A Ritz Carlton Portfolio Review

Most people are familiar with the exquisite level of service associated with the Ritz-Carlton brand. Possibly the most definitive quote to describe that level of service is: “You can defend your price, or explain your value.” Most that have experienced the Ritz Carlton experience would agree with me that they don’t need to defend their price because the value speaks for itself. However, many investors probably don’t realized how under-served they are when it comes to the review of their portfolio. That is to say: what are you truly paying for when you pay asset management fees, commissions, or mutual fund loads? Can it be quantified? It may not be the most comfortable topic to discuss with your financial advisor, but after all he or she works for you, right?

Let’s cover some of the most likely components of the portfolio review process. (By no means is the following an all-inclusive list, however I feel they should be covered at a minimum.)

  1. What is portfolio policy?

The investment policy statement (IPS) should have been written prior to your first deposit. (Check my previous posts on developing this crucial component). There can never be enough written on the topic of investment performance, so I will not try to accomplish that goal here. Suffice it to say, your standard for performance should be as it relates to your individual investment policy and investment goals, not the broad market. Unless your goal is just to beat the market (which it rarely is). That is to say your questions should be framed like the following:
“As it relates to my overall return objective, how has my portfolio performed?”
“As it relates to my overall risk objective, has my portfolio experienced more or less than I expected?”

The same exercise should be done with the other aspects of your IPS like taxes, liquidity provisions and asset allocation.

Note: Other things included in the IPS would be the frequency of portfolio reviews, and whether your portfolio will be managed with or without discretion, etc. Needless to say, you need to spend some time on this part making sure it is done correctly.

2. What market expectations does your manager(s) have?

Developing capital market expectations is a big part of your investment manager’s job. Will equities outperform fixed income? How will alternative asset classes like commodities and real estate perform? What effect will interest rate policy have on the assets in your portfolio? Is the current economic environment sustainable or is there a significant probability of slowdown? All these questions and more guide the way your portfolio is constructed and positioned to achieve your investment goals. Further, these should be part of the portfolio review discussion (to the extent you permit it).

3. Why has my portfolio performed the way it has?

This can be a touchy subject. Why? Because it introduces the “luck or skill” argument when it comes to portfolio performance. Here’s the quick and dirty version: if your financial advisor manages to a benchmark it is rather easy to see how much “extra” return was added by having them control portfolio decisions. The difference between what your portfolio actually returned and what the benchmark returned is called “active return”. Obviously the benefits of having a manager control the portfolio decisions is to have positive active return. Otherwise you could have just purchased the investment that mimicked the benchmark. (Note: Consider that once transaction costs, management fees and taxes are included, this may be true.) My point is that you should be able to quantify the “active return” your manager is delivering to your portfolio.

4. The X-Factor

I call the X-factor all the stuff you really cannot quantify. It is how you feel during an office visit or when you call and hear a person on the other end of the phone. Do you feel reassured or more nervous after you talk with you advisor? (Hint: You should feel reassured!!) One of the greatest things about what I do as an investment consultant is the comfort I give clients that their plan is working. And further, if there are adjustments that need to be made, then we will make them before it results in a detriment to the portfolio.

It is true that a subset of this list may be enough in and of itself for a lot of investors. However, in today’s world of greater overall transparency including advisory fee disclosure and cost efficiency, advisors have to rise to the occasion to deliver the best client experience–a Ritz Carlton one!

5 Additional Things to Do in Volatile Markets- Part 2

A couple of weeks ago we started a two-part series to discuss recommendations in volatile markets.  As promised, here is installment #2 of things to do in volatile markets.

3) Diversify a bit more.  There is probably not enough written about diversification in portfolios, but it has been proven that superior returns are directly related to diversified portfolios.  From my experience, the problem with portfolios that experience volatility beyond the investor’s tolerance are the ones that are not diversified enough. This can happen for many reasons, but the quickest way to address and/or fix the problem is to have the portfolio reviewed by your advisor.  I won’t use this segment to discuss variance, covariance and correlation but suffice to say all these terms are important when it comes to diversifying your portfolio.

TAKEAWAY:   Building a diversified portfolio will dampen or lessen volatility in your portfolio.

