Investing is much like gardening. You’ve got to start with a vision, plant your seeds, and take care of them as they grow. Eventually, you’ll harvest your crops. Simple enough. But there’s always something to complicate such a simple plan. First, you have to know the soil and climate where you’re planting. You have to decide which seeds will work best. Then you have to deal with weather and the inevitable forces of nature that can either help or hurt your plans. In much the same, investing involves how to choose among the thousands of stocks, mutual funds, or ETFs. Like bad weather, investors need to contend with bad market conditions and other things beyond the control of any individual. Consider these tips of a portfolio strategist on how to grow money.
My firm’s investing approach is driven by academic research and not Wall Street hype. This means we focus on what we believe is time-tested, optimal, and prudent rather than faddish and fashionable. As noted by a wise investment commentator, “when Wall Street builds a better mousetrap, investors are generally the mouse.” And it should be noted that it is often NOT different this time. Our approach is long-term, strategic, and based on well-established financial and economic theories, data, experience, and a little judgement. That means building broadly diversified portfolios that have meaningful international exposure and are built to be tax efficient.
While I may not be very good with gardening and pruning, these time-tested tips of many a portfolio strategist on how to grow money have served me and my clients well in good and bad markets.
Markets are Efficient and Day-Trading Can Be Futile
With few exceptions, we accept that markets are efficient most of the time. This means that individual securities are generally priced correctly. Incurring additional costs in the hopes of finding a mispricing is usually a futile exercise though, of course, an apparent mispricing will seem obvious after the fact. To summarize, active management does not consistently add value through security selection or market timing. So, we will invest almost exclusively through index funds and other similar passively managed vehicles (ETFs for example).
Factor Investing Can Make a Difference
While markets are mostly efficient, there are persistent anomalies that tend to be evident most of the time. These are termed “factors” and the most significant of these are “value” and “momentum.” So, we will tilt portfolios toward factors such as value and, to a lesser extent, momentum, meaning we won’t “fight the tape” when a trend is evident in an asset class or stock.
It also appears that stocks of smaller and midsize companies have periods of out-performance compared to larger companies. So, we will tilt portfolios toward smaller and midsize companies.
Including such tilts means that our portfolios will most likely give rise to “tracking error” which means that your portfolio will not exactly track vanilla indices like the S&P 500. Results are not guaranteed, and it can take time for out-performance or lower risk to show itself.
Control What You Can with Low-Cost Investments
Diversification AND cost control are crucial. So, we will primarily use Exchange Traded Funds (ETFs) and other open- and closed-ended mutual funds to gain the exposure needed to various asset classes. We will use these because of their broad holdings and low costs. We will seek out funds that tend to have lower turnover which also reduces costs. Individual stocks can also play a role especially those that have a track record of paying increasing dividends over long periods of time. Such stocks tend to also hold up better during market corrections.
Expect Market Corrections, Dips, Pullbacks and Dark Times
Any portfolio strategist worth his or her salt will tell you that one of the best lessons to learn on how to grow your money is to be properly diversified and to expect market corrections.
From peak to trough, US stocks as measured by the common indices like the S&P 500 declined in nominal dollars between 45 and 55 percent in multiple time periods: 1973-1974, 2000-2002, and 2007-2008. Market corrections of lesser amounts are not unheard of as well: 34% during the CORONA Virus sell-off; 20% during the tech bubble sell-off in early 2000; 10% during the Asian and Long-Term Capital Management crises near the end of the 1990s. In general, the S&P 500 Index has a tendency to blow off steam and have a pullback between 5% and 10% once each year at least.
It is always darkest before the dawn. And stock market strategists are waiting for ordinary investors to throw in the towel as a sign that dawn is near. So, to grow your money, you need to expect such dark times and resist the urge to sell out.
So, during poor markets, investors should expect the risky portion of their portfolio to decline by up to half. The “risky asset portion” is everything that is not investment grade bonds or cash. For example: An investor with a $1M portfolio with 60% in stocks and 40% in bonds and cash should expect to experience a decline to $700,000 periodically. This is the necessary pain to achieve the higher returns that are expected from risky assets. This is not a “worst-case” scenario but an expected periodic case. If stocks did not occasionally experience losses, they would cease to be attractive to earn superior returns over the long-term.
It is our job to make sure client portfolios are positioned at an appropriate level of risk and that our clients do not increase their risk when things look rosy and do not decrease their risk exposure when the outlook is frightening (2008 and 2020).
To help control for this risk and deal with the inevitable corrections, we will determine an appropriate level of cash that each client should hold. That cash level can range from several months to three years of fixed expenses. And we’ll add into the global allocation an amount invested in alternative assets like gold and real estate. These kinds of assets have had a good track record providing a buffer to a portfolio.
To best determine the optimal allocation to risky assets, investors need an asset map that is based on their personal risk tolerance, risk capacity, and time frame for when cash is needed.
Let Your Money Travel Abroad
Foreign investments will be used for added diversification. They may zig when domestic stocks are zagging. So, we will include international exposure including smaller companies in emerging markets.
What Matters Most
In the end, what matters is not how your portfolio tracks an index but whether it is positioned to fulfill your goals. While comparisons with benchmarks are helpful, our real benchmark is how well a selected allocation helps you meet your goals even after market corrections.
Grow Your Money with a Plan
Ultimately, the best way to grow your money, whether you’re working with a portfolio strategist or not, is to have a plan that includes what amount of money you need, when you’ll need it, and whether your portfolio is aligned with your personal risk capacity and tolerance. Investors need to chart their course before they are confronted with bad choices brought on by emotionally charged decisions. Reach out to a fiduciary financial planner for help.
