Building a Strong Portfolio in 7 Simple Steps

Originally published CNBCThe movement of markets is so incredibly complicated that even the world’s most skilled portfolio managers struggle mightily to “beat the market” over the long-term. Building a strong portfolio, therefore, must be similarly (and singularly) complex, right? Wrong. While portfolio architecture and management is not easy, here is a seven-step process that makes it surprisingly simple:

Step 1: Know thyself.

This ancient Greek wisdom is where we must begin, because personal finance is more personal than it is finance. Investing is complex because we are complex. Therefore, we must understand ourselves before we try to understand the markets. This means honestly gauging your time horizon and the returns necessary to meet your goals, but it’s especially important that you understand your willingness to take risk in the markets. You must take the gut-check test.

Step 2: Understand investing.

It’s true that you shouldn’t invest in something you don’t understand, because when times get tough you’re more likely to part with even the best investment strategy if you don’t sufficiently comprehend the logic behind it. My colleague, author Larry Swedroe, says in his unmistakable New York accent, “You oughta be able to explain your investment strategy to a fifth grader.” You should be familiar with the compressed history of “the market” and work to become conversant in the foremost systematic, academic approach to market investing—Modern Portfolio Theory (MPT).

Step 3: Design your portfolio.

Once we’ve acquainted ourselves with, well, ourselves (as well as the fundamentals of markets and investing) it’s time to build our portfolio. I’ve created a simple starting point for investors that synthesizes the essentials of MPT—by diversifying across a broad cross section of equity asset classes, favoring those that have historically outperformed—and a basic understanding of behavioral finance—by reducing portfolio volatility through the anchor of conservative fixed income. Refer back to Step 1 to determine if this balance of stocks and bonds is appropriate, or if it should be calibrated more aggressively (by increasing the allocation to stocks) or conservatively (by increasing the bond allocation).

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Step 4: Implement your portfolio.

Ok, now you’ve got the knowledge and the plan, but all of that is worthless if you don’t actually translate it into action. Because we have no control over market fluctuations, we must focus on controlling the factors that we can. Chief among these is the cost of investing. I recommend avoiding commission-sold mutual funds and “actively” managed funds with higher internal expense ratios, favoring instead no-load, “passive” or indexed funds in your corporate retirement plans, self-managed accounts and accounts under the stewardship of a financial advisor.

Step 5: Monitor—but don’t micro-manage—your portfolio.

You want to be cognizant of what’s happening in your portfolio but not obsessed about it, because paying too much attention to your portfolio usually works against you. Yes, certain actions may be advisable when markets move—see Step 6—but making major changes midstream typically hurts more than it helps. And if you absolutely must, when it’s appropriate, “get out of the market,” click HERE.

Step 6: Rebalance your portfolio.

Especially in times of significant market volatility, the inevitable question arises: “So, I’m just supposed to sit here and watch my portfolio get clobbered?” No, you need not sit idly by. If the market has moved enough that you’re getting a nervous feeling in your gut, chances are good that your portfolio is out of balance. In such cases, it’s entirely appropriate to bring your portfolio allocation back to its starting point through the act of rebalancing. While rebalancing has not necessarily been proven to “make you more money over time,” it does help reduce overall portfolio volatility.

Step 7: Fund your portfolio.

Too often, we seek to blame others—perhaps a spouse, investment managers or even the markets—for having too little in our portfolios. But while any (or all) of those parties may share in the blame, don’t forget that we—YOU—are the primary determinant of your investment success through the contributions you make. How your portfolio is structured absolutely is important (and that’s the focus of this article) but the biggest factor for success in investing is not the nuance of your portfolio management style, but your willingness to persistently save a meaningful portion of your hard-earned income. This ensures you can recreate your income at some point in the future when you’re unwilling or unable to do so.

How To Know When To Get Out Of The Market

Originally published CNBCHas the market’s recent volatility worried you? Me too. It’s inevitable. Apparently, it’s how we’re wired. But better understanding that wiring can give us a clear decision-making framework to help us know if and when to get out of the market.

The field of behavioral finance has demonstrated that the pain we derive from market losses impacts us twice as much as the pleasure we feel from market gains. For this reason, investors are well served to name and address these emotions instead of setting them aside as they (unfortunately) have been taught.

We’ve all heard of the cost/benefit decision-making model, but “cost” and “benefit” are intellectual constructs too distant from the actual emotions that drive our decision-making. We need to address the gut—the “pain” and the “pleasure” associated with a tough decision. The following four-step model seeks to merge the head and the gut. And while it’s applicable in virtually any either/or scenario, let’s specifically address the decision to stay invested in the market or to move to cash:

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1) The pain of staying invested is that I could lose even more.

Why The Stock Market Is Volatile, Why Volatility Hurts, And What To Do About It

Originally in ForbesUnless you made a resolution not to read, listen to or watch the news in 2016, you’ve likely noticed that “the market” is off to a stumbling start. Indeed, one glance at the headlines, at least the ones that don’t involve the presidential election, quickly reveals that the market is having one of its worst starts to any new year. This is a dubious distinction, to be sure.

The factors involved appear similar to those credited for causing the extreme volatility we saw in the fall of 2015—slower growth in China, falling oil prices, geopolitical instability and the threat of bankruptcies in junk bonds. But the optimist’s case seems equally compelling—high-quality bonds (the only kind I recommend) are performing very well, falling oil prices are good for consumers, the Fed’s interest rate rise signals a strengthening U.S. economy and the most recent jobs report was positive.

An objective view of the market reminds us that on every trading day in history, there have been compelling cases to be made for both optimism and pessimism—for purchases or sales. (Remember that every single security transaction involves a buyer and a seller, each of whom believes he or she is getting the better end of the deal.)