4) Bifurcate risk:  What can you actually quantify?  Consider your appetite for risk.  Risk tolerance has two crucial aspects as it relates to your investing.  The first is your ability to assume risk, and the other is your willingness to assume risk.  Briefly I’ll say that although your ability to assume risk could be high (e.g. because you have high income or great wealth) your willingness to assume risk could be very low.  The latter is more psychological based (see point #2 on biases) and largely formed from our experiences.  Make sure your risk tolerance and thus your investing style reflect both aspects.  Here is a link to a really good risk survey that you may take and get some feedback from your current advisor about.

TAKEAWAY:  Understand what you can handle and have your plan built around that.

5) Consider your total wealth, not just your financial assets.  Many investors today do not have a plan that considers their “human capital” as well as their financial capital.  Human capital is simply defined as the value of your future earnings.  Obviously the younger you are the more you have.  The point I’ll make here is that a financial plan that doesn’t consider this major source of wealth for most Americans is an incomplete one.  Also worth noting is the fact that younger investors have longer investment horizons mostly offsetting the effects of temporary (be it current or not) market volatility.

TAKEAWAY:  Your entire financial picture = your future earnings + your current savings.

This recommendation list is by no means inclusive of all the strategies one can undertake in volatile markets.  Other important strategies include dollar cost averaging and tax-loss harvesting (see our Aug 10th post for more info on the latter).  And more than anything, count your blessings and be thankful for what you have.  If you are investing for the long haul you will most likely just remember this time as a blip on the radar.

 “Remember, whatever you focus upon, increases…When you focus on the things you need, you’ll find those needs increasing. If you concentrate your thoughts on what you don’t have, you will soon be concentrating on other things that you had forgotten you don’t have-and feel worse! If you set your mind on loss, you are more likely to lose…But a grateful perspective brings happiness and abundance into a person’s life.” (Andy Andrews, from The Noticer: Sometimes, All a Person Needs Is a Little Perspective)

5 Additional Things to Do in Volatile Markets

A few weeks ago I penned a post highlighting some of the most important things I recommend doing in volatile markets.  In light of the continued volatility, I thought I would provide some additional thoughts on what can be done to provide perspective and help ease any anxiety you may feel about your investment portfolio.

1) Focus on your number.  Do you recall the Fidelity commercials that were popular in the not so distant past about “knowing your number?”  They were designed to get investors to focus on their own individual plan.  My point in bringing that up is probably obvious.  Good portfolio performance is always the result of a strategic plan.  However, performance (e.g. investment returns) is just a metric.  Focus on reviewing the merits of the plan not interim individual investment performance.  Granted, one will inevitably lead to the other, but in my experience, investors often judge a plan by the performance of individual investments not the aggregate plan.  There are no solo acts in the portfolio, think of your portfolio as an orchestra.

TAKEAWAY (a big one!):  Conduct a periodic review of your plan with your advisor, and judge whether or not goals are being fulfilled instead of whether you are beating the market.  Most of the times, this revolves around a number needed for retirement which may take a little work on your part to create a monthly budget.  Most advisors can help you estimate what this number will be well into your retirement years.  

2) Put on a different set of lenses to avoid inherent biases.   Behavioral finance has grown as a discipline greatly in the last decade and half or so–just Google it.  I won’t be able to do justice to all the research in this venue, but will highlight the four biases I see the most often as a practicing investment consultant.  These are just behaviors to be aware of in order to get the most out of your investment experience.

Overconfidence– you weight the accuracy of your information more heavily than needed and feel your timing is never off.  For instance, you feel your ownership of Apple products and overall knowledge of Apple as a company justifies the overweight position in your investment portfolio, but in reality you need to diversify.

Regret avoidance – you let past mistakes prevent you from moving forward with good advice.  For example, you discount sound recommendations by your financial advisor because it reminds you of mistakes previously made in your portfolio.

Loss aversion – making sure you avoid losses is weighted more heavily than achieving gains.  So although you are able to assume more risk than average (i.e. because of your wealth), you choose not to because of your fear.

Confirmation bias – you tend to seek out and notice what confirms your own beliefs at the expense of undervaluing other information

 TAKEAWAY:  Sometimes seeing things from another angle helps.

(Next time we’ll cover the rest of the list…)