How We Do Investing and Portfolio Management Differently

By John H. Robinson, Owner/Founder

Our portfolio management style has been honed over the past 35+ years and has been shaped by critical thinking.  Just because the rest of the invesment industry has always managed money a certain way doesn't mean it is the optimal way.  "Question everything" has been our guiding mantra since Day 1.  Instead of accepting common industry practices as rote, the principles we apply are evidence-based, which means our portfolio managament recommendations must have empirical support and/or backing from credible domain authorities.  The 15 basic pillars of our investment management philosophy described below exemplify how intentional and circumspect we have been breaking away from the investment advisory herd.

• Occam’s Razor – Unnecessary complexity in terms of the number of accounts and the number of investments is often low hanging fruit in our investment recommendations.  Simply put, most people do not need to have multiple accounts at different banks and investment firms, nor do they need dozens of different securities to be properly diversified. Portfolio complexity ("diworsification") is inversely correlated to portfolio performance and optimization. Account and investment consolidation and simplification is a  common recommendation. 

• Expense Minimization – Academic research has shown that investment performance is inversely correlated with investment expenses.  Wherever possible, we seek to minimize portfolio management fees and expenses. This applies to our own advisory fees too.  Our pricing generally follows the Costo model - we provide great value at prices that tend to be much lower than our industry peers.  While some industry thought leaders have been critical of our pricing because we leave too much revenue on the table, our position is that our clients are paying us to leave as much money on their table as possible.

• Maximize Portfolio Flexibility- Since most consumers have limited resources to allocate across multiple objectives, where possible, we strive to incorporate account types and portfolio management strategies that may simultaneously address multiple objectives (e.g., Roth IRAs, 529 Plans, Trump Accounts).

• Optimize Cash Management – For the portion of the portfolio that needs to be risk-free and liquid, we often coordinate and link client bank accounts with their investment accounts to help make sure their cash is working as efficiently tax-wise as possible and is earning as much interest as possible. Many of our clients are small business owners, and improving corporate cash management is also low-hanging fruit for providing great ongoing value.

• A Curated Strategy for Investing in Individual Bonds and/or CDs – In the consumer market space, the “bond” (and “cash”) portions of the portfolio are regarded as the “safe” portion of the portfolio. For this reason, we only use individual securities, such as certificates of deposit (CDs), treasuries, agency securities, municipal bonds, and/or investment-grade corporate bonds.  We do not ever use bond mutual funds or ETFs because they are volatile in rising interest rate environments and do not provide the same assurance of return of principal that individual securities do if held to maturity.  In low interest rates environments, we keep maturities short.  We may extend maturities out as long as 5-7 years as interest rates rise.  Our objective is to capture 75%-80% of the long-term bond yields with limited risk to principal from rising rates.  The yield to maturity is known for each fixed income investment from the time it is purchased. In our view, the "safe" portion of the portfolio should be as close to risk-free as possible.

• Index Funds/ETFs for Growth – For the “stock” portion of the portfolio, there is overwhelming research support for using ultra-low cost, capital-weighted index funds and/or ETFs. In terms of portfolio construction, we will typically employ 1-5 index ETFs in taxable accounts for tax efficiency.  In retirement accounts, the preference is for open-end index mutual funds. The basic mix is typically 50%-60% large cap U.S., 20-30% U.S. Mid-cap/Small Cap, and 15-20% International. 

• Reimagined Risk Tolerance – We reject the standard industry practice of making investment allocations based upon the client’s stated “risk tolerance.” There is overwhelming research demonstrating that investor risk tolerances are ephemeral.  Consumers tend to have a high stated tolerance for risk when stock markets are rising and lower tolerances when they are declining.  Similarly, consumers view risk differently. For instance, some people may view the stock market as risky while others may view investing in stock market index funds as conservative.  

  Our experience is consistent with behavioral finance research findings that consumers feel more pain from market declines than joy from market increases.  In this vein, we recognize that many consumers’ fear of investment losses is attributable to lack of education and understanding rather than an amorphous individual definition of risk tolerance. At FPH, we strive to educate our clients so that the recommendations we make are truly the ones we believe set them up best to meet their planning objectives.  

  It is important for our clients to understand what they own and to plan in advance for potential problems that may arise in their portfolios. We strive hard to help our clients understand the difference between the risk of permanent loss and market volatility.  We illustrate what adverse investment environments may look like in their portfolios and explain to them how we plan for that in advance.  Our goal is to change fear of the unknown to educated acceptance that stock market volatility is both normal and expected.  For investors saving for future goals, we encourage them to view severe down markets as rare wealth-building opportunities.  

• Growth-Favored Asset Allocation – For investors who are more than ten years away from retirement, we reject the standard investment industry approach of apply applying risk-based portfolio models with varying allocations to bond funds.  Instead, for long term objectives, such as saving for college expenses or retirement, we will typically recommend a 100% allocation to growth using stock index funds/ETFs. Only as the objective nears (typically within 5-10 years), will we recommend gradual, opportunistic shifting to risk-free investments.  We avoid shifting the allocation from stocks to risk-free during periods when the stock market is depressed.  

