About
HOW WE INVEST
Before we invest, we need to first understand why you are investing, what the goal is for the investment, and what level of risk you are willing to take on as the investor. Whether you work with us to develop your goals, time horizon, and risk tolerance through our financial planning process or determine them on your own, it is a critical part of our investment process as it dictates how we invest your assets.
Once objectives and risk tolerance are determined, we can invest the assets in such a way to optimize the chances of meeting your goals while staying within your risk tolerance. It is important to understand that all investments involve risk. If you want to earn more return, you have to be willing to take risk. The goal of our investment approach is to maximize the amount of return we earn for our clients for the amount of risk they are willing to take. In other words, we are looking to increase the efficiency of the portfolio. In our attempt to maximize efficiency, we seek to:
Optimize Diversification
We optimize diversification through the use of a risk parity investment approach. Standard asset allocation tends to overweight risk towards stocks in such a way that even a seemingly balanced allocation such as 60% stocks, 40% bonds still has over 90% of its risk coming from stocks. This leads to a less-robust portfolio that is highly dependent upon stocks performing well. Risk parity tries to solve for this by diversifying into several assets so the portfolio is not as dependent upon just one.
When implementing our portfolios, we diversify funds across a broader variety of assets to create a portfolio that has a higher potential for efficiency (higher return/risk ratio). This portfolio generally consists of stocks, treasury bonds, commodity producers, treasury inflation-protected securities (TIPS) and gold.
To find balance among these assets, we must first realize that every asset has a certain expectation of economic growth and inflation already baked into its current price. As actual growth and inflation play out against these expectations, the prices of assets adjust accordingly.
We must also understand that each asset is predisposed to perform well in a certain economic environment, as shown in the chart below. For stocks, they tend to perform well when economic growth is higher than expected and inflation is lower than expected. However, this economic environment may only be expected to occur 25% of the time (it is one quadrant of the chart). Therefore, we want to include other assets that tend to perform well during the other economic environments. A risk parity approach seeks to create a portfolio that spreads risk more evenly across each of these economic environments because you never know which one will occur next.
Limit Expenses
We minimize trading expenses by investing in index funds that utilize passive approaches that tend to have lower expense ratios than actively managed funds.
Optimize Tax Efficiency
As an investor, you never want the tax tail to wag the investment dog. However, you always want to make prudent decisions when determining what types of assets to hold, where to hold them, and how long to hold them. We seek to improve tax efficiency by holding highly taxed assets in tax-advantaged accounts where possible. In taxable accounts, we try to reduce taxes by using investments that help limit our capital gains to the long-term variety (which is a lower tax rate than short-term capital gains).
Mitigate Turbulence
For clients that prefer to add an additional hedge to their portfolio, we use portfolio insurance (e.g. buy put options) to protect against turbulent events and target a more standard distribution of outcomes. We also sell call options against holdings (covered calls) in order to help offset the cost of the put options and provide an additional hedge against underlying holdings. The trade-off with selling covered calls is that you are giving away some of your upside potential in order to increase current income.
Despite the efforts listed above, it is still important to understand that all investments involve risk. The risks of trading derivative contracts, such as options, are substantial.
*Note - The graph shown on this page does not depict actual investment results and does not make any claims about future investment performance. The image is solely for the purpose of conveying the concept of risk parity.
