5 Ways to Improve Your Investment Portfolio

Kinniry Jr., Colleen M. Jaconetti, Michael A. DiJoseph, and Yan Zilbering, 2014. Putting a value on your value: Quantifying Vanguard Advisor’s Alpha. Valley Forge, Pa.: The Vanguard Group.) While they pointed out that the number is not an exact science, saying that “[f]or someone, advisors may offer much more than that in added value; for others, less. The potential 3 percentage points of return come after taxes and fees.”

In other words, to use a grossly oversimplified example, if your portfolio consisted of 100 percent low-cost index funds that generated 10 percent after fees, it is a fallacy to look at hiring at advisor as resulting in your returns being 10 percent minus the advisor cost when, in actuality, your results could be materially lower due to behavioral issues (buying when you shouldn’t buy, selling when you shouldn’t sell, maintaining positions that are too concentrated, ignoring the opportunity to exploit certain tax arbitrage situations through strategies such as asset placement, developing and calculating a spending pattern during the portfolio distribution phase, etc.) If your experience trying to go it alone would have resulted in you earning, say, 5 percent or 6 percent, you ended up making more money despite paying higher fees because of the handholding and experience of the advisor. To focus on the potential gross return is not only inappropriate, it could end up costing you far more in lost compounding than avoiding the expense.

You must develop a well-constructed plan, based on sound portfolio management principles, and stick to it through both calm weather and stormy skies.

2. Unless dealing with moral or ethical considerations, do not make fixed-income investment decisions for the bond portion of your portfolio based solely upon how you feel about a company’s products or services. Benjamin Graham wrote a particularly beautiful passage touching upon this point, which can be found in the 1940 edition of Security Analysis. In his legendary treatise, he stated, “By a coincidence all three of the noncumulative industrial preferred stocks in our list belong to companies in the snuff business. This fact is interesting, not because it proves the investment primacy of snuff, but because of the strong reminder it offers that the investor cannot safely judge the merits or demerits of a security by his personal reaction to the kind of business in which it is engaged. An outstanding record for a long period in the past, plus strong evidence of inherent stability, plus the absence of any concrete reason to expect a substantial change for the worse in the future, afford probably the only sound basis available for the selection of a fixed-value investment.”

Here, Graham was talking about the fact that choosing bonds and fixed-income securities is inherently an art of negative selection. You are looking for a reason not to buy something as your major concern is whether or not the enterprise is capable of returning the promised principal plus interest on the money you have loaned to it. An investor who rejected buying snuff (smokeless tobacco) preferred stocks or bonds because he or she was not a fan of the industry had to content himself or herself with potentially higher risk and/or lower return. If avoiding securities issued by tobacco companies is important to you, this is a reality you must confront. Life is full of trade-offs and you have made one of those trade-offs. You cannot always have your cake and eat it, too. It might not be fair but it is a fact.

3. Think about how your investment portfolio is correlated to the other assets and liabilities in your life then attempt to reduce that correlation as intelligently as possible.When managing your investment portfolio, it pays to think about ways to intelligently reduce risk. A major risk is having too many of your assets and liabilities correlated. For example, if you lived in Houston, worked in the oil industry, had a major part of your retirement plan tied up in your employer’s stock, owned part of a local bank, and held real estate investments in the Houston metro area, your entire financial life is now effectively tied to the outlook for energy. If the oil sector were to collapse, as it did in the 1980s, you could find not only your job at risk, but the value of your stockholdings plummeting at the same time your local real estate and bank holdings suffer due to tenants and borrowers, also in the Houston area, experiencing the same economic hardship you are given the area’s reliance upon oil. Similarly, if you live and work in Silicon Valley, you aren’t going to want most of your retirement assets in technology stocks. Rather, you might want to consider owning things that are likely to keep pumping money out through thick and thin, good times and bad times, even if it means generating lower returns; e.g., holding ownership stakes in blue chip stocks, particularly consumer staples companies that make things like toothpaste and laundry detergent, cleaning supplies and candy bars, alcohol and packaged foods.

It is generally a wise practice to look through everything on your personal and business balance sheets at least once or twice a year in an attempt to find weaknesses and correlation; areas where a single force or misfortune could cascade and cause outsized negative consequences. Common exposures can be an input cost, such as the price of gasoline, interest rates, the economic health of a particular geographic area, reliance upon a single supplier, exposure to a particular industry or sector, or any number of other things.

For most investors, the single biggest risk they face is an over-reliance upon cash flow from an employer. By focusing on acquiring productive assets that generate surplus cash flow, and thus diversifying away from the employer, this risk can be somewhat mitigated.

4. Pay careful attention to the structure of your liabilities because it can mean the difference between financial independence and total ruin. Whether you have a preference for investing in stocks or real estate, private businesses or intellectual property, how you pay for an asset is of the utmost importance. If you need, or prefer, to use debt in order to increase your return on capital and allow you to purchase more assets than your equity alone would permit, a good rule when managing a portfolio is to avoid borrowing short-term money to fund long-term assets because the funding source can dry up and leave you illiquid long enough to plunge you into bankruptcy. Ideally, you only want liabilities with easily-accommodated cash flow demands that have fixed-rate interest terms. Even better, you want this debt to be non-recourse, if possible, and to avoid the ability to have the lender demand the posting of additional collateral. Special exceptions sometimes apply. For example, if you were a high net worth individual with tens of millions of dollars in cash and cash equivalents, it wouldn’t necessarily be imprudent to have something like a pledged asset line of creditthat was filled with Treasury securities and tax-free municipal bonds so you could easily tap your funds without having to sell your positions.

5. Do not allow yourself to forget that good times come to an end. This seems particularly important at the moment with stock markets, real estate markets, and bond prices near, or hitting, all-time highs. Your asset prices will decline in market value. Depending upon the asset, your assets will also experience drops in the cash flow they generate. A good investment portfolio is not only capable of dealing with this, it expects it. Unless you are young, have an extraordinarily high risk tolerance, and have plenty of time and energy to recover if you miscalculate or suffer misfortune, it is often prudent to avoid reaching when making an investment. Hope is not an investment strategy. When you acquire an asset, you should do so at a price, and on terms, that if the worst were to happen, you could still survive without having to start over in life or your career. For many investors, once wealth has been accumulated, the emphasis should be on protecting that wealth for the long-term, not aggressively going after the highest possible theoretical returns, particularly if the latter introduces wipe-out risk.