Published by Robert W. Huntley, CFP®, CHFC®
I like simple and I like systems.
I heard a successful entrepreneur early in my career say this: “When I encounter a problem, I create a system and delegate running the system to a trusted person on my team. Problem solved.”
Life is just easier with less clutter, confusion, and moving parts. However, financial planning is by nature a complex business.
When done properly, it covers multiple areas of your life. One of the more complex and important areas we deal with is successfully investing someone’s life’s savings.
I want to show you how even a complex part of the planning process, like investing, can be simplified and systematized.
I’ll use the word INVEST to walk you through our approach to crafting a client’s portfolio. This is the exact process we use for every client we work with.
Keep in mind, there are no shortcuts. Doing this correctly requires looking at the big picture financially, not just a piece of money; that’s the right way to make good investment decisions in my opinion.
I= Income Needs
When we are helping a client put together an investment plan we always begin with a few basic questions.
The first, how much income is needed now or in the near future? This is important to know because it affects the type of investments that are appropriate, and it impacts the amount of liquidity needed in the portfolio.
N= Necessary Returns
The second important question we ask is what is the minimum rate of return required to achieve the stated goal or overall game plan success?
We call this number your “Family Index” because it’s the index we want to manage expectations to in the overall portfolio.
For example, your overall plan shows you meet all your goals and objectives and never run out of money to age 100 if you average a 4.5% rate of return. That becomes your “Family Index” benchmark which we keep an eye on during investment selection and monitoring of your results.
Third, numbers are great but what about your feelings on market volatility? I often refer to this as your “pillow test.” How much of a drop in your portfolio value can you experience and still sleep soundly at night?
The worst thing you can do is build an elegant portfolio and then bail out at the first sign of a serious market sell-off. We use a risk analysis tool to help you tell us what your “pillow test” tolerance really is. This is an important consideration before assembling your portfolio.
Volatility doesn’t just involve fear of loss. Greed is an equal threat to investor success.
Greed shows up in chasing headline investments of the day or chasing past returns. Research by trusted organizations such as DALBAR repeatedly show that investors routinely underperform the investments they own.
Source: DALBAR QAIB, 2017, https://www.dalbar.com/ProductsAndServices/QAIB
The reason is the twin terrors of fear and greed. A successful portfolio has discipline and ideally someone to help you avoid making bad decisions based on emotion.
This is an ongoing process, but it is easier if you’ve done a good job of building your portfolios correctly up front. You should already know what your worst-case scenarios are likely to look like in a big market sell-off. That makes it easier to stay the course when the bombs are falling, and bullets are flying all around you (i.e. 24/7 news headline cycles).
Most people who walk into my office don’t know what they’re paying for their current investments. Some of them think they know, but when we dig a little deeper they really don’t.
Once you look at the hidden fees, it’s common for people to be paying 2%, 3%, and even 4+% and not even know it. Part of building a successful investment portfolio is knowing what your costs are.
In addition to fees, another cost that’s crucial is taxes. You should consider the drag taxation plays on your portfolio returns and own the best types of assets and strategies for each portfolio, depending on your overall taxable situation and the type of account you’re allocating.
IRA’s, for example, might hold different strategies than your taxable portfolios. When blending your overall family investments together those sorts of things can make a big difference in how much money you actually get to keep over the longer term.
Finally, it’s time to decide what you’ll own in your portfolio and how it will be managed.
There are many ways to approach investing and managing the risks in your portfolio. Some of these ways include using fundamental research, looking at company balance sheets, and industry outlook. Others use technical or momentum-based trading platforms that are built on sophisticated mathematical probability calculations.
There are macroeconomic approaches that monitor economic, political, and demographic trends around the world. Still, others emphasize certain styles of holdings such as value or growth.
Modern Portfolio Theory is probably the most commonly used approach to managing risk which allocates among stocks, bonds, cash and a few other categories such as real estate. Less common are strategies use hedging techniques such as put and call options.
The point here is once you know how much income you need, your necessary rate of return, your volatility threshold and your taxation and cost requirements; it’s time to put together the right strategies that you understand and are repeatable.
Keep in mind that strategies don’t have to be complicated. Your strategy might be as simple as buying a single stock and holding it forever. This is not recommended, but at least you have a strategy. Many people have no strategy and thus make poor decisions at the worst times.
The final piece to the puzzle is transparent returns and costs.
Do you have a way to see exactly how you’re doing and keep those results in the context of your necessary rate of return? Do you know what your costs are in terms of fees and taxation? Are you able to answer the question on demand “how are we doing” and have the answer filtered in perspective of long-term expectations?
You don’t need to and should not watch the values on your portfolio daily. In fact, when done properly, you can really let your strategies run and just check in on your money every so often.
Having confidence that you have carefully built your strategies and knowing they are disciplined and repeatable makes it possible to relax, tune out the noise and live your life focused on the people and causes you really care about. That’s really what you’re trying to accomplish, isn’t it?
Hope this gives you something to think about. Investing done right isn’t easy, but it can be simple and built on repeatable systems that free you to live life the way you want it.
If you know someone who should read this, please forward it to them. Until next time- here’s to money simplified!
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.