Portfolios are constructed using strategic asset allocation (“SAA”), a long-term portfolio strategy that aims to diversify risk across asset classes, while improving risk-adjusted returns. SAA is the key driver of your long-term investment success. Studies have shown that asset allocation policy explained over 90% of the variation in a portfolio’s return over time, with security selection and market timing playing minor roles (“Determinants of Portfolio Performance” research by Brinson, Hood, and Beebower published in the Financial Analyst Journal in 1986).
Using your investment objectives, risk tolerance, and time horizon, we calculate a “recommended risk score,” which determines your target asset allocation. Our risk score ranges from 0 (most conservative) to 10 (most aggressive) in 1 point increments.
Investors with lower risk scores have higher allocations towards fixed income. Fixed income securities are generally lower risk, and as the name implies, their return is often fixed. The tradeoff for this safety is a lower return. Equities, on the other hand, have higher risk of loss, but also have a higher expected return over long time periods. It is appropriate for investors with higher risk scores to have higher allocations to equities.
Using your target allocation, we construct your portfolio with exchange-traded funds (“ETFs”). ETFs are pooled securities that invest directly into stocks and fixed income securities. For equity exposure, we use ETFs that invest into both U.S. and international stocks. For fixed income, we use ETFs that invest in U.S. Treasuries, agency bonds, corporate bonds, and securitized bonds.
Over time, your risk score may change. We suggest you review your profile at least annually for major updates, or when circumstances change significantly. That said, we do not recommend changing your risk score frequently as a way to time the market. The success of any financial plan requires discipline to stick to the strategy you’ve put in place, a focus on long-term fundamentals, and a systematic approach to rebalancing. This is especially true during market downturns and unpredictable market conditions.