Am I Invested Correctly?
About the author: Chris Abts is the President & founder of Cornerstone based in Reno, NV. He helps people to better manage their wealth so they can focus more of their time on what truly brings meaning and fulfillment to their life. Abts is also the TV show host of Redefining Retirement, which airs every Sunday evening at 5:30pm on KTVN Channel 2. Chris has passed the Series 65 examination, earned the Certified Estate Planner (CEP) and Chartered Retirement Planning Counselor (CRPC) professional designations.
am i invested correctly?
We met with a couple last week that was referred to us by some of their friends. They have accumulated about $2 million dollars in their investment portfolio and they plan to retire in about two years. They came in to see us as they wanted our help to properly manage the risk in their investments, create a retirement income plan, and reduce their tax liability during retirement. One question they asked was, “How do I know if I am invested properly?” This is such an important question that I believe all investors should ask.
Unfortunately, the brokerage industry all too often offers poor advice in this area. As a result, it is extremely common for an investor to hold 20, 30 or more holdings of mutual funds, stocks, bonds, exchange traded funds, REITs, annuities, etc. Yet, studies show that a portfolio with this many holdings leads to poor diversification and lower returns.
Since there have been numerous studies that show that proper asset allocation is the most important concept when it comes to investment results, let’s first understand the different asset classes that exist. As it turns out, there are only five major asset classes: cash, commodities (like gold & energy), stocks, bonds, and real estate. So, to answer the question, “How do I know if I am invested properly”, let’s start by reviewing the two asset classes that should never be held: cash and gold. Cash held long term without purpose is a poor investment and will lose purchasing power due to the corrosive effects of inflation. Gold on the other hand produces no income and is not a critical resource. In fact, gold has averaged a little over 1% over the past 30 years.
Let’s now shift our focus to the two or three asset classes that should be held in an investment portfolio. The first is stocks. Quality stocks, both domestic and internationally have proven to increase in value over the long term. While many people try to predict whether the stock market will go up or down, the short term direction has always been unpredictable, but the long-term direction is very predictable. Anyone who tells you differently is lying. The second asset class that should be held is bonds. Quality bonds tend to move in the opposite direction of stocks. Used properly, bonds are designed to off-set the short term volatility of stocks. The third asset class to consider is real estate and energy. For higher net worth investors, real estate and energy can act as hedges against inflation. But for most investors, and those that want minimal complexity, a simple allocation to stocks and bonds is far superior.
Now that we understand the different asset classes to hold in a portfolio, let’s take a look at how to hold them in the most efficient manner. Based on years of data, the simplest and most cost-effective way to build an efficient portfolio is to hold a small basket of broad exposure exchange traded funds (ETF’s). As John Bogle, the founder of Vanguard, said, “if the data do not prove that indexing wins, well, the data are wrong”.
As a result, which is probably caused by poor advice from the media and the brokerage industry, most retail investors hold far too many investments in their portfolio as they are led to believe this will reduce volatility and increase returns. However, all that is really needed is a U.S. index fund, an international index fund, a bond index fund and a cash equivalent fund for future opportunities. Adding any other instruments will most likely add unnecessary complexity, risk and/or portfolio inefficiency, thus dragging down returns. Think of it this way, if a $35 billion pension fund can outperform their peers with a portfolio as simple as this, then you have got to ask the question, why not you?
At Cornerstone, as a fiduciary-based Registered Investment Advisor, it is imperative that we manage the assets of our clients in the most efficient way possible to generate return, provide for income distributions and manage risk. Our investment models are designed to try and maximize the return for the risk we assume using the fewest tools allowable.