Reevaluating Your Investment Philosophy

Every advisor, myself included, has an investment philosophy from which all investment recommendations are developed.

Advisors will regularly reevaluate their investment selection, but rarely do they re-evaluate their investment philosophy.

With the availability of new information, the introduction of new products and the discussion of new strategies, it may be time to reconsider some long-entrenched thoughts regarding investments.

Investment philosophy considerations

Here is a short list of considerations that I have gathered from various advisors. This is not an all-inclusive list, as there is a multitude of items and issues to consider. How do you currently feel about your response to each bullet point? Is it outdated?

  • — Passive versus active management, or a blend
  • — Fund family (e.g., if fewer than 35 fund options, eliminate due to lack of selection for inter-family transfers)
  • — Company’s trading infrastructure – a small fund company may not have the trading capability of a larger firm
  • — Style purity, portfolio characteristics, number of holdings, risk/return profile, investment philosophy of fund manager/team
  • — Small-basket strategy – a few well-chosen stocks
  • — Use balanced funds for core, allowing the fund manager to decide on the allocation of growth versus value
  • — Management tenure, support team, compensation structure, succession plan
  • — Expense ratio
  • — Portfolio turnover, tax efficiency
  • — What is your definition of asset allocation? For example, what is the makeup of your “moderate” portfolio? Is it 50/50 or 40/60 equities to bonds or something entirely different?
  • — Will you compare selected funds to their corresponding index (apples to apples)?
  • — Is this a qualified or non-qualified portfolio or a combination of the two?
  • — How do you incorporate fringe/alternative investments into your larger portfolios?
  • — What is your sell discipline or risk management process (very important to high net worth clients)?
  • — How long does an investment stay on your watch list before you make a change?
  • — How often will you review and evaluate your pick list? When do you rebalance a client's portfolio?
  • — Do you want to be true to the top picks or evaluate top picks based on wholesaler relationships (a second set of eyes watching out for your clients’ investments)?
  • — Do you believe in timing the market? Sell in May, then go away? What about October?
  • — How do you handle clients who are decumulating their portfolio; pulling money from their accounts to live on? Do you incorporate a three-bucket strategy for the portfolio?
  • — Time period – when does the client plan to use the money?

As I mentioned earlier, there are several points to consider when creating an investment philosophy and ultimately a pick list. Allowing your biases to come into play during the evaluation process could be detrimental to your clients. Sharing your thoughts with other knowledgeable individuals and being open to hearing their feedback can be one of the most important actions you can take.

After you determine your investment philosophy, what next?

  1. Determine your filters; run them through a program such as Morningstar (broad based filters)
  1. Conduct your due diligence
  1. Determine how you would like to select the finalists
    • Secondary set of filters (more specific than above)
    • Wholesaler relationships (second set of eyes offering their perspective)
    • Biases of client, i.e., socially responsible investments
    • Talk with other advisors and peers
    • Read, e.g., Wall Street Journal, newsletters such as Advisor Perspectives
    • Listen, e.g., economists you follow
    • Crystal ball J
  1. Fill in your investment grid – selected investments by asset class
    • Consider having three options for each asset category. If something goes awry with your one small cap fund, you have to take time to evaluate what your new small cap fund will be. Having at least a second and maybe a third option available can save you time.
    • Are there holes in your investment grid after the initial analysis?
      • Re-do or adjust filters
      • Consider ETFs
      • Discuss options with wholesalers
  1. Put the investment grid aside for a day or two, then review it with a fresh set of eyes
  1. Provide your investment grid to wholesalers prior to your meeting so he or she can come prepared to discuss ideas
  1. Review your investment grid on a quarterly, semi-annual or annual basis
  1. Determine how best to communicate to clients when and how you make changes in the portfolio

Are you inundating clients with investment information?

Your clients are generally not that interested in learning about how you make investment recommendations – engineers and those truly interested in investments being the exception. Your clients are, however, interested in knowing that you have a process for researching and reviewing investments on a regular basis, so be sure to share this information with them at a high level.

Are you focusing too much of your time with clients discussing investment performance? If so, you are training your clients to focus on investment performance. By doing so, you may be setting yourself up for the loss of a client.

Another advisor can come in and show your client how they are a better portfolio manager than you. It is easy to create an example that outperforms the portfolio you developed. All they have to do is change the dates on the analysis to a better performance period to illustrate better performance.

Even if they are not a better portfolio manager than you, they may be a better salesperson than you, making your client wonder why you are not employing whatever strategy this salesperson is selling.

The family index

I don't remember where I first learned of this idea, but I think it is great.

