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In this short series (see the Introduction), I lay out the four key categories of work that we do on behalf of our investment management clients — four kinds of activities that are difficult for folks without our training and experience to do for themselves. I hope that this series will help explain what we do for our clients, why we do those things, and how we think that these things help explain the fees we charge. As always, if you have questions about these posts, let us know!



Once we’ve completed our DUE DILIGENCE process, and identified the investments that we think it would be prudent to use in client accounts, we begin the second of our behind-the-scenes steps: we begin thinking about how to put the investments that pass our criteria together into coherent portfolios. As fiduciary advisors, one of the key ideas that drives our prudent process is diversification: we don’t want to put all of our clients’ eggs into one basket, if we can help it. We want to spread investments into as many corners of the investment marketplace as we can, so that if one part of a portfolio is dropping, another part is rising.

It seems obvious, but it’s not as easy to accomplish as it might seem. It’s easy to build a portfolio of mutual funds or ETFs and think that it’s broadly diversified — it holds a dozen different funds, after all! — only to discover that each of them owns the same handful of stocks, for the same reasons.

Our portfolio construction process has five levels of diversification. First, we start with four main broad asset classes, the basic building blocks of a portfolio. For most of our clients, we want to own some stocks, some bonds, some specialized investments (utilities, for example, or real estate), and at least a little bit of cash. Second, within each of these categories, we want to make sure that we have a wide variety of different types of sub-classes represented — among stocks, for example, we want to have investments in both the US and the rest of the world. Third, we want to break each of these sub-classes down further: for our US allocation, we want to make sure that we own small, medium, and large US-based corporations, and for our non-US allocation we want to own stocks from both “developed markets” (such as Europe) and “emerging markets” (such as most of South America). Fourth, we want to use both active and passive strategies when we can: for our large US company allocation, for example, we use both index funds and actively-managed funds. And fifth, among those active funds we try to have a variety of different strategies — growth and value, for example, can both have a place in a portfolio.

Using these five levels of diversification means that our client portfolios can have a lot of individual investments, especially in larger accounts; we believe the benefits of diversification outweigh the hassles of keeping track of all the moving parts. The portfolio management software we use, provided by Morningstar, allows us to make sure that we’re getting the diversification we want, and at the same time to make trading client accounts relatively simple and easy. Broadly diversified portfolios will not always go up, of course, since all investing involves risk of loss. And it’s important to keep in mind, as advisor-guru Michael Kitces puts it, “Diversification means always having to say you’re sorry: if everything is up at once, you’re probably not diversified!” But good diversification can help a portfolio to weather turbulent markets — and therefore to help us maintain a DISCIPLINED approach to investing, which we’ll discuss further next time.