Using model portfolios to reach your client's financial goals
Designing a risk-appropriate portfolio requires tremendous insight, research, and expertise if you are an independent financial advisor. When managing investments, you want to ensure your client's financial future is sound and trusted. Like a seasoned financial advisor, crafting a model portfolio aligns with their risk tolerance, investment goals, and time horizon. This requires careful consideration and a deep understanding of the ever-changing market dynamics and investment options.
This article explores constructing a well-balanced and tailored portfolio, drawing upon the expertise of seasoned financial advisors, TAMPs, and some of the best investment software available. Whether you're a new Investment Advisor Representative or a seasoned financial advisor looking to refine your investment strategy, this article will equip you with the knowledge and tools to design a risk-appropriate model portfolio that stands the test of time.
The Ultimate Goal of Portfolio Construction: Risk Management
An investor's most important decision is determining the most appropriate long-term strategy mix. Brookstone has created a conceptually sound decision-making framework for effective diversification. This approach is meant to help clients consistently exercise patience and discipline across all market cycles.
Brookstone advisors and their clients have access to advanced investing opportunities and strategies. Our process of building portfolios is called RAISE, our methodology for determining broad portfolio balance. It is designed to mitigate drastic downturns so investors can take advantage of the benefits of compounding returns.
RAISE stands for Risk Appropriate Investment Strategy Evaluation. This process aims to deliver competitive returns by limiting significant losses or drawdowns using a risk-managed approach by blending strategic, tactical, and active and passive investing from boutique and brand name managers. With a focus on goal-based performance instead of benchmark chasing.
Risk: Assess your current investment mix
Appropriate: Formulate a client's risk profile
Investment: Identify the right selections from the investment rooster or universe
Strategy: Determine the appropriate asset allocation and investment mix.
Evaluation: Implement and stress test the strategy
Brookstone creates model portfolios for many advisors that serve as guides to help create portfolios that match a client's risk tolerance. Our investment process starts with a seasoned Investment Committee that provides platform oversight and Advisor guidance. The investment platform is a robust open architecture platform that is comprised of professional model portfolios from highly vetted managers that are reviewed and selected. Some examples of our open architecture investment platform options and asset managers may include:
- Brand Names: Large institutional firms with solid core strategies
- Boutique Firms: Smaller under-the-radar firms with unique strategies
- Traditional: Familiar asset classes of stocks and bonds (Exchange-traded funds, mutual funds)
- Alternative: Different asset classes and strategies beyond traditional asset classes (Structured Notes)
- Passive: Low-cost index-based exposures/ index funds
- Active: Individual security selection
Accessing an Investment Platform to Leverage Model Portfolios.
By leveraging an open architecture investment platform, financial advisors can act as portfolio managers by selecting strategies and creating customized portfolios for clients that suit their investment objectives, financial goals, and time horizons.
With the right TAMP (Turnkey Asset Management Platform), advisors can select to do it for me, with help, or DIY (do it myself).
Brookstone offers financial advisors:
- Do it for me: Turnkey solutions using our RAISE model portfolios (Globally diversified, risk-based model portfolios).
- Do it with help: Risk-based templates for any fully scalable client profile and support mass customization.
- Do it myself: An expanded rooster of investment options with ongoing manager due diligence of all strategies, funds, and managers.
Why Use a TAMP for Portfolio Construction & Management?
Outsource Investment Management. Financial professionals can save time and leverage strategic model portfolios so they can focus on client relationships and getting new clients and spend less time picking stocks or their investments.
Investment Decisions and Expertise: Having a Chief Investment Officer, CFAs, and other investment professionals as part of your team that has a pulse on current market conditions.
Access to Technology: Use a platform to elevate the client experience, operate more efficiently, and offload administrative tasks. Financial advisors can also access risk management software like Riskalyze to understand better clients' risk tolerance, financial planning software to run client or prospect meetings better, and enhanced reporting and operational efficiency through software like Orion.
Custodial Integration with large firms like Fidelity and Schwab.
To explore how Brookstone Capital Management helps independent financial advisors design model portfolios or to see our full capabilities visit brookstonecm.com/advisor-solutions or contact us to learn more.
Designing a Risk-Appropriate Portfolio Transcript
Erin Kennedy:
Mark, really good to see you. Today, we are talking about designing a risk-appropriate portfolio. Every investor, of course, is different, we have different goals, but we all have a different tolerance for risk. So let's talk about designing a risk-appropriate portfolio. Brookstone manages about $8 billion, that allows Brookstone advisors and their clients access to advanced investing opportunities and strategies. Can you explain that process?
Mark DiOrio:
Sure. A term we use and an acronym we've used around Brookstone has been RAISE, and it stands for risk, appropriate, investment, strategy, evaluation. And I'm glad you said appropriate because that's the most important term in the entire philosophy of RAISE. I often get asked the question, "What's the best investment?" And the reality is, you don't know what the best investment is until you look in hindsight. So when you're building a portfolio, it's what's appropriate, what's in your best interest given your certain circumstances, your goals, your risk tolerances. And a risk tolerance is really your ability and willingness to assume volatility in the portfolio.
And so if you want to take money out of the portfolio very soon, you have a limited risk profile or what we call a conservative risk profile, because we don't want too many big swings in your portfolio while you're trying to take money out of the portfolio. Whereas if you have maybe a longer term timeframe before you're going to need that, you'll let some volatility and some growth in the market take precedent and you'd be more of an aggressive investor.
And of course, a lot of investors are kind of a combination or a blend of the two and what we'd call a moderate or a balanced portfolio, where you have some growth type assets where you can grow higher rate of return over a long period of time. And then you have some income producing assets. And then what we do as an advisor, is look to see what is the appropriate blend, and again, that's the appropriate blend of different strategies.
