This blog explores how Individual Investors might benefit from Institutional Investor practices.
Financial Planning surveys say investors don’t plan. And commissioned Advisors don’t get paid to help investors plan. Further, when investment geeks talk, we digress into jargon and the investor hears gibberish. It’s no wonder Individual investors don’t have a plan.
In contrast, Institutional investors have to plan. Regulatory authorities require it. And good thing too. pension plans are responsible for the retirement income of millions. So Pension Plans put a lot of resources – time, effort, skill, money, technology – into planning.
The premise of this blog is that if Individual Investors don’t have a plan, then they can then mimic a pension plan and piggy-back off of all the work that pension plans do. For free. Herein we explore some pension practices and attempt to find practical implementation for the Individual Investor.
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A risk management approach to investment portfolio management delivers more consistent performance which means moderate and more predictable returns (which translate into faster compounding). Investor requirements are straightforward: Investors focus on risk, return, tax and cost. These requirements are attainable with a focus on what is controllable – investment process, reasonable expectations, investment policy, asset allocation, the amount of risk assumed, costs and tax efficiency and simplicity.
Whatever else the investor does, getting the Asset Allocation right is key. The point of portfolio management is protection of capital with prudent growth. Client requirements influence investment policy but any strategy must revolve around asset allocation. Asset allocation, as documented in the investment policy, is THE key to achieving desired risk and return characteristics … and asset class structure determines performance more so than individual securities. “… Institutional investors have, to a large extent, concluded that asset allocation decisions … account for the largest part of returns …” “Institutional investors know that they get the most value (80 – 90 percent) through asset allocation rather than through the asset manager.” (CFA Research foundation, Investment management after the Global Financial Crisis, October 2010, page 21).
For individual investors, a top-down, macro discipline adds value more so than bottom-up individual security selection. With a top down, macro discipline, the focus is on the most important and controllable portfolio management decisions: global asset class, region, country, and sector and currency decisions. This broad and global diversification is THE antidote to managing portfolio volatility … and opportunities for return diversification are global. In recent years, investors have seen (bottom-up) fundamentals take a back seat to (top-down) macro news. Consequently, asset allocation is even more important than normal. Large market oscillations warrant being more active around the strategic asset mix. I call this the active management of passive investments. Others would call it tactical asset allocation. Importantly, asset allocation also avoids the high cost and significant risk of individual security selection.
Mutual funds did a good job in their day. But, they are yesterday’s news. The roughly 1% embedded fee is intended to pay for Advisor advice (called a ‘trailer’). However, if the Advisor doesn’t advise, then the investor should not be paying the additional 1% fee. Simple. If the investor is not getting advice, then they ought to consider index funds or using Exchange Traded Funds (ETFs) or lower cost mutual funds which don’t include a trailer fee.