Ultimately, there is only one sufficient answer to the question, “Why is the market so volatile?” The market exhibits volatility because that is its nature.

The Market Volatility Survival Tool: True Grit

Originally in ForbesIs recent stock market volatility bugging you?

True Grit

Do you wince with every headline announcing Greece’s demise, China’s bubble(s), the Federal Reserve’s indecision or the Dow’s down day?

Do you sneak a peak at your portfolio’s performance more than quarterly (or perhaps even annually)?

Does market volatility tempt you to question your investment strategy, even if it’s well thought out and carefully implemented?

Does it weaken your resolve to resist the sky-is-falling siren song heard so frequently in the financial media, or the sales pitch du jour?

Having the right investment strategy is important—really important—and surely contributes to long-term success in building wealth. But no matter how superlative your strategy, it’s your willingness to stick with it that ultimately will help you meet your financial goals.

Short-Term Memory Threatens Long-Term Success

When it comes to investing, rely on long-term wisdom

Originally published CNBCWhen it comes to the market’s peaks and troughs, investors often don’t react as rationally as they might think. In fact, in times of extreme volatility or poor performance, emotions threaten to commandeer our common sense and warp our memory.

Don't Forget --- Image by © Royalty-Free/Corbis

It’s called “recency bias.”

What the heck is recency bias?

Recency bias is basically the tendency to think that trends and patterns we observe in the recent past will continue in the future.

It causes us to unhelpfully overweight our most recent memories and experiences when making investment decisions. We expect that an event is more likely to happen next because it just occurred, or less likely to happen because it hasn’t occurred for some time.

This bias can be a particular problem for investors in financial markets, where mindful forgetfulness amid an around-the-clock media machine is more important today than ever before.

Try thinking about it this way. In the high-visibility and media-saturated arena of pro sports, every gifted athlete knows that the key to success can be found in two short words: “next play.”

Does Greece Really Matter?

The Bigger Picture for You and Your Portfolio

Originally in Forbes“Greece is a tiny player in global capital markets. Its default is 100% certain,” says Larry Swedroe, Director of Research for The BAM ALLIANCE and the author of 14 books on investing, including his most recent, The Incredible Shrinking Alpha, co-authored with Andrew Berkin.

“The only question is how much and what they default on,” Swedroe continues. “But with a GNP that is similar to Rhode Island’s, Greece’s default should have little to no impact on the world’s economy, at least not directly.”

So why is everyone so worried?

Greek crisis

Because raging forest fires are kindled from a single, tiny spark. “Greece’s default could trigger a broader contagion, like a run on Portuguese banks or a lack of confidence in the ECU, that may have wider ranging implications for larger economies,” says Swedroe, my colleague.

The Disciplined Investor’s Worst Enemy: Tracking Error

Originally in ForbesLast year was a tough one for disciplined investors. Disciplined investors know that diversification is a key element of successful portfolio management. But investors who stayed the course and remained diversified were punished for it in 2014, at least in the short term.

Disciplined investors will continue to be taunted over the coming weeks and months by headlines touting the success of “the market” in 2014. “Which market is that?” many of them will ask.

Head in Hands

Well, “the market” we hear about most often is the Dow Jones Industrial Average, which represents only 30 of the largest U.S. companies trading on the New York Stock Exchange. A slightly broader barometer of “the market” is the S&P 500 index, a benchmark tracking 500 of the largest U.S. stocks. In this case, “the market” could more accurately be translated as “the U.S. large-cap stock market.”

The Real Danger In Overstating Returns (Like PIMCO)

Originally in ForbesAs if PIMCO needed any more bad press, The Wall Street Journal reported this week that the Securities and Exchange Commission is investigating whether the bond giant “artificially boosted the returns of a popular fund aimed at small investors.” While we should all be attentive to the results of this probe—because I’d bet my lunch money that its implications will be felt beyond just PIMCO—there is an even deeper issue to consider. And this issue has a more direct impact on our individual portfolios and money management choices. The real danger in overstating returns, and indeed the root of most financial missteps, is self-deception.

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“How’s your portfolio?”

Who among us wants to feel like a failure? We’ll generally avoid experiencing this sensation at all costs. So, absent conspicuous success, we permit ourselves to believe that we’ve at least not failed, frequently through self-deception.

The Top 10 Places Your Next Dollar Should Go

Originally in ForbesThere is no shortage of receptacles clamoring for your money each day. No matter how much money you have or make, it could never keep up with all the seemingly urgent invitations to part with it.

TOP 10 DOLLAR

Separating true financial priorities from flash impulses is an increasing challenge, even when you’re trying to do the right thing with your moola — like saving for the future, insuring against catastrophic risks and otherwise improving your financial standing. And while every individual and household is in some way unique, the following list of financial priorities for your next available dollar is a reliable guide for most.

Once you’ve spent the money necessary to cover your fixed and variable living expenses (and yes, I realize that’s no easy task for many) consider spending your additional dollars in this order: 

My bad! I was wrong about rising rates and bonds

Originally published CNBC

“I was wrong.”

There are few words strung together that possess such power to free us. In less than a second, we’re able to reconcile the inconsistency between our previous conviction and the apparent truth. Humbling, yes, but also strangely euphoric.

Well, I’ve earned the opportunity to claim said euphoria, as I must confess that I had bought into the most prevalent myth du jour surrounding bond investing. You’ll forgive me, I hope, because this misconception—like all of the most powerful ones—is especially deceptive because it’s grounded in half-truth.

bondpit

Let’s be quite clear: Rising rates simply do not guarantee negative bond returns.