3 Steps to Managing Your Portfolio
Implementing a disciplined money management process has three steps. They are: having a diversification strategy for a portion of your assets, having a process that reallocates the portfolio(s) on a regular basis, and adding money to the portfolio(s) periodically. The following is an outline of a strategy that I have found is an easy way to implement all three of these steps, doing it in a way that seems natural. I call this the Core/Satellite Strategy.
In the investment industry, some of the high-end money managers use a money management strategy with the same name. What I am referring to has similarities, but it is very different than how, say, Goldman Sachs would define the strategy.
Before I get into the whole picture, let’s first touch on the three main principles of the strategy and why each step is important and how, if done properly, they work. Then we will get into how you can put them all together.
The first of the three steps is to ensure you have a portfolio that is diversified. Diversification means you should not put all your eggs in one basket and try to own assets with a negative correlation. Negative correlation means if one asset moves higher, the other typically moves lower. An example of this is the U.S. dollar and crude oil. You also want to be diversified across different assets classes as well. Asset classes are US stocks, international stocks, fixed income, etc. If you believe as I do that the market is going to go higher over the next ten, fifteen, or twenty years and you have a long term perspective, then asset diversification ensures you will participate in this market growth. Your goal for these portfolios should be to come as close as possible to the over-all market returns. As an example, you do not want to see the market go up 30% over four years, and your Investment portfolio management software tag along at just 5% growth. Unfortunately it is very common that the average client’s portfolio will lag the market by a substantial percent.
The second step is to have a process that reallocates the portfolio on regular basis. Coming up with how your assets should be diversified — based on your risk tolerance and goals — is relatively easy. What takes discipline, work and focus is keeping your assets diversified. This may be the single biggest mistake the ‘do-it-yourself’ investor makes. They will get an account diversified, then a stock gets bought out for cash, or international funds outperform the US equities for a few years, and they do not sell international and buy the other asset classes that did not do as well, which would get the portfolio back in balance. I have seen different studies as to how retail investor portfolios perform versus institutional portfolios (institutional portfolios are pension funds, endowments, some trust accounts, etc.). In most of these studies, the institution portfolios outperform the retail portfolios. The primary reason is this step. They have a disciplined process to reallocate the portfolios on a regular basis.
The third step is to add money to the portfolio on a regular basis. As you have cash, either from a bonus, you sell an investment, or you find your savings or checking account is accumulating more moneyhen you need in them, you want to add some of these funds to your portfolio as part of this strategy. As you will see, it does not have to include all of the excess funds, nor do you have to do it every time. If you get into the habit of adding a portion of these excess funds on a regular basis, you will see your wealth grow with less stress over time.
When I refer to the Core/Satellite strategy, it can be explained as more of a way to manage the pieces, rather than the whole. As an example, most investors might make six or seven investments, such as a mutual fund in an IRA or 401(k), small business, a specific stock, etc…over a period of time. Most investors look at these investments individually for the most part, not as a whole — and this is okay. However, there is a piece missing.
As I said earlier, the high-end money managers imply that all the pieces of the Core and Satellite investments work together and they see (and invest in) all of the parts as a whole. For example, if you have $100,000 invested with them using this strategy, they would have some in a Core investment and then some in Satellite investments, and then they would make adjustments to the whole. They might have $60,000 in the Core, $10,000 in managed futures, $10,000 in a hedge fund, $10,000 in metals, and $10,000 in a REIT. The whole is $100,000 spread across five investments, but it remains one investment.
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