We focus on what we can control, which is to leverage the extensive body of academic research on the behavior of stocks and bonds.
Academic research has provided evidence that asset allocation, the selection of asset classes, which include US stocks, Non-US stocks, US bonds and Non-US bonds, and the portfolio percentage allocation to each, is the single most important element in a portfolio strategy -- and accounts for over 90% of a portfolio's performance.
Global Stock Diversification
We achieve broad stock diversification by investing in a wide range of asset classes using mutual funds and exchange traded funds, which include categories such as large company stocks, small company stocks, and real estate securities. We then follow the overall allocation of the global market by aiming for a world-market cap weighted portfolio of US and non-US stocks.
Dimensions of Expected Returns
It has been demonstrated that the size of a company influences it expected return, with the stocks of smaller companies offering higher returns than stocks of larger companies over the long run. A well diversified portfolio will have a significant allocation of smaller company stocks.
Value stocks are stocks with price-to-book ratios (the price of the stock divided by the assets of the company) that indicate they are underpriced. It has also been demonstrated that value stocks tend to outperform growth stocks in the long run. It is advantageous to overweight exposure to these stocks relative to the global market capitalization, as they are priced for higher returns.
Overweighting in small stocks and value stocks will enhance the expected return of a portfolio compared to the market. These risk premiums are not predictable over short periods of time and may persist or be absent or present during any given year.
Global Bond Diversification
Our bond allocation is designed to be the stable reserve within the portfolio. We work along several dimensions to minimize macroeconomic risks.
We achieve stable optimization by investing in bonds with shorter maturities, that have a low correlation to stocks, are investment grade -- and utilize a global strategy, which includes US and non-US bonds, that hedges all currencies.
Inflation is an important consideration for many long term investors, especially for mature investors with a higher percentage allocation of their portfolio to bonds. While stocks are more volatile than bonds, they have also been more likely to outpace inflation over long periods.
To blunt the effects of inflation we include Treasury Inflation Protected Securities (TIPS) in our bond allocation for our retirement accounts. TIPS are indexed to inflation to protect investors from an erosion in purchasing power.
Investing Your Money
Your money will be invested according to your Investment Policy Statement. We invest your money directly into the market if your money is currently invested. If your money is not currently invested, we utilize dollar cost averaging to reduce the risk of market volatility.
Our rebalancing policies help to reduce risk and increase returns by capturing periodic buy-low/sell-high opportunities. It is through this disciplined approach to rebalancing we can capture the full benefits of diversification.