How To Design Your Investment Portfolio

Long-term Bedrock Principles

How do you successfully build and manage an investment portfolio to accomplish long-term goals?  This is a critical question that too often is neglected.  Sometimes investors aren’t even asking this question. Instead, they’re chasing the most recent stock that’s “up” or they’re taking the “hot” advice from a buddy who claims to be making a killing.  Other times, investors ask the question without focusing on the long-term.  They ask what they should be doing because of the “recession” or because of “what’s going on in the White House”, or because of some other short-term event or circumstance.  Successful investing has to be a long-term proposition, and it has to be based on bedrock principles.

Core Principle One:  Select an Investment Benchmark for Your Portfolio

The benchmark will most likely be a combination of investment categories that are appropriate for your goals and risk tolerance.  It might be something like 40% long-term bonds and 60% S&P 500 stock, or even more detailed like 5% short-term bonds, 35% long-term bonds, 45% Large value stocks, 10% small company stocks, and 5% international stocks.

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The point here is not to make specific recommendations of benchmarks.  Instead, we want to illustrate how specific a benchmark might need to be.  Developing an appropriate benchmark for your goals is critical in determining your target rate of return. It’s also absolutely necessary in determining your acceptable level of volatility.

The benchmark provides the basis for constructing the portfolio, controlling risks and measuring performance.  This must be realistic both in terms of your time frame as well as your emotional perspective.  Designing a portfolio to maximize return when at heart you can’t stand volatility is not going to work.  There’s also something to be said on the opposite end of the spectrum. Taking too little risk when you can tolerate more, will deprive you of the return you need to meet your goals.  The benchmark defines the structure.

Core Principle Two:  Select “Pure” Investments Which Fit into the Investment Portfolio That’s Right for You

What we mean by pure is that each investment meets the definition of one of the components of your benchmark structure and won’t drift away from that definition.  For example, if you need 10% of your portfolio to be in large growth stocks, you have to actually use stocks or mutual funds of companies that fit that definition.  If you load up on value stocks, or small company stocks because someone says they’re hot right now, you will destroy your portfolio’s structure.  More importantly, you will lose the ability to target a specific return or control risk.

On a similar note, you need to make sure that the investments you select to fit each investment category remain true to that category.  If you select a large-company growth fund because you need that, then so far so good. But what happens if that fund decides to time the market and starts loading up on large value stocks?  Your portfolio structure will have changed you will lose the ability to target a specific return or control risks.

Core Principle Three:  Monitor Your Investment Portfolio’s Actual Structure, Return and Risk Against the Goals You’ve Established

If you’ve selected a benchmark structure of 40% bonds and 60% S&P stocks, then you should regularly check your portfolio to make sure it stays true to that 40%/60% mix.  Also, the benchmark you’ve selected will generate a certain return and will experience a specific amount of volatility.  You should measure your portfolio’s actual return and volatility against that benchmark’s performance.   For example, if your benchmark structure generates a 7% return with 8% volatility, but your portfolio only delivers a 5% return with 10% volatility, there may be something wrong.  All investment performance measurements should be relative to something – relative to a goal, and relative to a benchmark.

Core Principle Four:  Guard Against Emotions

The emotions at both ends of the spectrum are deadly.  Greed and arrogance will prompt you to take more risk than you should in pursuit of that “hot” stock.  On the flip side, fear prompted by an economic recession, or by a market correction, or even by a one-day reaction to some negative piece of news will prompt you to bail at exactly the time when you need to remain calm and committed to your long-term plan.

Core Principle Five:  Enlist the Help of a Certified Financial Advisor

Enlist some professionals to come alongside and offer 100% objective advice. This is important both when you construct your portfolio and when you manage it on an on-going basis.  These principles are rather simple to explain.  Actually implementing and investing is complex.

A great analogy to use would be fixing a broken finger.  We all kind of know how it should be done – you get a splint and wrap the finger, right?  But how long should the splint be? Where should it be placed and how often should it be adjusted? When do you determine if there are problems with the bone setting or the mobility of the joint?  All these are questions that common sense tells us are better answered by a doctor.

Successful investing is similar.  Determining exactly which benchmark structure to use, what the target return and risk will be, which investments are true to each investment category, and when to make changes if the portfolio’s performance is different than the benchmarks are all questions that hopefully common sense now tells you should be addressed with the help of a professional.

We offer a 100% objective, independent advice.  If we can help you with any of these questions, or if you’d just like to chat further about your specific situation, please give us a call or feel free to reach out.  We’re happy to help.

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