Financial Fitness Basic Training – Investments Part 2

In our prior segment, we covered some of the steps involved in the initial construction of an investment portfolio. However, the more important components of investment management revolve around ongoing maintenance and rebalancing. More important still, is a disciplined commitment to a sound investment philosophy. Even a perfectly constructed portfolio will fall short of its potential if these ongoing pieces are not regularly adhered to. It all starts with a sound investment philosophy.

Investments Component #4: What Is A Sound Investment Philosophy?

An investment philosophy is a set of beliefs and principles that guide our decision making when it comes to investing. At Patriot our investment philosophy centers around a few main beliefs.

  • Diversification– Having a broadly diversified investment portfolio greatly increases your chances for success while capturing market returns.
  • Asset Allocation– We constructing portfolios across different asset classes to obtain an optimal balance of risk and return. It is the art and science of our work and vital to performance.
  • Costs– Your portfolio’s rate of return is always it’s return less fees and expenses. Reducing investment fees, transaction costs, and taxes can significantly improve long-term results.
  • You Can’t Time TheMarket – No one can consistently or reliably beat the market. We utilize low-cost, diversified index funds to track and capture market returns.
  • Disciplined Behavior– You should buy and hold to invest for the long-term. Time IN the market is more important than TIMING the market. Remain disciplined and avoid the behavior gap caused by emotional investing.

The last point in our investment philosophy leads us to our next investment component.

Investments Component #5: What Is Disciplined Behavior? 

Disciplined behavior may be one of the most significant pieces of investment management. Once you understand that no one can consistently or reliably beat the market, you can accept that there will be unpredictable ups and downs. However, over time capitalism and a proper asset allocation can help set you up for success. However, it’s important to ensure you do not make emotional decisions that will negatively impact your long-term growth.

This is the “Behavior Gap.” This is the gap between the returns earned by an investor who builds a diversified portfolio and sticks with it versus an investor who makes changes and emotional decisions in response to the volatility of the market.

A recent study by Vanguard looked at the performance of more than 58,000 portfolios over five years ending on December 31, 2012, which was a very volatile period in the market. They compared the portfolios to a target-date benchmark that remained invested the entire time. For accounts that made no changes through this period, they averaged an excess return versus the target-date benchmark of 0.19%. For those who made changes, making emotional decisions, they averaged 1.5% less than the benchmark. That’s a “behavior gap” of 1.69%, which compounded over your lifetime can have a significant impact on your portfolio. Having a trusted advisor to talk with and help you through more troubling times in the market can be truly invaluable.

Investments Component #6: What Is Account Maintenance? 

While it seems like common sense, ongoing maintenance of your accounts is vital to their long-term growth. This encompasses all the prior components of your investments. You should regularly revisit those steps to ensure your portfolio remains appropriately invested. I’ve outlined some examples below:

  • Risk profiling – As you get older and your financial situation changes, so too will your risk profile. The level of risk you need to take, are willing to take, or are able to take will undoubtedly shift. This will lead to ongoing tweaks to your overall asset allocation.
  • Asset Allocation & Diversification – As these components do their job, certain asset classes will outperform others. This will lead to drift outside your target allocations. This is why regular rebalancing is important. Without it, you could end up taking on more or less risk than is appropriate.
  • Sound Philosophy & Disciplined Behavior – While less involved in ongoing maintenance, it’s crucial to regularly ensure you are disciplined and sticking to a sound investment philosophy.

It’s already difficult to initially construct an appropriate portfolio. More difficult is the ongoing maintenance and tweaks needed to ensure your investments help you accomplish your goals over the long-term. This is yet another advantage of having a trusted advisor to help you along the way.

How Does It All Fit Together? 

From a broad view, the process for initially creating an investment portfolio and maintaining it indefinitely is easy to describe. It all starts with developing a risk profile for yourself that truly fits you and your goals, while also adhering to a sound investment philosophy. From there, it’s a simple matter of filling your portfolio with proper allocations to asset classes, ensuring you are diversified, and remaining disciplined and diligent.

Sounds simple enough right? In reality, each of these steps can be vastly improved and better handled by a trusted financial advisor. As we’ve mentioned before, they can help you define your goals and true purpose, then help you align those with your money. This means they should construct a portfolio that adheres to your specific needs.

After you have your lifestyle envisioned and your portfolio properly constructed, you should ensure you have tools in place to protect your financial life. In our next Basic Training piece, we will begin to dig into insurance and protecting the various areas of your life. As always, if you have any questions or want to reach out, please contact us.