By Ryan Gilmer, CFA – VP Investment Management – TOPS ETF Portfolios
The interwoven network of the world’s global financial markets is inherently complicated.
Likewise, the investment strategies investors carry out are often laced with complexity, including sophisticated algorithms and computer driven trading carried out in milliseconds.
Despite the complexities of investing, many investors would be well advised to focus on 3 simple elements:
- Asset Allocation
- Costs
- Discipline (Behavioral Management)
When describing our strategies we tend to favor simplicity and we rely upon the proven principles that underline our decisions. As such, we rely on things like the law of parsimony, a principle stating that the explanation of an event should be made with the fewest possible assumptions. Perhaps you’ve heard of Occam’s razor, which similarly states that the assumptions made in explaining a thing must not be more than is necessary to fully explain it. Both principles have the same theme: the optimal solution should be simple and principles based.
Simplicity is important, but that doesn’t mean it is easy. For example, the concept of moving a 1 ton boulder a distance of 25 feet is simple. Anyone can look at the boulder sitting in one location and visualize it instead sitting 25 feet away. However, that doesn’t mean it is easy to move it.
In investing, these 3 simple elements may help to lay the base for sound investment strategy. However, we recommend utilizing an experienced investment team with a disciplined investment process to help navigate the complexities on global markets, as it is not easy.
Asset Allocation
Each of our portfolios has defined strategic allocations to equities and fixed income. But within these broad categories, our investment team analyzes over 30 underlying asset classes, all with different risk and return expectations and correlations to each other.
According to the Investment Company Institute, there are over 1,400 exchange traded funds (ETFs) domiciled in the United States. We can use these products to assemble asset allocation portfolios to fit different investor goals and objectives ranging from conservative, balanced, or aggressive growth.
Our research shows the various asset classes we use (including bonds, international stocks, emerging markets, commodities, REITs, and international bonds) provide diversification benefits through different risk, return and correlation attributes. Our ultimate goal is to combine these asset classes in a manner to optimize the risk/return equation for each level of portfolio risk. This simply means we strive for the highest amount of expected return possible for the risk we take. As such, we feel portfolios allocated only to only US stocks and bonds may be missing potential risk adjusted return opportunities over time.
Costs
Over the past few years, investors and researchers alike have debated the merits of index versus active investing. Typically, index strategies mirror a market index at a low cost. Active strategies typically charge higher costs, attempting to add value by beating index returns or by reducing drawdown in bear markets.
In both cases, however, the charges you pay to invest directly decrease your rate of return. Investors should be cognizant of the fees they are paying and should realize that higher fees equate to a higher probability that they forfeit a larger portion of their returns.
Trading costs and taxes are other fees that eat away at the investor’s rate of return. Again, ETFs have become increasingly popular because they score well in all three areas: lower annual costs (expense ratios), better tax treatment and lower turnover (which leads to typically lower trading expenses).
For example, the iShares S&P 500 Value ETF (IVE) charges just 0.18%. Vanguard FTSE All-World ex US ETF (VEU) and Vanguard Emerging Markets (VWO) charge just 0.13% and 0.15% respectively. Likewise, none of these three ETFs passed along fund level cap gains in the last 5 years.
Discipline (Behavioral Management) – Rebalancing and Tactical Allocation
Human beings tend to be bad at investing. We have a host of intellectual and behavioral biases, including recency bias, which make us bad gut feel investors. Recency bias leads us to assume recent performance will continue indefinitely, when in reality, returns tend to mean revert in the long run.