If you have a portfolio, chances are you probably know why you’re invested. Whether it’s a 401(k) or a brokerage account, your portfolio serves some purpose. But if I were to ask you which of the asset classes you currently hold provides you with the most income or best returns, would you know the answer? No judgment: Knowing exactly which one of your investments is your top performer on a daily basis is something I only did in my days as a portfolio manager. I’d guess you’re more interested in the outcome. In other words, will you have enough money to take that fabulous vacation through Italy or pay for your child’s education? Do you need money, whether it’s on a periodic basis or not, now or later?
Getting what you want
In today’s yield starved environment, I don’t have to tell you that it’s harder than ever to get the income you need to reach your financial goals. Here’s what you would find in your search for yield, before and after the financial crisis:
Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Your search pre-crisis probably led you to traditional bonds and occasionally into high yield, whereas today’s pursuit of yield likely forces you to look to different asset classes, like stocks. As my colleague Russ Koesterich says, diversification is an investing best practice, meaning that you want to hold a variety of asset classes in your portfolio. But how does one choose what to buy? Exchange traded funds, or ETFs, can be one great way to gain diversification and, at the same time, get the targeted and precise exposures you want.
Considerations for building an outcome oriented portfolio
There are many ways to construct an outcome oriented portfolio, but it’s actually possible to boil it down into four steps:
1. Determine the outcome, or goal, you are trying to achieve. It may seem a bit obvious, but it’s worth stating: Saving for your five year old’s college education requires a different investment strategy than saving for that Italian getaway you hope to take next summer. Once you have a goal in place, and a realistic timeline for achieving that goal, you can start building your investment strategy.
2. Define your asset allocation. If you’re saving for college, the appropriate asset allocation can be derived from factors such as your child’s age, how much time you have for your money to grow and risk tolerance. Answering these questions leads you from a very conservative portfolio (e.g. 70% in bonds, 30% stocks, 10% cash) to an aggressive one (e.g. 80% equities, 15% bonds, 5% cash).
3. Choose your investments. Once you’ve determined your objectives and risk tolerance, it’s time to select your stocks or bonds, mutual funds or exchange traded funds, or a blend of each. Just remember to keep it simple, though. We have seen even sophisticated institutions overcomplicate things, choosing many strategies which sometimes end up cancelling each other out.
4. Consider your portfolio weightings. Using your original asset allocation as a guide, you will need to periodically rebalance (buy or sell to return to the initial desired weights) to ensure you are still on track to meet your goals. Take it easy on the rebalancing though, as frequent trading may incur costs that eat into your return. If you have ETFs in your portfolio, the ease with which you can trade in and out means that you will be able to efficiently and cost effectively re-align your portfolio to help ensure it is positioned to do what you want it to do. Keep an eye on tax or capital gains opportunities and think a bit more about how different trades may impact your portfolio performance.
The key is diversification and monitoring your portfolio. The more aggressive (or risky) your portfolio is, the more closely you will need to monitor it.
Jane Leung, Managing Director, is Head of iShares Precision Exposures, where she and her team develop innovative ways to help investors reach their goals. You can read more from Jane here.