As discussed on our Financial Planning page, we believe that proper investing is done with a process, not a product. After you have documented your goals (step 1), the next step is to assess your personal (family's) risk tolerance (step 2) and then select suitable investments (step 3).

In the absence of assessing one's risk tolerance, most people just look at the historical returns of a stock or mutual fund and make their decisions from that limited information. Many people do not realize that numerous studies have been done and proven that less than 20% of investment managers can repeat their top performance from one 5-year period to the next. In a large study performed on the investments within many pension and endowment funds (organizations with a required distribution flow, much like a family), it proved that over 90% of the investment return of a portfolio comes from asset allocation:
 
 
 
Asset Allocation
So, what exactly is asset allocation. Asset allocation is the single most contributing factor to the long-term performance of an investment portfolio. This is done by dividing assets among major categories such as cash, bonds, stocks, real estate and other areas. Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a settlement for mediocrity, but for most investors it's the best protection against major loss should things ever go amiss in one investment class or sub-class. Here is an example of what true asset allocation looks like.

But there is a big problem with this methodology. All of these asset classes are not always on top and so people try to time the market. The chart to the right highlights how poor your investment performance would be by missing just 60 of the best days in the last 10 years. The next chart below reflects the investment returns for each asset class over the last 20 years. The top row is the best performers and the bottom row is the worst ones. Do you see any pattern? There really is no pattern other than what goes up goes down and what goes down goes up.

With this information it should become obvious that the object of the game is not to pick the best performing class or manager but to pick the most consistent performers; ones that are disciplined and perform well compared to their peer group and the relative benchmark; and ones that have an investment path that is suitable for your specific needs. From our experiences, the very best advisors perform the following steps for their clients:
 
Step 1 - Review Your Personalized Financial Goals & Objectives
Whether or not you complete our customized Financial Life Planner™ or some other document, the best way to plan your finances going forward is to make the best attempt you can at documenting your cash flows throughout your life. If done properly, it will conclude the investment rate of return required to meet all these goals. Without preparing such a model could result in you pulling cash out of an investment portfolio at an inopportune time in the market or leaving large amounts of cash on hand without being properly in the market. Any investment advisor worth their salt would want to see these goals, flows and results before making a proper recommendation for investing.

Step 2 - Assess Your Personal Risk Tolerance
Once you have completed a financial model and have determined the required rate of return, you have a decision to make: do you invest to a rate of return equal to, greater than or less than that required rate. Of course nobody wants to leave money on the table by under-investing but very few people properly screen themselves to determine what the rate of return of a portfolio would be based on the volatility that they can handle. Let's face it, if the portfolio moves up and down to an uncomfortable level, you will exit and never achieve its long-term rate of return. Completing a properly worded risk tolerance questionnaire will help you determine what volatility level is appropriate for you. 

Step 3- Create a Suitable Investment Portfolio
Now that you have documented your goals (step 1), and assessed your risk tolerance (step 2), you can get started on creating an investment portfolio. Ideally, your target investment rate of return should be between the rate you need/require (as determined in the financial model) and your risk tolerance level rate (as determined in step 2 above). Unfortunately, this too is a very overlooked, underanalyzed area. Most people in fact often skip the model and risk tolerance process and just jump right into picking investments. Investing, if done properly, has many issues to consider.

The most marketed form of investing is the mutual fund industry. Fidelity, Templeton and many other companies spend an enormous amount of marketing dollars to bring in billions of dollars of assets.This is normally a suitable product for certain investors with small amounts to invest. There are, however, several pitfalls and issues when investing in a mutual fund that many people are not aware of. Click on the image to the right here for a comprehensive summary.

The newest form of investing that is sweeping the industry is one that GCD has embraced fully. It is referred to as Separately Managed Accounts (SMA). SMAs are accounts for investors that are looking for a more tailored approach than with mutual funds. This is not to say that it is necessarily for more sophisticated investors, but can be a valuable tool with many benefits and processes that help to enhance the ultimate values that investors need in order to achieve their goals. As can be seen by clicking on the image to the right, a portfolio can have the same annual rate of return and yet can result in LOWER values at the end of a timeframe. GCD is very focused on the values, and not the rates, to ensure that our clients do in fact achieve their goals. Although not all SMAs use these processes, we believe that a better SMA starts with these Steps 3a through 3c. By adhering to these steps, it takes away the focus on pure return and focuses more on the path to the return which leads to better values:

Step 3a - develop forward looking risk, return and correlation assumptions
This needs to be done for all the different asset classes that are suitable for you. This is something that very few investors ever do. They tend to just look at past history which, as we know, has very little relevance on the future. That's because this is a very difficult task that requires the input from one of the few massive, independent research and analytical firms such as RogersCasey, Callan Associates, Inc. or Mercer Investment Consulting.

Step 3b - determine the proper asset class mix
Using the forward looking assumptions from one of the firms mentioned above, models are created mixing the various asset classes in order to take into consideration the various levels of acceptable volatility for different risk tolerances. Below is a summary of the historical performance and high/low performance of several equity mixes over the past nearly 30 years. You should find the results very interesting.

Step 3c - choose suitable investment managers
Using a rigid, scrutinous research process, only available at certain investment firms, suitable, efficient investment managers within each asset class required are selected. Again, this is NOT chosen purely based on past performance but is determined based on the Six P's: Philosophy, People, Process, Product, Progress AND Performance. See below to see exactly how GCD can make these selections with you.

Step 4 - monitor the ongoing investment process
Once an investment portfolio is crafted and implemented, the process is far from over. In fact, it is NEVER over. If done properly, your advisor should monitor not only your investments but should make sure that issues that would effect your financial model, income taxes and other financial issues are periodically being addressed to make sure these investments remain suitable for you. If not, there should be changes. But these changes should not be market driven!

So how exactly does GCD get involved? Click here to see our complete process.
 
Contact us if you would like to learn more about our unique process or any of the other topics in this section.

Please go back to Financial Planning to learn more about the other steps in this process.