Concepts of Investing

Our Three Principles, or Postmodern Portfolio Theory

© Can Stock Photo Inc. / nahlik

We recently wrote about the conventional investment wisdom, as embodied in Modern Portfolio Theory. No surprise here: we don’t like it. The pie charts, talk of asset classes and correlation…it is all wonderful until it isn’t. Our alternative approach relies on three fundamental principles. We believe they apply in every season.

Our first principle, avoid stampedes in the markets, is based on our understanding that the stampede is usually going the wrong way. There was a stampede into tech stocks in 1999, which ended badly. There was a stampede into real estate in the early 2000’s, which ended badly. There was a stampede into commodities after that, which ended badly. In short, major peaks are usually accompanied by a stampede of money that drives prices to extremes.

Our second principle, seek the best bargains, lets us sort “the market” into its pieces. The three major asset classes are stocks, bonds, and cash alternatives. Cash and its alternatives currently earn practically zero-point-nothing interest rates; bonds are barely better. Diving one level deeper into stocks, we find that some sectors and industries are expensive and others appear to be bargains.

Our third principle is to seek to own the orchard for the fruit crop. Portfolio income is an important component of total returns, and those among us who rely on our portfolios to buy groceries surely understand the importance of cash income. As noted above, interest rates remain very close to zero—we do not believe that bonds or cash alternatives are a good way to generate income these days. But we are currently enjoying generous dividends from many companies in the bargain sectors, including the oil and natural resource companies. Other holdings purchased in past years continue to pay regular dividends, from pipelines to telecom to auto stocks.

We must note that, in actual practice, these principles require patience. One should always know where needed cash and necessary income will come from. Please see our post ‘The Fruits of Investment (link)’ for a fuller treatment of the three principles in action.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

The Fruits of Investment

© www.canstockphoto.com / Kurhan

Imagine for a moment that you are a simple farmer cultivating a modest but lush orchard of apple trees. Every year you reap a bountiful harvest of fruit to feed your family, with some surplus to sell for other foods and necessities you can’t grow yourself.

Every once in a while your neighbor comes by and offers to buy all your trees for firewood. Even if he offers you a generous price, accepting it would be foolish: the money you could sell it for would sustain you for a while, but it would not produce new crops for you year in and year out. It would run out where a well-tended orchard could keep providing for you long after.

One day your neighbor comes up to you in a bad mood, still wanting to buy your trees. The timber market has been flooded with cheap wood, cutting into his profits, so now he can only offer a much lower price for your trees.

If you wouldn’t sell your orchard when the price is high, why on Earth would you want to sell it when the price is low? As long as you plan to keep your orchard and live on your fruit crop, it shouldn’t matter to you what price someone may quote for it.

For those of us planning to retire on our investments, we would do well to heed the parable of the orchard and the fruit crop. Many retirees plan to live on a portfolio of income-bearing investments. We know that investments are subject to volatility, and at some point in your retirement you will probably see price swings in your investments—even government bonds and other conservative investments are not immune. But your ability to pay bills and buy groceries doesn’t depend on the market value of your holdings, it depends on the dividends and interest payments they generate. As long as your “fruit crop” is secure, you have no reason to sell your orchard. Therefore it doesn’t matter what someone wants to buy it for.

Investors, like farmers, sometimes suffer crop failures—there are no guarantees. But it is the stability of your income that should concern you first and foremost, not the stability of your price.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Government bonds are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

Filling Your Investment Basket

© www.canstockphoto.com / gpointstudio

We believe in investing for the long haul. Regardless of your investment objective, having more money in the future is better than having less money. Our main focus is on maximizing total returns over a long time horizon.

However, sometimes we need to draw down investment assets, and investments tailored for potential long term gains may not be the best place to keep money you need soon. Planting grain will grow you more grain in the long run, but having seeds in the ground does you no good if you need grain to eat right now. So while we like investing for total return potential, sometimes you need a different mix in your basket to work towards your goals.

For immediate money needs, nothing beats cash. You may not see much (if any) growth on cash or equivalents, but it’s always right there if you need it.

If you don’t need money in your hand right away, but still expect to spend a chunk of money by and by, you have the potential to earn a little bit more with short term CDs and investment grade bonds. You can’t spend them on demand, but they have a face amount they’ll pay back in the not too distant future.

Diversified investment portfolios are a step between using lower-risk securities and more volatile holdings like individual stocks because they can include a wide variety of investments. They can potentially capture some market growth, without the same level of volatility presented by investing in only individual stocks.

Our total return philosophy is built around finding the biggest bargains in the investment universe, which sometimes leads us to more aggressive holdings such as individual stocks. These holdings are volatile in comparison and not good places to park money you may need to pull out suddenly.

We know that our preference for total returns does not always fit client goals. These other types of holdings allow us to build a basket that will accommodate your needs. Talk to us if you have any upcoming expenses looming on the horizon and we can help structure your basket to manage your goals.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing.

CD’s are FDIC Insured and offer a fixed rate of return if held to maturity.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.