The Investment Management PyramidSubmitted by Orange CA Financial Advisor | Sterling Wealth Partners on February 6th, 2017
Choosing an investment portfolio that will help you work toward your financial goals can be a confusing and daunting task. There is an enormous amount of conflicting advice and information available at the touch of a keystroke or through a 30 second sound bite on the financial news. As investors, we are constantly barraged with confusing ads from mutual fund companies, insurance companies and self-professed financial gurus. What we find as we work with clients, is that all this information either leads to “analysis paralysis”, where nothing has been invested, or where the client ends up holding a portfolio of the “hottest” funds of the month, leading to an overly concentrated and inefficient portfolio.
At Sterling Wealth Partners, we take a “pyramid” approach to investment management that is customized to meet your risk profile, time horizon and financial planning objectives. Our pyramid approach is comprised of three segments which build upon one another to create a cohesive financial portfolio. The three components are: goal planning, asset allocation, and investment selection.
The cornerstone or foundation of any portfolio should be having a clear understanding the purpose of the investment, the time horizon before the funds will be used and the tax aspects of the goal being funded. Having clearly defined goals and a laser focus on the eventual purpose of the funds is the basis for creating the next level of the pyramid – asset allocation.
Once the goal of the investment has been clarified, the next step is to create an asset allocation model that meets the client’s risk tolerance and time horizon. With asset allocation, we are not selecting individual investments but instead are deciding what broad “asset classes” will be used. The purpose of asset allocation is to hopefully diversify away some risk and volatility by using a variety of investment classes like domestic stocks, international stocks, bonds, real estate and cash.
We use a process called a “risk score” to determine risk tolerance and time horizon which helps in creating an appropriate asset allocation. Another important part of the asset allocation process is “tax location” where we try to optimize tax benefits by allocating asset classes between taxable and tax deferred accounts.
At the top of the pyramid is the final phase of the process – investment selection. Only after goals have been clearly defined and an asset allocation model determined, can the actual investments be selected. The first step in investment selection is to determine whether an active, passive or blended investment selection approach will be used. Active investing involves using a tactical approach and making bets on certain sectors, industries or individual companies. Active investing may generate additional returns over a more strategic or passive approach, but this isn’t always the case. A more passive approach is to diversify broadly across several asset classes, typically using index funds. The reality is that no one can predict which approach will work best, so we will typically use a combination of active and passive when determining investment selection.
Once the portfolio is designed, ongoing monitoring and rebalancing is needed as the economy, markets and your situation change. Investment management is not a once and done prospect – it requires constant monitoring.
By going through a structured process using the investment management pyramid, we can usually create a portfolio that will be consistent with your financial objectives, risk tolerance, time horizon, and tax situation. If you would like an independent, objective portfolio analysis, please contact us.