PREP: Important steps to consider when building an outcome-oriented portfolio

A few months ago my physical therapist used the word apparatio to explain the importance of preparation. Any of you who have had to do physical therapy know that it’s a long, painful process. Let me tell you how I came to this suffering.

In the summer of 2017, I was 38. In order to stay active, I joined a soccer league in Montreal. Growing up, I was an avid soccer player and held the enviable position of striker. But it had been 10 years since I played soccer, yet the excitement (or ego) of showing off my capabilities was enough to convince myself that I could do it. We had a terrific season and I was one of the top scorers in the league. We finished second. I was on a high. I was so lucky: age clearly was no match for my prowess on the field! Then ... I injured myself. My physical therapist kindly reminded me that I was no longer 20 years old and that preparation was necessary to get me ready for each game. Here’s what she said I had to do:

  1. Stretch for at least 20 minutes prior to any game or practice
  2. Build muscle strength throughout the season
  3. Cool down and rest to recover after each game or practice

To be clear, I already knew I was supposed to stretch, cool down and weight train. I just didn’t do it. I fell into a predictable behavior trap: the inability to change my behavior even though I knew better.

This painful lesson can be applied to investing. When it comes to building a successful portfolio, we also need to take preparatory steps to improve the potential for sustainable financial success. In other words, PREP is an important step to help provide more predictable outcomes:

P - Process

R - Role

E - Emotions

P - Patience

Process

I should have stretched.

Process includes the critical steps to get to a positive result or outcome. Stretching, building muscle and cooling down would have given me the highest probability of avoiding injury. We believe advisors should apply the same rigor and discipline when it comes to helping their clients and building portfolios.

Consider your current client portfolios:

  • How and why did you select the strategies you are using?
  • What made sense five or 10 years ago that might not apply today?
  • How do you continuously evaluate and revisit these strategies?

There’s a great quote from U.S. General Colin Powell that reads: There are no secrets to success. It is the result of preparation, hard work and learning from failure. We believe advisors should have a defined process to help them build an all-weather portfolio in order to deliver the best outcomes for their clients.

Role

Stretching would have improved my muscle’s elasticity and helped to achieve muscle tone. The outcome would have  increased muscle control, flexibility and range of motion.

A process is necessary, but equally important is understanding the role your decisions make. Building a portfolio of asset classes means that each asset has its own role to play in helping your clients reach their goals. It’s not about buying your next wholesaler’s idea but understanding how a strategy will impact the long-term direction of your clients' portfolios. 

The Periodic Table of Investments 
Click image to expand to full size.

Periodic table of investments

Source:The Periodic Table of Investments from Visual Capitalist, as of November 28, 2018. https://www.visualcapitalist.com/periodic-table-investments/

To quote the author of the periodic investment table illustration: For serious investors, the foundation of the discipline is to understand the properties of these individual components, and to have them work in harmony to achieve a specific portfolio goal.

When you select a strategy, consider this:

  • What role does it play in a client’s portfolio?
  • How are you ensuring that it’s in line with your client’s portfolio objective?

Emotions

My excitement in winning led me to believe I was immune to injury.

We can be our worst enemy. A great illustration of this occurred on Dec. 17, 2017: the price of one Bitcoin reached nearly $20,000.1 Many advisors were fielding questions from their clients on how to include Bitcoin in their portfolios. Perhaps, at the time, you were tempted, too. Yet by Feb. 5, 2018, Bitcoin had lost 50% of its value.2  Psychologist and Nobel Laureate Daniel Kahneman reminds us that often it’s necessary to put your intuition on ice, as people often make good or bad decisions due to a mix of good and bad reasons.3

In our 2019 Value of an Advisor study, Russell Investments advocates for advisor value. According to the study, addressing the investment behavior of clients may be the greatest value you provide. If you think you’re immune to these behavioral tendencies, consider this:

  • Have you ever introduced a hot new fund or strategy in your client portfolio?
  • Do you have a process in place to guard yourself from emotional decision making?

Even hedge fund billionaire Ray Dalio recognizes that the biggest threat to good decision making is harmful emotions.

Patience

My physical therapy sessions are going to last a long time. As the ancient Greek general Pericles said, time is the wisest counselor of all.

Here’s an interesting stat: Between 1997 and 2017, equity mutual fund investors have seldom managed to stay invested for more than four years.4 For fixed income investors, the average holding period for the 20-year time frame ending in 2017 was 3.45 years.5 There’s a popular saying that time in the market is more important than timing the markets. Evaluating a strategy after only one year might not be the way to create sustainable results. When selecting a strategy, time and patience are your allies, accompanied by a rigorous process of due diligence. 

The bottom line

Having a Process provides the necessary steps to identify the right strategies to build a client’s portfolio.Understanding the respective Roles strategies play can help provide a likelier outcome for your clients. A disciplined process can keep Emotions in check, and having the Patience to commit time in the markets and staying invested can help build wealth.

Even though you know you’re supposed to stretch, build muscle and cool down, changing your own behavior is difficult. Having someone else tell you you’re supposed to do these things and hoping someone else will change your behavior is near impossible. But, having a process like physical therapy in place over time helps hold you accountable and prevents you from making the same mistake in the future.

1 Source:  Fortune Magazine, “Bitcoin Hits a New Record High, But Stop Shorts of $20,000, December 17, 2019”: https://fortune.com/2017/12/17/bitcoin-record-high-short-of-20000/
2 Source: Bitcoin History, December 1, 2019: https://en.bitcoinwiki.org/wiki/Bitcoin_history#Bitcoin_in_2018
3 Source: Daniel Kahneman Podcast #68: Putting your Intuition on Ice: Knowledge Project Podcast Ep#68
4 Dalbar’s 2018 Quantitative Analysis of Investor Behavior (QAIB) Report
5 Dalbar’s 2018 Quantitative Analysis of Investor Behavior (QAIB) Report