Do you know a good investment portfolio when you see one? Based on my experience, few investors do. In fact, the investment industry thrives on the prospect that you don’t know the difference between a good portfolio and a bad one. Of course, the former will usually be much less profitable for them than the latter, so your ignorance about this is one of the keys to Walls Street’s amazingly profitable business model. Since managing your investment portfolio is basically a tug of war over profit between you and everyone else in the investing game, it is critical that you gain the best foothold and grip you possibly can before the pulling even begins. Your effort in this struggle is expressed in the way you manage your portfolio – including your TSP account – during your lifetime. The decisions you make today, tomorrow and twenty years from now will determine how well you do taking your share of the profit that’s out there to be taken.
I think it’s useful to try to distill this complex recipe for managing your investment portfolio down to its essential ingredients. What makes an investment management strategy good? Good decision-making. What makes decisions good? Their effectiveness in moving you toward achieving your objectives. What moves you toward your objectives? The right mix of investments. What is the right mix of investments? It depends. The right mix of investments for you and your situation depends entirely upon where you are, where you want to go, and how you’d like to get there. But, although each investment portfolio must be evaluated within the context of its beneficiaries’ unique set of facts, there are a number of characteristics that all good – the very best – investment portfolios have in common. A good portfolio is always:
- Risk Averse. Your portfolio should not expose you to any more risk than is necessary to meet your needs. For some this will mean a portfolio composed of mostly stocks. For others, it will mean all cash. For most, it will mean something in between. For every investment portfolio, there is a minimum level of risk and return that are necessary to safely achieve its objectives. You must identify this level before you can evaluate the quality of your portfolio.
- Cost Efficient. A good portfolio achieves its objectives at the lowest possible cost. If you’re portfolio costs more than about 0.20 percent to own, it could probably be better.
- Risk Efficient. Risk is something to be avoided, when- and wherever possible. To know the quality of your portfolio, you must know how much return to expect from it and how likely it is to deliver something else. A good portfolio delivers the expected return you need with the least possible risk. Risk efficiency is achieved by properly diversifying your portfolio.
- Tax Efficient. Like other costs, taxes must be minimized in order to maximize the quality of your investment strategy and the portfolio it produces.
- Simple. A good portfolio minimizes complexity and avoids using unnecessary components. If your portfolio contains more than 20 securities, you can probably do better. When it comes to selecting the building blocks of your portfolio, fewer is better than more. You should be able to quickly review and assess your portfolio’s performance from a few account statements that each contain no more than a handful of securities and transactions each year.
- Transparent. You should clearly understand what each element of your portfolio is, and what it is supposed to do. Trust is not something that should be given to anyone in the investment business. It should be earned, and then given only sparingly and where absolutely necessary. A portfolio that you contains unknowns is not good.
- Easy to Manage. Professional investment managers are good at making what they do seem too complex and mysterious for you to do yourself. The truth is that most of what goes on in retail investment management is activity that is more valuable for justifying high fees than anything else.
Take a hard look at your portfolio and evaluate it against each of these attributes. For it to be the best it can be, it must possess every one of them to the maximum extent possible.
You might also notice that your TSP account gives you the ability to develop and manage a portfolio that scores highly on every one of them. Attributes 2, 5, 6 and 7 are inherent to the TSP, while attributes 1, 3 and 4 can be readily produced with the right approach.
Written By Mike Miles
For the Federal Times
Publication November 17, 2014