The Value of an Advisor Part 3: Asset Allocation

Study after study has shown that a portfolio’s asset allocation – the precise mix of equities, fixed income, alternatives, etc., should be the most important determinant of investment returns. The percentages allocated to each asset class should be based on an investor’s financial situation, risk tolerance and time horizon. Vanguard’s Advisor’s Alpha® study suggests that the proper process of determining and implementing an investor’s asset allocation delivers significant value to clients, but is too unique to each investor to quantify in a broad sense.

Developing an Investment Policy Statement

The first, and most important, step in developing a sound investment plan is the creation of an investor’s Investment Policy Statement (IPS). The IPS outlines the financial objectives for the portfolio and any other pertinent information such as annual contributions, risk tolerance, annual withdrawals and time horizon. This may be the most critical endeavor for any investor. An IPS is a blueprint for a client’s entire financial house and when executed properly, provides a firm foundation on which all else rests. An often overlooked benefit of the IPS is how effective it is at helping clients tune out the ever-present market noise and stick to the plan. Unfortunately, many ignore this effort because it is often very time consuming, detail oriented and tedious. As we would not take off for a cross-country road trip without a map, the advisors here at Claris insist upon working with our clients to create an IPS at the onset of each client relationship.

Building a Portfolio

Once the IPS is complete, we build a client portfolio with each involved party understanding fully that risk and return are directly related, and that it is exceedingly rare to expect higher returns without a proportionate increase in risk. From here, we use broadly diversified, low-cost, tax efficient investment vehicles to give our clients exposure to desired asset classes, as revealed by the IPS. Following these evidence-based directives, an asset allocation can be implemented using a relatively small number of funds. With asset allocation, complexity is not necessarily sophisticated, it is just complex. In most cases, the greater complexity leads to little more than increased transactional and frictional costs. Simple is thus a strength, not a weakness. In fact, according to Vanguard and NACUBO, a “simple” 60% stock/40% bond portfolio has outperformed 90% of endowment portfolios over the last 1, 3, 5, 10, and 15 year periods.

A client’s asset allocation and IPS can change over time. As an investor’s ability, willingness and need to take risk change, we recommend changing the IPS and asset allocation accordingly.

The next step in delivering value to our clients is the cost-effective implementation of investment strategies. We will explore this topic on our next blog. If you have any questions about asset allocation or creating your IPS, contact Claris.

Read Part 1: 7 Strategies to Quantifying Value
Read Part 2: Asset Location

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