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Investing discipline by design

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Investors make their biggest mistakes at the extremes of the market, either by being too fearful near the bottom or too greedy near the top.

With the major stock indexes recently regaining all-time highs, we are reminded of the good disciplines that can help limit mistakes. Just in the last year, we had a taste of euphoria as many investors experienced the booming markets and began looking for places to ratchet up their risk and return.

We were not surprised to be asked “What is Bitcoin and where can I get it?” It is times like this, where good old diversification and traditional portfolio strategies start to seem…boring.

The urges to dive in or out of the markets are natural, but experience proves again and again that those urges are the enemy to successful investing.

Great investors typically have a design or framework that they use to help them think in certain terms about their investments while acknowledging the uncertainty of the future. For example, Warren Buffett designs his value investment style to be consistent with his holding period: forever. If he thinks of the stocks that he owns as perpetual investments it helps both he and his investors ignore the day-to-day noise and stay invested in the long term.

The genius behind Buffett’s design is that it acknowledges that the investing strategy that works best is the one that you can stick with. There is no better way to stay disciplined than to think of what you own as perpetual.

INVEST WITH INTENT

Using the word “design” to describe one’s investment strategy invokes intention and purpose. A designed portfolio is thoughtfully constructed to respond to both an unpredictable world and our own base instincts. Thinking in terms of design makes us consider not just what we own, but why we own it. What purpose does each stock, bond, or fund serve and does it act as a complement to the other assets and our own behavior?

Could we all design a portfolio like Warren Buffett? Yes, but one of the world’s wealthiest people is different from me and you. He isn’t balancing income and growth goals or weaving Social Security decisions into his thought process. We are finite beings, so our horizons are pulled a little closer to the here and now.

 

TWO SLEEVES

What if the design of the portfolio helped someone to hold on during the rocky periods and stay grounded during euphoria? The key to such a design would be to assign distinct profiles to two unique sleeves. One sleeve would be a long-term, buy-and-hold strategy that would constitute the core of the portfolio. The design features of this core portfolio are diversification, low cost and simplicity. Think of this as what the famous investor Sir John Templeton called the “Get rich slowly” strategy. This is the sleeve that might look boring, but when aligned with the long-term goals of a family, it is doing much of the hard work.

In a separate sleeve, one would place tactical or opportunistic investments that help create a sense of risk-taking and participation in the movement of the market. This opportunistic sleeve of your portfolio could hold actively managed funds with a unique strategy, speculative stocks, or illiquid investments like private equity. Conversely, it could be the place where cash is raised if fear creeps in. Simply knowing that this sleeve exists could help the investor stick with the core strategy that is designed for the long run. The key to making this strategy work effectively is to make sure that these two strategies remain distinct. The core is steady, the opportunistic is reactive.

In the end, portfolio design is a framework for understanding. It helps us understand the purpose for each investment that we own as well as the biases that can derail us. When well designed, our investments support healthy behavior and can increase our odds of success.

Dennis Morton is founder and principal of Morton Brown Family Wealth, a Registered Investment Advisor located in Allentown. He can be reached at dmorton@mortonbrownfw.com.

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