philosophy, but it also has the potential of the most long-term reward.
Anyone can have great returns when the markets are heading higher, but we believe investors with sound investment philosophies are more likely to have
