A disciplined process does not promise better outcomes. It is a way of making decisions deliberately, in advance and on a schedule, so that the inevitable turns of the market are met with a plan rather than with a reaction.
Why process matters
Markets rise and fall, sometimes sharply and for extended periods, in response to economic, political, and other developments that no one reliably foresees. No method of analysis or investment strategy can eliminate the risk of loss or assure a profit, and no adviser can identify market tops and bottoms in advance or protect a portfolio from loss in a declining market. These are not disclaimers added at the end of a document; they are the conditions under which all investing takes place.
Given those conditions, the question is not how to avoid uncertainty but how to behave well within it. A process answers that question. It sets out in advance how a portfolio is to be constructed, how it will be maintained, when it will be reviewed, and under what circumstances it will be changed. Its purpose is to make decisions considered rather than reactive, and to make them once, calmly, rather than repeatedly under pressure.
A written policy as anchor
The center of an investment process is usually a written document: an investment policy statement or a comparable profile. It records the investor's objectives, risk tolerance, time horizon, liquidity needs, and tax circumstances. It sets a strategic allocation among asset classes that follows from those facts, and it may record any restrictions the investor wishes to impose.
The document does two things. It translates personal circumstances into portfolio terms, so that the portfolio reflects the person rather than the mood of the moment. And it provides a standard against which the portfolio can be reviewed: not "how did it do?" but "is it still what we agreed it should be, and are the facts on which we agreed still true?" That is a question that can be answered in any market.
Diversification and its limits
Diversification is the practice of spreading investments across holdings that are not expected to behave identically, so that the portfolio as a whole is less exposed to any one of them. A portfolio concentrated in a single issuer, sector, asset class, or region may be more volatile and subject to greater loss than a more diversified one. That is the case for diversification, and it is a sound one.
Its limits should be stated just as plainly. Diversification does not guarantee against loss. In severe market declines, holdings that ordinarily move differently can fall together. Diversification also means that some part of a portfolio will always be doing less well than the best-performing asset of the moment, which can feel like a mistake precisely when it is working as intended. Understanding both the benefit and the limit is part of what allows an investor to hold a diversified portfolio through the periods that test it.
Rebalancing as a habit
Over time, the holdings that have risen most come to occupy a larger share of a portfolio than the policy intended, and the portfolio drifts toward more, or less, risk than was chosen. Rebalancing is the practice of periodically returning the portfolio toward its intended allocation. It is a mechanical discipline: it tends to involve reducing what has done well and adding to what has not, which is uncomfortable, and which is the point.
Rebalancing is not free. Transactions carry costs and, in taxable accounts, may realize gains that are taxed. How often to rebalance, how far to let the portfolio drift before acting, and how to weigh costs and taxes against the benefit of realignment are judgments that depend on the investor's circumstances. What matters is that the judgment is made in advance and applied consistently.
Behavior and time
The evidence on investor behavior is consistent on one point: people tend to react to recent events, buying after prices have risen and selling after they have fallen, and the cost of doing so over a lifetime can be considerable. This is not a failure of intelligence. It is how people are made, and a process exists in large part to stand between the investor and the impulse.
Time is the other half of the discipline. Most of the goals that a portfolio serves are measured in decades, while most of the information that arrives each day is measured in hours. A long horizon does not make losses impossible, and it does not guarantee recovery from them. What it does is give a well-constructed portfolio the opportunity to do what it was constructed to do, provided the investor is able to leave it alone long enough. Patience, in this sense, is not a temperament. It is a decision, made in advance and supported by a process.
- Do I have a written statement of what my portfolio is for, how it is to be built, and when it will be reviewed?
- When markets fall, what do I actually do, and is that what I decided in advance I would do?
- Is my portfolio as diversified as I believe it to be, or has it drifted toward whatever has done best recently?
- How do I decide when to rebalance, and do I weigh the costs and taxes of doing so?
- Am I judging my portfolio against my own plan, or against whatever is being talked about this month?
For clients who engage the firm for discretionary portfolio management, the firm prepares an investment policy statement or comparable profile recording the client's objectives, risk tolerance, time horizon, liquidity needs, and tax circumstances, and constructs and manages the portfolio in accordance with it. Accounts are reviewed no less than annually against that statement, and additionally when a material market event or a change in the client's circumstances calls for it. Clients may impose reasonable written restrictions on the securities or categories of securities held. Investing involves risk of loss that clients should be prepared to bear, and the firm cannot guarantee any level of performance. The firm's methods of analysis, risks, fees, and conflicts of interest are described in its Form ADV; a general description of how the firm works is on the Approach page.
This note is provided by Swiss Finance Private Wealth Management LLC for educational and informational purposes only. It is general in nature, does not take into account the objectives, financial situation, or needs of any particular person, and should not be relied upon as investment, legal, tax, or accounting advice, as a recommendation of any security, strategy, or course of action, or as an offer of advisory services. Advisory services are provided only under a written advisory agreement. Investing in securities involves risk of loss that clients should be prepared to bear; no method of analysis or investment strategy can eliminate the risk of loss or assure a profit, and diversification does not guarantee against loss. The firm does not provide legal or tax advice; readers should consult their own attorney and tax professional about their circumstances. Laws and regulations change, and the firm undertakes no obligation to update this note. The firm's services, fees, methods of analysis, risks, and conflicts of interest are described in its Form ADV, available through the SEC's Investment Adviser Public Disclosure website.