Instead of focusing on portfolio performance as it compares to say the S&P 500, compare a client’s portfolio performance to their family index. Their family index is the return they personally need to earn to reach their goals, e.g., 8.37% on average to reach their retirement goal. When your client comes to you and says, “My neighbor earned a 17% return from his broker,” you can respond. You might say, “We can increase the aggressiveness of your portfolio to try to match what your neighbor earned, but why would we unless your goal has changed, which is an entirely different conversation.

It is important to me that you understand the difference between your neighbor's or Dow Jones’ returns and your family index. When you understand how important your family index is compared to what your neighbor or the media and newspapers are discussing, you will be able to disregard the “noise” you hear from outside sources and have comfort in knowing that your family index is really all you have to be concerned with."

Helping clients avoid pitfalls

As an advisor your biggest value is in managing clients, not the portfolio. This includes managing portfolios with an eye toward the risk clients are willing to take. The smartest allocation possible doesn’t help much if a client doesn’t stay with it.

An important point of differentiation – The fiduciary standard

Looser rules currently in effect (until the DOL regulations kick in for retirement accounts), which only require brokers to recommend investments that generally fit clients’ needs and tolerance for risk, are costing investors as much as $17 billion per year, according to White House economists, because self-serving brokers are investing money in inferior products.

If you currently adhere to a fiduciary standard that requires you to put clients’ interests ahead of your own, share this distinction with your clients.

Investment policy or investment strategy statement

Many advisors use an investment policy statement (IPS) as part of their conversation with clients regarding investment selection. If you don't currently have an IPS available to you, I am happy to send you a sample. Be sure to get approval from your compliance officer/OSJ before using an IPS document.

An important strategy

If you have a client who is thinking irrationally about an investment, here's a technique you can use to work through it with him or her. It's called the Best-Worst-Most Likely exercise. Say a client insists on moving 50 percent of his assets into gold. Try saying, "Before we do anything, let‘s talk about three scenarios: the best case, the worst case and the most likely case. Is it okay if we do that?” When he or she agrees, lay out each scenario and ask for the client’s thoughts. If the client is missing something you think is an important point, ask him or her to consider it. Many times irrational investors only see the best-case scenario. A quick look at other possibilities can change their mind.


My clients are familiar with my one-liners. I have a document where I compile good ideas I hear or have read. Below is my list of accumulated one-liners that relate to investments. As with the family index, I don't know where I heard or read about each thought.

  • — You and I together will select, hire and fire investment managers.
  • — You know as well as I do that if you practice diversification and asset allocation, you are never going to do as well as one spectacular asset class or stock will. But nobody knows what that asset class or stock will be.
  • — Good advice outperforms great investments.
  • — Investments, the one thing Americans won’t buy on sale.
  • — Clutter is not diversification.
  • — No load is a lie. It should be help vs. no help. Fund companies have to sell these funds to make a profit. Huge dollars go into marketing and advertising.
  • — Wealth accumulation is driven by behaviors, not by performance.
  • — Volatility is not risk; it’s volatility. You don’t lose until you sell.
  • — Journalists sell copy, not advice. News is often irrelevant to your ability to reach your financial goals. Tune out when it comes to investment news. Don’t feel that you need to react to every bit of information you hear.
  • — You can’t make a good investor out of a pessimist.
  • — Advisors create portfolios in this order: Performance > Positioning > Process > People > Philosophy. Institutional investing looks like this: Philosophy > People > Process > Positioning > Performance.
  • — Whenever you need money, there will be a smart place to get some.
  • — Sometimes, liquidity allows clients to do the wrong thing at the wrong time.
  • — If you always sell your doubles, you will never hit a triple.
  • — I am not here to focus on performance and prediction. I’m here to provide perspective and planning. I am looking for progress, not perfection.
  • — Your investments aren’t working very hard for you. In fact, they are virtually unemployed.
  • — Rebalancing = not overhauling an engine, just tightening a few bolts.
  • — We will create two portfolios, distinct from one another. One will be your core portfolio, which will provide you with your basic living expenses for as long as you live. The other is your discretionary portfolio, which is designated for additional expenditures you wish to make that are not part of ongoing expenses.

A good reminder and food for thought

Investment professionals get it wrong 30-40% of the time even with large budgets and teams of people behind them. Many have the luxury of visiting the headquarters and/or factories of the companies in which they invest. How can we do better than them? Yet, our clients expect this of us. How do we deliver the message that the majority of the time we likely are not going to perform better than the professionals?

As you sit down, either by yourself or with your team, to review your investment choices, take time to evaluate your current investment philosophy to be sure it is not biased or outdated.

If you feel you are too close to the subject, ask one or two trusted wholesalers for their opinion. This is a terrific value add they are happy to offer.

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