  However, it should be noted that our growth-heavy allocation for long term investment objectives is a reflection of the relatively low interest rates available on risk-free assets today.  If interest rates were to creep much higher in the future, the attraction to higher risk-free yields can be expected to crowd out investors' appetite for stock market volatility.  While most planners today were not working in the 1980s or ealry 1990s when interest rates on CDs and treasuries were in the 7-10% range, portfolio construction for long term objectives such as retirement looked very different at that time than it does today.  Simply put, if we could get 10% interest on short-intermediate term CDs, our allocation to equities would likely be considerably more muted.  Investors should always be aware that principles of portfolio construction today should not be regarded as constant through time.

   

• No "60:40" Model Portfolios - We reject the popular, but not empirically supportable, notion of a universally optimal asset allocation for long term investment success.  The oft-touted success of the 60:40 balanced portfolio model is based upon the stability of bond returns through a period of nearly 40 years of declining interest rates from the late 1970s to the early 2020s. That long string of bond market success to offset stock market volatility is simply not repeatable in an environment in which bond interest rates are on the lower side of normal. If we were to experience a prolonged period of rising interest rates, we believe the 60:40 model would not provide the same comfort during down stock market years as it had in decades past.  2022 provided a text-book example of how that model might perform in a persistently rising rate environment.  The double-digit declines in the intermediate and long-bond indexes and paired with a double digit decline in the stock market, produced one of worst annual returns for that basic portfolio allocation in modern history. It also serves as to underpin the cautionary mantra that past returns are not predictive of future results.

• We Eschew Market Timing – Individual security risk can be effectively diversified away with index funds, but market volatility cannot.  Research has shown that while there are fundamental reasons why the market indices generally rise over time, over shorter periods, returns follow a random walk. Since bear markets are unpredictable in magnitude and duration, we believe investors should expect them to occur and plan and prepare for them in advance. This should enable them to avoid the temptation to react whenever sharp market declines may occor. 

• Dollar Cost Averaging for Growth – Whenever there is a new lump sum that is to be allocated to growth, our preference is to invest the money gradually over time.  As noted above, behavioral finance research teaches that individual investors are inherently risk averse and feel pain from declines in market value more than the enjoy gains from appreciation.  Investing a lump sum and seeing it decline 20% or more in a short period of time can be emotionally painful for consumers.  To ameliorate such "buyer’s remorse," we routinely employ dollar cost averaging as a powerful behavioral solution that enables consumers to not only tolerate near-term market declines but view them as a opportunities for wealth accumulation.

• Opportunistic (not automatic) Rebalancing - We do not endorse the industry standard practice of automatic portfolio rebalancing.  Research on the value of automatic rebalancing is mixed at best.  We prefer periodic/opportunistic rebalancing.  This is consistent with principles of tax efficiency and portfolio management simplicity.

• No Automated Tax-Loss Harvesting – As with automatic rebalancing, we view tax-loss harvesting as a tool that creates the appearance of sophisticated portfolio management, but lacks convincing empirical research support. As with auto-rebal, we again approach tax-loss harvesting opportunistically.  Although it is not entirely in our control, our great preference is to avoid having losses to harvest.

• No Alternative Investments – While alternative investments may play a significant role in institutional portfolio management, we believe the lack of liquidity and retail pricing makes them generally unsuitable in the consumer market space.  As a rule, we do not include alternative assets or strategies in portfolio construction. 

• Say No to Monte Carlo  – Most of the financial planning and wealth management industry uses software that applies Monte Carlo analysis to produce retirement savings and spending simulations. While this simulation methodology may create the appearance of sophisticated analysis, in truth it requires the user to make a broad range of assumptions about the standard deviations and expected returns about various asset classes and inflation.  Small differences in the assumptions relative to real-world outcomes may lead to dramatic disparities between the projections and reality when illustrating long periods of saving or spending.  Additionally, to the extent that advisors are making different assumptions from one advisor to the next, there may even be inconsistency of output even for advisors using the same software.

  To solve for that, we created our own retirement savings and retirement spending simulation software – Nest Egg Guru – which obviates the need to make assumptions about future market returns.  Instead of traditional Monte Carlo simulations, we apply bootstrapping with replacement as our simulation methodology.  In plain English, our simulations are generated by randomly sampling 50+ years of monthly return data from major stock market asset classes.  For bonds, we assume our users are investing in CDs or treasuries. We believe our simulation software is vastly more useful to consumers in helping them to realistically assess their retirement saving and spending preparedness.  We also make it easy for consumers to see how changing variables that are within their control may impact their results.  In doing so, our software is intended to make retirement planning more tangible and realistic.

The Final Word...

As with every element of our business model, Financial Planning Hawaii’s approach to portfolio management is thoughtfully conceived.  Each one of the principles outlined above has been developed through critical thinking and decades of experience in managing other people's money. We have zero interest in doing financial planning the same way as every other advisory or planning firm.  We take great pride in being one-of-one.