YOU SEE AND HEAR IT EVERYWHERE: "INDIVIDUAL STOCK OR FUND PERFORMANCE IS THE MOST IMPORTANT ELEMENT OF INVESTING."
To us, this approach is counterproductive to long-term financial success because study after study has concluded that the critical factor is the ‘mix’ of stocks, bonds, and other assets owned. This mix, called asset allocation, is vital to the success or failure of your investment plan.
The easiest way to reduce risk in a portfolio is to increase diversification. Diversification does not mean just adding more securities or funds to a portfolio; it means adding asset classes that respond differently to various economic factors and market events, such as a recession. Ideally, some of the asset classes are moving up, while others are moving down, or at least moving at different rates. While counterintuitive, adding an asset class that is quite risky by itself, such as emerging market equity, can actually serve to reduce the risk of the portfolio as a whole, because it doesn’t move in lockstep with some of the other asset classes.
Diversification provides many benefits to a portfolio, but one of the hardest parts for investors to accept is that it virtually guarantees that you will always have underperforming asset classes in your portfolio. Fortunately, it also creates a strong likelihood that you will own the best performing asset classes as well. The key to a diversified portfolio is recognizing that it is extremely difficult to predict which asset classes will outperform in the future, and that it makes sense to have an allocation across an array of asset classes at all times.
The belief that diversification is critical and that short-term asset class predictions are nearly impossible does not mean that asset allocations should be static. In fact, we revisit our clients’ asset allocations annually, or more often if necessary, to reflect changing client desires or situations, as well as updated long-term (10-15 year) capital market assumptions. We use elements of Modern Portfolio Theory (MPT), for which Harry Markowitz was awarded the Nobel Prize, to help clients establish an asset allocation with a level of expected risk and return appropriate for their individual situation. The model helps us to select an optimized asset allocation for each client, without basing the results on feelings or hunches that can be biased by short-term events.
Asset allocation is a key element of our investment process. We believe that diversification, done collaboratively and honestly, will help investors build a balanced portfolio—one that they are confident and comfortable with through all phases of the market cycle.