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Top 5 Portfolio Management Techniques

August 11, 2019

So today we’re going to talk about five main
techniques for portfolio management. And we’re going to look at when you use these,
how you might incorporate them in a portfolio, and how you might build these types of portfolios. So, how do you decide which of the five main
techniques to use? Well, really it depends on your goals. As with anything in portfolio management,
the journey depends upon the destination. And so, the first thing you want to do as
always, fall back on your financial planning. What does your financial planning say that
you’re trying to accomplish? What is your goal? What is your destination? That’s what’s going to drive the technique
you use in order to get there. Five main types, like I mentioned; we’ve got
conservative, we’ve got moderate, we’ve got aggressive, we’ve got income-oriented, and
then we’ve got tax efficient. Let’s take a closer look at each of those
five now in order starting with conservative. When would you use a conservative portfolio
management tactic? Maybe you’ve got a short-term time horizon? Maybe this is college savings? Your child is in high school, and you’re looking
at paying for college, you want to be conservative. Maybe you want to focus on principal preservation
because you can’t afford a large loss? Again the college example. Maybe this is a home purchase? Maybe you’re buying a home in the next couple
of years? You don’t want to put your principle at risk. We’ll look more at the techniques you might
use to get to a conservative strategy. But again, time horizon and risk tolerance
are going to play a large role in determining whether or not this is the right approach. So if you’re not conservative, what are you? Maybe you’re an intermediate approach? An intermediate approach, as the name implies,
it’s your mix of aggressive and conservative, somewhere in the middle. Here you’re focusing on some growth, yeah,
but also some principal preservation. This is your moderate approach. You’re moderate risk tolerance. And then you’ve got your growth approach;
this is more aggressive. This is when you’ve got a long-term time horizon. You’re willing to tolerate some fluctuations. You’re willing to see your portfolio bounce
around up and down with the hopes that in the long run, it will generate higher returns. Importantly, this isn’t the portfolio management
approach of swinging for the fences. Swinging for the fences or trying to hit the
proverbial home run usually isn’t really a portfolio management technique, it’s a gamble. What we’re talking about here is managing risk. Taking a little bit more risk than average
in order to generate higher returns, but doing it in a prudent manner, taking risks that
are well rewarded and still within a diversified portfolio. Then we have the income-oriented approach
this is where you’re not so worried about future growth. You’re worried more about putting dollars
in your pockets. Money you can spend in your bank account every
day from your portfolio. Maybe this is in retirement. Maybe this is just cash flow you need to live off of. And then, while we’re talking about income,
there are two main ways of generating that, there’s a total return approach and there’s
a dividends and interest approach. Dividends and interest: that’s when you’re
just clipping the proverbial coupons from your portfolio. So, your portfolio is kicking off cash in
the form of dividends interest payments and the like. You spend those you don’t touch the principal. The total return approach, that’s where not
only are you may be collecting coupons in the form of dividends and interest. You might be selling some securities, harvesting
some gains. Choosing how to generate that cash flow from
your portfolio. For many people that total return approach
is a more…a more reasonable approach to follow. Dividends and interest only, there are some
flaws to that. For some people it works, but for many that
total return approach to generating income is the way to go. And then the final portfolio management approach,
tax efficient. So this is where your primary goal isn’t just returns. It’s returns net of taxes. Now to be fair, taxes should be a consideration
in almost any of your portfolio management approaches, assuming you have some assets
in taxable accounts, but here this is the main focus. Maybe you’re in a high tax bracket. Maybe you have other sources of income that
are going to push your adjusted gross income up, and you want to make sure that what’s
coming out of your portfolio is tax efficient. Maybe here you’re focusing on qualified dividends
or long-term capital gains for tax efficiency. Maybe you’re focusing on municipal bonds for
tax efficiency. Those are the main portfolio techniques, let’s
talk about the building blocks. How do you get to those portfolios? And here you’re talking about, really, two
main types of assets. People talk about all different asset classes,
asset types. I focus on two, I focus on growth, and I focus on safety. And when I talk about growth, these are your
assets that, as the name implies, are intended to grow. They’re intended to generate higher returns over time. With those higher returns does come some higher
levels of volatility, of course, it’s a tradeoff like everything. You don’t get something for nothing when it
comes to investing. What kinds of assets fall within the growth pool? Well, I might look at things like stocks,
I might look at things like natural resources, I might look at things like real estate, I
might look at things like alternative investments as asset classes designed to generate more
growth from your portfolio. And then in addition to growth, you have your
safe assets. These are the assets that are designed to
preserve your principal, not fluctuate as much. Perhaps provide a solid foundation on which
your growth assets can rest. These are things like cash perhaps, and these
are things like high-quality bonds. Notice that word I use, “high-quality”
bonds: aggressive bonds, your high yield bonds, your emerging market bonds, your preferred stocks. Those should be part of the aggressive or
the growth pool. When you’re focusing on safety in the bond
market, you want those shorter and intermediate-term high-quality bonds because that’s really where
that safety and that stability is coming from. How you choose to combine these growth assets
and these safe assets will, to a large degree, depend on which of the portfolio management
techniques you’re focusing on. If you’re focusing on a growth portfolio,
you’re going to want obviously more of the growth assets, less of the safe assets. If you’re focusing on the conservative approach
to portfolio management, you’re gonna want more of the safe assets, less of the growth
assets of course. And then in the tax efficient or the income-oriented,
it’s going to be a combination of both and determining whether or not those assets will
help you accomplish the additional goals of tax efficiency and income generation, depending
on which the portfolio management techniques you’re going for. Once you’ve determine what mix of growth and
safety you want, of course, it’s how do you then implemented from a vehicle perspective? And that’s the topic of another article, another video. But importantly of course there are multiple
approaches some will use actively managed mutual funds, some will use index mutual funds,
some will use our preferred approach, which is an institutional approach of mutual funds
and exchange-traded funds designed to capture market returns while overweighting factors
that have proven to generate higher returns in the long run. Some people buy individual securities, that
can work for some. But that vehicle selection comes after determining
your mix of growth and preservation. And then of course as you put this all together,
you need to determine which of the portfolio management techniques is right for you? And that circles us all back to the financial
planning which is, what are your goals? What is your response? Importantly, what is your required rate of
return? When you ran your cash flows when you did
your financial planning, what rate of return do you need to meet your financial goals? Because to a large degree that’s the number
that’s going to determine whether you want an aggressive portfolio, a conservative portfolio,
an income portfolio, etc. And then, where do your assets lie? What kind of tax bracket are you in today? And what kind of tax bracket are you going
to be in the future, based on your tax projections and your tax planning? Because that’s going to determine whether
or not that tax-efficient portfolio is the one to focus on. As you can see, and as always, investing is
a very important discipline, but it’s one piece of the larger pie. Investing takes place within the context of
your financial planning, because without the financial planning, you’re not going to know
which portfolio management technique is appropriate for you. So, in order, first you do your financial
planning that leads you to which portfolio management technique is appropriate for you. Then having determined which is the appropriate
portfolio management technique, whether it’s conservative, intermediate, aggressive, whether
it’s tax efficient, or income generation, you then figure out based upon that what mix
of safe and growth assets is appropriate for you? What proportions? For most people, it’s going to be some mix of both. And then finally, what vehicles will help
you implement the strategies you’ve chosen? So there you have it, five main types of portfolio
management technique ranging from conservative to growth, incorporating perhaps tax efficiency
or income generation as a goal, and then determining what mix of growth and safe assets is appropriate
to get you there. For more on this topic or on any others visit
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