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Dallas Registered Investment Advisor – Myths Part 8

Myth number 8, according to Wall Street Journal writer Brett Arends, occurs when you hear your investment advisor say, “We recommend a diversified portfolio of mutual funds.”

If your broker means you should diversify across things like cash, bonds, stocks, alternative strategies, commodities and precious metals, then that’s good advice.

But too many brokers mean mutual funds with different names and “styles” like large-cap value, small-cap growth, midcap blend, international small-cap value, and so on. These are marketing gimmicks. There is, for example, no such thing as “midcap blend.” These funds are typically 100% invested all the time, and all in stocks. In this global economy even “international” offers less diversification than it did, because everything’s getting tied together.

I’m largely with Arends with this one.  I’m on board with diversification, of course, although I differ when he gets to precious metals.  I’ve got clients in portfolios that contain companies that mine precious metals, companies that sell precious metals, that sort of thing.  I don’t have any portfolios that actually contain the metals themselves.

I’m big on diversifying across a number of asset classes – and alternative strategies can be a big part of that.  I use real estate, leasing companies, all sorts of alternative strategies, if that’s what is needed for a client’s portfolio.  I’m not as keen on commodities, because the volatility is so extreme.  I’ve got some commodity portfolios for some of my biggest customers – those with a couple million and above.  Those are very volatile, very risky investments.  But for some customers, to properly diversify their portfolios, you look for creative places to put money.  I’ve found some commodity-based investments that make sense.

He’s got a good point about the global economy.  AT&T is in large-cap funds, you’ll find it in a blend, and because it’s an international company, you’ll find it in an international fund.  So the challenge is determining what an asset really is.  The good news is that in my firm, we don’t use mutual funds in the way the rest of the market uses them.  Our ‘funds’ are built completely differently than the way the rest of the market builds them.  Ours are not actively managed, which holds down the internal costs.

When you want to build a portfolio, you want a broadly-based portfolio with stocks, low-risk fixed income investments (5 years or less), with a tilt toward value equities and small international equities.  Build it as broadly as you can, as cheaply as you can, controlling costs and maximizing returns.  I’m rebalancing my funds on a daily basis, and I’m recommending my clients rebalance their portfolios quarterly.  Then you can build in your alternative strategies to manage risk and optimize returns.  Creating a comfortable retirement using a diversified portfolio is no mystery, and its no myth.