A B L E APPROACH
INVESTMENT APPROACH
Asset Allocation:
The most important determinant of returns and risk is asset allocation. Based on our understanding of a client’s objectives, risk tolerance, and current circumstances, we develop for a client a customized equity allocation target. Our goal is to lay the foundation for solid long term returns, yet keep risk and volatility within reason.
We normally recommend that the balance of the accounts be in fixed income with virtually no cash. Quite simply, cash has never yielded less so return prospects are minimal.
Having a defined asset allocation serves as a mechanical prompt to rebalance portfolios when market fluctuation causes the mix to deviate from plan. Rebalancing reduces risk by subtracting from the outperformers, and presumably more expensive asset classes, and adding to the laggards, and thus less expensive asset classes. If the outperforming asset class tanks, you’ll have less exposure.
PORTFOLIO HOLDINGS
Prefer Direct Holdings of Stocks and Bonds to Mutual Funds/ETFs:
Our investment approach normally recommends that a client allocate most of his or her monies into direct holdings of stocks and bonds instead of funds. With direct holdings you (i) minimize costs by not incurring the ongoing fees and other expenses like trading costs and market impact costs typically borne by mutual fund holders, all of which can total 2.25% or more annually; (ii) in taxable accounts, minimize taxes by establishing your own, current tax basis for your securities (instead of inheriting the fund’s basis in its securities), and control taxable turnover of the positions; (iii) improve transparency by knowing exactly what you own at all times; and (iv) improve return and risk by being able to customize your holdings, instead of just accepting what the fund has and does.
Fund investing becomes even more problematic when you have several of them. First, each fund operates in its own silo. The funds do not coordinate their holdings. The same security may be held, inefficiently, in a number of funds. One fund may be selling that security, another buying. The end result is many transactions that may cancel each other out, imposing unnecessary costs and unlikely to achieve superior results.
Bottom line, we create a custom designed investment portfolio for each of our clients, planned to avoid the costs of mutual funds but still provide their diversification benefits.
WEIGHTING & INDEX FUNDS
Be Wary of Market Cap Indexing:
Indexing via a market cap weighted index, like the S&P 500, sounds good, but over the long haul a client may leave significant profits on the table. That’s because in market cap weighting, the more expensive the stock, the greater the emphasis, while the cheaper the stock, the lesser the weighting. That’s counter intuitive to most investing, which seeks to deemphasize the more expensive and the overpriced, while rotating into the less expensive, the bargains.
An alternative is to weight each stock equally, for instance buying 0.2% of each of the 500 stocks. While you’ll still have some exposure to the “mistakes” in the index, you’ll reduce your exposure and risk to any one stock because of the smaller weighting.
It’s been shown that this equal weighted approach outperformed the market cap weighted index approach over the last 40 years, before trading costs. That’s too much to leave on the table. Still, few of us want to manage 500 different stocks.
Bottom line, we advise our clients to avoid index funds. Use individual stocks to accentuate the less expensive equities, the bargains, and exit or reduce exposure to the overvalued, the more expensive.