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.  Instead of accepting common industry practices as rote, the principles we apply are evidence-based, which means our recommendations must have empirical support and/or backing from credible authorities.  The fourteen basic pillars of our investment management philosophy are as follows.

• 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, you do not need a dozen or more mutual funds or ETFs to be efficiently diversified, nor do you need accounts at four different banks and eight investment accounts. Portfolio complexity is inversely correlated to portfolio performance and optimization. Account consolidation is a common recommendation. Portfolio simplification is another.

• 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.

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

• Optimizing Cash Management – For the portion of the portfolio that needs to be risk-free and liquid, we often coordinate and link accounts to make sure your cash is working as efficiently (tax-wise) as possible and as earning as close to the risk-free rate as possible.

• Income Investments – In the consumer market space, the “bond” (and “cash”) portion of the portfolio is 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.  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 that is purchased.

• Growth Investments – 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.  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. 

• Risk Tolerance Reconsidered – We reject the standard industry practice of making client 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 markets are rising and lower tolerances in declining markets.  Similarly, consumers view risk differently. For instance, some people 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 investments 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 the ones truly the ones we believe are best for their objectives.  It is important for clients to understand what they own and to plan in advance for potential problems that may arise in their portfolios.

• Asset Allocation – For investors who are more than 10 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 7-10 years), will we recommend gradual, opportunistic shifting to risk-free investments.  We strive to avoid shifting the allocation from stocks during periods when the stock market is depressed.

• No Market Timing – Individual security risk can be diversified way with index funds, but market volatility cannot be.  Research has shown that while there are fundamental reasons why the market indices generally rise over time, over shorter periods they follow a random walk. Since they are unpredictable in magnitude and duration, investors expect them to occur and plan and prepare for them in advance. Investors should not be adjusting their portfolios in reaction to a bear market.  The time to plan for a bear market is before it happens.

• 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, dollar cost averaging can be a powerful behavioral solution that enables consumers to not only tolerate market declines but view down-market volatility as an opportunity for wealth accumulation.

• Opportunistic (not automatic) Rebalancing - We do not endorse 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 approach tax-loss harvesting opportunistically.

• 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. 

• No Mont Carlo Simulations – 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 creates the appearance of sophisticated analysis, in truth in requires the user to make a broad range of assumptions about standard deviations and expected returns about various asset classes and inflation.  Small flaws in the assumptions may lead to dramatic disparities between projection and reality when illustrating long periods of saving or spending.  Additionally, to the extent that advisors are making different assumptions there is no consistency of output for advisors using the same software.

To solve for that, we created our own retirement savings and spending simulation software – Nest Egg Guru – which obviates the need to make assumptions about future returns.  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 simulations software is vastly more useful to consumers in helping them to realistically assess their retirement saving and spending preparedness.

The Final Word...

As with every element of our business model, Financial Planning Hawaii’s approach to portfolio management is extremely intentional.  We have zero interest in following the herd.  We take great pride in being one-of-one.