The design of an investment plan should not be boilerplate. This part of the financial planning process is an important factor in the outcome. There are no standard templates for constructing a portfolio and it can be expected that no two firms would design an identical portfolio for the same client. Our team utilizes more than three decades of combined professional experience in investment portfolio planning and construction. We are also data driven, which strengthens our conviction on the probability of a successful outcome. These are some of the more commonly utilized strategies:

1. Constructing a portfolio using market timing.

I’ve heard stated that the best portfolio is one that is heavy in stocks when stock prices are going higher and lighter when prices are headed lower. As logical as this may sound, it’s purely unrealistic. I have seen a few instances where luck played a role in successful market timing but have not seen it performed consistently, reliably or skillfully. There are those who profess these abilities but track records speak for themselves. Unfortunately, there are too many investors with portfolios designed around future price expectations. Current stock prices are determined by the aggregate actions of millions of investors who utilize current information to formulate differing conclusions. The act of trying to predict the future actions of the aggregate of investors is futile.

2. Constructing a portfolio based on risk tolerance.

The popularity of risk tolerance questionnaires likely peaked in 2008 - 2009 when many investors realized the emotional impact of (actually) seeing their account value decline 20% or more (in some cases) was far greater than what they anticipated when answering a question such as “How would you respond if your portfolio fell by 20% or more?”. None of us can say for sure how we would respond to highly emotional events until we experience it firsthand. I think it’s safe to conclude that (for many of us) our risk tolerance is greater when stock prices have been trending higher and lesser when prices have been falling. This provides little benefit when determining how to weight assets in our portfolio.

3. Constructing a portfolio based on age.

Age based investing was a concept long before I entered the profession. While there are shortcomings to this strategy, there is some logic to it. For starters, younger investors have more time for the investments to work and more time to wait for a recovery. Older investors are more likely to be taking income distributions and can be more averse to volatility. The problem with this strategy is that it does not consider the goals and objectives of the individual. This is a macro approach that could lead to achieving one’s goals at the end but it leaves the outcome more to chance than to design.

4. Constructing a portfolio based on retirement date.

The popularity of “target date funds” has been on the rise for several years. Often used inside employer sponsored retirement plans, these options help guide retirement plan participants towards options that are strategically allocated for an anticipated retirement date. Sans the process of individualized goal setting and portfolio construction, this option may be an appropriate consideration. It relies on little more than choosing the anticipated retirement date when selecting investment options. Once retired, a comprehensive review of your future goals and objectives may be of long term benefit in deciding how to construct the post-employment portfolio.

5. Constructing a portfolio based on your goals and objectives.

This strategy is tailored to your individual needs and wants. When the strategic mix of stocks (equities), bonds (fixed income) and cash inside your investment account is aligned with your specific financial goals; we believe that your likelihood of a satisfied outcome is greater. Notice I didn’t say that this strategy would produce the highest return or the lowest volatility (common misconceptions of satisfaction). It has been my experience as a financial professional and as an investor that satisfaction is often determined by whether (or not) you achieved pre-determined goals. Those who wish to maximize their financial potential may not only be required to commit to a high savings rate but also may seek a high expected return. This would require a portfolio with greater volatility than someone looking to simply maintain the purchasing power of their assets (keep up with inflation). At the end of the plan, both may be satisfied if the result met expectations, even while investment returns were different. The “conservative” client does not need or target high returns and high volatility to reach her goals. In fact, too much volatility may crash the plan altogether if emotional stress leads to unplanned liquidations. Trust me when I say, there is no satisfaction in that scenario. An “aggressive” client should have realistic expectations and a long-term commitment to the investment plan. An unrealistic plan is likely doomed from the start but a solid, realistic financial plan with the proper mix (allocation) of investments can lead to long term satisfaction and that probability is enhanced when it is reviewed periodically, adjusted as necessary and updated when life throws us a curve.

The next time you meet with your financial advisor, make sure to review your goals and objectives and ask how the investment plan aligns with those. An understanding of the various portfolio construction strategies can be beneficial in preparing for these conversations.

-Rick O’Dell