Lon Jefferies, a Certified Financial Planner™ (CFP), is a fee-only financial advisor and trusted fiduciary at Net Worth Advisory Group in Salt Lake City, Utah. He is dedicated to providing comprehensive financial planning and investment management on a fee-only basis.
Could you explain your investment strategy if you were handed a piece of chalk and directed to a chalkboard? How did you choose the investments within your portfolio? Common responses include, “I invested in what a friend or co-worker recommended,” or “I invested in what performed well last year.” For most, the honest response is a simple “I’m not really sure.”
At Net Worth Advisory Group, we believe an investor’s ability to adequately pass this “chalkboard test” is crucial to their long-term success. Saving for retirement requires a different investment approach than does ensuring that resources are available and secure over a short period. How can an investor be confident they are taking appropriate actions if they aren’t sure how they chose their investments?
Net Worth Advisory Group ensures that our clients are capable of passing the “chalkboard test.” This four-step process is how we recommend investors design their investment portfolios:
Step One: Asset Allocation – Stocks, Bonds, and Cash
This is the most important investment decision you’ll make because it has the largest impact on both risk and return. A simple approach to determine an appropriate mix of stocks vs. bonds is based on age (for example, take the number 110 and subtract the investor’s age; the answer equals the percentage of a portfolio to invest in stocks). An asset allocation based on age makes a portfolio more conservative at the appropriate time by reducing the allocation to stocks as retirement nears. Additionally, be sure to consider the risk associated with the asset allocation you choose. Examine how such an allocation performed during historical bear markets and be sure you can endure that degree of short-term loss.
The “bucket approach” is a more involved asset allocation strategy that considers spending needs. For more information on this strategy, view the second article in this month’s newsletter or click here.
Step Two: Diversification Across Different Asset Classes
A baseball team prepares by placing nine players across the field because they never know where the ball will be hit. Similarly, diversification of investments is important because we never know which asset classes will do well and which won’t.
Diversification lowers risk because it reduces the volatility of a portfolio. It creates ‘zig-zag’ relationships between asset classes so that when one investment is down, another will be up. These relationships are created by diversifying across asset category (stocks vs. bonds), size (large, mid and small cap), style (growth vs. value), and geography (U.S. vs. international).
The 2000’s are referred to as “the lost decade” for the S&P 500, but a diversified portfolio vastly outperformed the market as a whole. For instance, most stock categories lost nearly 40% in 2008, but government bonds gained 23%. Further, when the tech bubble burst in the early 2000’s, most growth stocks suffered but value stocks made huge profits. Clearly, diversification enables gains during bull markets while minimizing losses during market pullbacks.
Step Three: Selecting the Best Investments
If you decide to buy mutual funds, then you want to have criteria for how to select the best fund managers. Here are some of the standards Net Worth Advisory Group uses:
Determine the asset category, such as large cap growth or small cap value.
Find funds that outperform their peers. Look for funds that performed in the top 25% of their asset category over one, three, five, and ten year time periods.
Choose managers that have at least 10 years of experience.
Look for low expenses. Total fees, covering your financial advisor, investments, and transaction costs should be no more than 2%.
Make sure the fund outperforms its benchmark index (S&P 500 for large cap, Russell 2000 for small cap, etc.).
*Note: Net Worth Advisory Group often identifies the top mutual funds in each asset category and then purchases the individual stocks owned by those funds. This strategy is more cost effective and allows more control over the tax implications.
Step Four: Maintain, Review, Rebalance
Every six months you should tune-up your investment portfolio.Your allocation will get out of alignment over time because some assets will appreciate faster than others. When this happens you should rebalance to make sure you’re allocated properly and not taking extra risk. Always consider tax consequences and costs associated with rebalancing your accounts.
You should also review the performance of your investments to see if they’re still meeting the criteria you set. If a fund isn’t keeping up with its peers, then flag it and give it a chance to redeem itself. If flagged funds continue to underperform, then replace them with funds that meet your criteria.
As you conduct your routine checkups, make sure you maintain sound investment behavior. Don’t panic when you see the market experiencing a pullback. Remember, when you built your portfolio you accepted a certain amount of risk. If you used the bucket approach to determine your allocation then the money invested in stocks is for the long-term, so expect some short-term uncertainty. Stay the course and make minor adjustments when necessary.
This four-step strategy is the foundation of the static portion of client portfolios at Net Worth Advisory Group. This strategy can be supplemented by various tactical strategies, which you can learn more about by speaking with our advisors.
Our clients understand the investment strategies they are utilizing and can be confident they are appropriately pursing their retirement goals. If you or your financial advisor isn’t following a clearly defined strategy that you could express on a chalkboard, contact Net Worth Advisory Group for a portfolio upgrade to ensure your approach matches your goals.