Building For The Future (Part 1)

In many ways, assembling an investment portfolio is like building a house.

Both tasks are public and intensely personal. Both require diligence and expertise. And both have general principles that everyone needs to follow, if they want to be satisfied with the result.

In both building a house and a portfolio you don’t begin by buying nails, you start by going over a set of plans—the blueprints. These make it clear how your home will be sited, what the layout will be, and the general framework. In the same way, an investment plan will tell you what your money is supposed to accomplish—whether it’s supplementing your income, saving for retirement, or establishing a personal rainy-day fund. In both cases the plan starts with your desires and limitations.

From planning, you move on to laying a foundation. And the foundation of any successful investment process is the investment policy. The policy will specify what the required return is, how much risk you can handle, and other restrictions, such as tax considerations, liquidity needs, your time-horizon, and so on. In any building project, the foundation is what supports the structure. When you’re investing, the investment policy supports every subsequent decision.

From the foundation, we go on to choosing materials. In investing, that’s your asset-allocation decision. When you build, you have to decide between quality and price; with investing, the trade-off is between risk and return. Assets with higher return potential have greater risk to them—it’s inherent to the asset. This is because what allows them to grow—either faster or slower—makes them more risky. It’s usually their position in the legal or economic capital structure that creates the risk.

Framing up the structure is like purchasing the stocks, bonds, and other instruments. And like putting up a frame, execution is everything. A great plan poorly executed won’t make anyone happy. Finishing out the home is akin to setting up proper reporting and access rules. You may have a superior structure, but if the details bother you, you won’t be happy. And home maintenance is like portfolio maintenance: evaluating and adjusting as time goes on.

The parallels are striking—and encouraging. Because building a home isn’t a mystery, it’s a rational process that takes discipline and planning. And everyone has one sort of home or another. It’s just a question of what kind of home we want.

Douglas R. Tengdin, CFA

Chief Investment Officer

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