Erin Kennedy:
And we'll get more into timelines in just a second. But first, I want to talk about portfolios that you help implement because some include institutional investments and multiple investment strategies. So can you explain why strategy diversification is so important?
Mark DiOrio:
Sure. There's a lot to talk about, maybe individual stocks or individual securities. And then the next layer is called asset allocation or talking about asset classes. So stocks would be an asset class, bonds would be an asset class. But I think we take it one step further to provide access to institutional strategies that most individual investors don't often see maybe in the news or read about. Here's a great chart that looks at different strategies, looking at different equity markets, and how you break down or categorize different sets of stocks. For example, just using dividend type stocks. So you may have a fund that says dividend, but that doesn't tell you what type of stock it is. There's a difference between a dividend grower and a high dividend yield stock. In this chart, the dark blue is high dividend yield, for example, and then kind of a teal color is the dividend grower.
And they actually move differently and have a different ebb and flow at their return. So it's really stratifying and getting down to what's the appropriate approach. Do you want a high dividend yield strategy or do you want a dividend grower, meaning that the dividend payment can grow quicker over time but it may start at a lower base. And the same is true with there's a growth asset class in there, and then there's a momentum in segment in here. And so each of these different colors represents that strategy. And as you can see, it's ranked from highest performing in that quarter to lowest performing. But you notice that these bounce around a lot, so blending them, can actually provide its own diversification benefits.
Erin Kennedy:
Now you mentioned stocks and bonds. So as we approach retirement, explain how a risk managed approach is different from simply just buying more bonds.
Mark DiOrio:
Well, that's been the traditional kind of, in the investment world, traditional advice. And it's broad across the landscape, which is as you get near retirement, you start to reduce stocks and add more bonds. But the reality is, if you're to look back over long data sets, the return on stocks is actually quite consistent over long periods of time. You get about a 7% risk premium above the risk-free rate that they say. So it's 7% real return, give or take, but that's been very consistent when you hold over long period of time in different subsections.
However, with bonds, it works a little bit differently. You can go through long periods of time where you have low returns and returns that are below the rate of inflation, which means your real purchasing power is declining. And remember, the goal of building up a portfolio is to maintain your purchasing power over time and grow that purchasing power over time. And so when you're losing out to inflation, if the interest rate isn't high enough to compensate you for the inflation risk, you're actually losing money in real purchasing power dollars over time. And so I think when you're looking at building a portfolio, that's something you want to keep in mind and what this blend really is telling you and how to put it together.
Erin Kennedy:
Now, explain why a risk-managed approach is particularly attractive to investors as they approach or enter retirement.
Mark DiOrio:
So if you are looking at more of a growth-type portfolio, you have to assume more volatility. And volatility is fine as long as you have that type of timeframe where you're not taking dollars out. And this is a great chart that just shows, well if you're holding for the long term and that kind of light blue line there shows you stocks, and stocks will have the highest performance over time. And then all the way at the bottom there, you'll see treasury bills and bonds and so forth having a lower rate of return. Well, you combine those, you get kind of the in-between return profile, but if you're too conservative, you could be losing out to inflation and you just don't know what the inflation rate is going to be in the future. And that can be pretty devastating if you don't have an investment portfolio designed to keep up with the rate of increase in costs and costs of living over time.
And then on the flip side, if you have too much volatility in your portfolio and you're trying to take money out, it becomes really challenging for the portfolio to withstand that withdraw rate. And so it's called the sequence of returns risk that we want to manage and make sure that you're not retiring just at a time, and you're overweighted in stocks, for example, and then the stock market has a two to three-year decline and downturn, while you're taking money out because that doesn't allow the portfolio to rebound. So what we're trying to do is build an enduring portfolio that balances the dual risks of volatility and inflation.
Erin Kennedy:
And last, you also help design and vet hedged equities, structured notes and buffered ETFs, which can also transfer investment risk.
Mark DiOrio:
Yeah, definitely. So in addition to stocks and bonds and then some of those individual strategies of how you approach stocks, how you approach bonds, we also try to enhance the opportunity set and add things, really institutional quality strategies, that are called hedged equity or buffered ETFs. Now what they do is provide equity exposure with downside levels of protection built into them. So it's a little bit more of an advanced strategy. You have to do a little bit more digging and due diligence.
In fact, one of the strategies on the buffered ETFs, which is a strategy we started to incorporate over the last couple years, we spent over two years studying these to make sure we understood how they worked in real time, in real market environments, as opposed to the theoretical. And then on the other side, we looked at structured notes, which a lot of even professionals aren't very familiar with how they work. They've been out there. Well, we took the time and this has been over many years now, to really study these, how they would work and then how they would work in a portfolio context and actually built a strategy around that investment vehicle of structured notes, which gives you a unique return and risk profile relative to stocks and bonds. So they really compliment the portfolio and that's what I mean when I say, we're enhancing the opportunity set, which gives you just different dimensions of risk return and enhance the diversification of the portfolio.
Erin Kennedy:
You have some industry-standard white paper on structured notes too, right?
Mark DiOrio:
Well, we like to call it the industry-leading.
Erin Kennedy:
Okay, yep, thank you.
Mark DiOrio:
White paper on structured notes, so that gives you an idea of the time that we spent putting this together to explain what these are and how to implement them in a portfolio context. And I think that's the important part where a lot of asset classes, some people would say they're good or bad, we think of them in the context of the overall portfolio. So you can add something and maybe it's not your favorite asset class, but it has diversification benefits that would really work. And in the structured notes, it has a really unique source of income generation that you don't get from other assets. And so that also helps the portfolio as well.
Erin Kennedy:
Really fun to take a peek under the hood with you, Mark. Thank you very much for your time today.
Mark DiOrio:
Thanks Erin.
