There are studies that show even a bad investment philosophy executed consistently will outperform the average investor. Why? Because the average investor tends to be swept up by emotion and headlines and follows the herd. This behavior often results in buying high and selling low.
What we seek, however, is a recipe for buying low and selling high. While some investment strategies can ‘beat the market’ in the short-term, we have seen no credible evidence that any strategy can do so consistently over time.
To accomplish our objective, very simply put, we create three buckets of money each with a different time horizon. Money that you will need in the coming year will fall into your short-term portfolio. Assets that you will need to utilize in the next 2 to 7 years create your medium-term portfolio. And any money that you won’t need for 7 years or longer funds your long-term portfolio.
Your short-term portfolio is held in (virtually no risk) checking, savings or money market* accounts. Your medium-term portfolio is typically invested in (low risk) short-term fixed income investments. And your long-term portfolio will be comprised of (riskier) equity, alternatives or fixed-income positions as appropriate for your age, risk tolerance, and goals.
Why the three portfolios? By safe-siding funds you will need in the next rolling seven years, you reduce the risk of principal loss for money that you know you need to spend, and don’t want to stay up at night worrying about. The long-term portfolio, however, can afford to take more risk (resulting in higher gains or losses). In our experience, market cycles tend to be three to seven years, your long-term portfolio can afford to wait out volatility associated with higher risk investments. We view time ‘in’ the markets as more important than trying to time the markets.
During the course of an economic cycle, we have observed that each asset class ‘has its day in the sun’. We don’t know, however, in advance, which day that will be. However, we do know that asset classes tend not to move together. Some will be going up while others are going down. By creating a diversified long-term portfolio across different asset classes based upon your risk tolerance, we create the opportunity to relatively buy low and sell high. When an asset class rises, we harvest gains from that asset class and redeploy that cash to an under-performing asset class.
In addition to the strategy above, when markets decline, we harvest tax losses** in non-retirement accounts that will directly reduce your tax liability. We then redeploy that cash immediately back into the market in the same asset class to maintain your overall strategic asset allocation. But, you now have an additional ‘asset’ to offset future capital gains and/or up to $3,000 per year of ordinary income. And, your portfolio balance remains the same as it was before the harvesting exercise. Finally, when deploying new cash to your long-term portfolio, we seek to fund the asset class(es) that are furthest below their target allocation.
Of course, part of the success of this model is to be disciplined about its execution in good times and bad. Our strategy helps us and you do this by keeping the emotional brain in-check, therefore, implying the rational brain stays in-charge.
* An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
** Tax loss harvesting is not suitable for all investors. Please consult your personal tax advisor as to whether tax loss harvesting is a suitable strategy for you, given your particular circumstances. The tax consequences of tax loss harvesting are complex and uncertain and may be challenged by the IRS. You and your tax advisor are responsible for how transactions conducted in your account are reported to the IRS on your personal tax return.