Are your investments running on all cylinders? How can you be sure?

How To Increase Your Investment Portfolio Efficiency To Outperform

High Efficiency Portfolios: All assets produce, either positive capital appreciation, interest or both.

Mutual Funds, ETFs or SMAs all have one debilitating feature, with the amount of money deposited into each of these bundled products, it is impossible for efficiency. Pop quiz: when considering a group of ten stocks, is it better to have most of them make a substantial rate of return while some of them lose proportionately or to have each stock either make zero or a nominal rate of return. Historically speaking, bundling equities in a product like a mutual fund, would result in 6 positions with positive returns, 1 relatively flat while the rest fall into negative territory.

For example, Portfolio 1 on the plus side had 3 stocks that garnered 15%, two at 10% another at 5%. To finish off the portfolio, each stock had 0%, -5%, -10% and then -15%. I’m sure if you paid any attention to the stocks in your mutual fund, you would be pretty happy seeing those types of returns and unfortunately, many of you do. Now Portfolio 2, our high efficiency model, would have returns that brought returns of two stocks that had 10% return, 8 stocks at 5% and the last one at zero. Not very exciting, so what’s the difference. Believe it or not, Portfolio 1 has a 4% average rate of return while Portfolio 2 boasts 5.5%. It may not seem much, but over a 10 year time horizon, that 1.5% increase compounded would realize a 13.3% additional return.

Retirement accounts, 401k plans are notorious for producing adequate returns, essentially because they are so inefficient. It’s no wonder why increasingly more employers are allowing “in-service withdrawals” for employees who want to manage their own investments without incurring all the embedded costs and mediocre returns from their employer’s retirement contribution plan. There is also a growing trend for smaller companies to administer “open architecture” retirement plans where the control of investing is completely up to the participant.

Efficiency has become very prevalent in recent years, from increasing the gas mileage on a car to tax credits for installing the right windows and furnace. Corporations and families alike are looking for ways be leaner, to work more productively. We are all in search of ways where we can get out a lot with putting in a little. So why hasn’t the way we manage our assets followed suit? Ease of use, convenience and simplifying are benefits extoled by the money managers who create the euphoria of investing in cookie cutter, bundled products. As investors, where do we go from here?

Let’s look at how a collection of stocks ought to be put together. We know that there is a level of risk needed to produce gain. How much risk versus how much reward is an important lagging measurement used to quantify this adverse relationship. There have been many money managers who would tell you that the number of stocks to reduce risk should be large. I’m sure you have heard that mutual funds are ‘safer’ than individual stocks. Well, that just is not the case. We proved that with our portfolio comparison. We can though, mathematically prove that the actual number of individual stocks needed to bring the risk/return ratio in-line is 13. Simply said, any more stock positions than that does not decrease the amount of risk. Through our many years of stress testing our data, we put together 5+1 High Efficiency Portfolios, made up of 10 positions in each portfolio. What makes them unique to each other is the amount of times they are rebalanced in a year. We have over 25 “filters” in a quantitative computer-based model that has proven to successfully produce some of the best rates of return collectively in the marketplace.

You can use the following to create your portfolio of stocks or streamline the current holdings you have whether its mutual funds and ETFs in your retirement plan or a small self-directed account you have in an on-line account. Putting together your portfolio needs to go through 4 “phases”. The first, where almost everyone goes to pick stocks, bonds, or commodities, are Quantitative Measurements. This is financial data of the company and the trade history of the stock. Price to Earnings Ratio, Earnings Per Share, or trailing 12 months are just some of the common data used to choose stocks. To create a high efficient portfolio, it is not only what you are going to measure, but how you are going to use the measurement in what-if scenarios and the hierarchy of importance within the data. Even the phases have a different level of importance in the final selection of your stock portfolio.

Our second phase is the Qualitative Measurement. This type of data can seem to be somewhat subjective, but certain events can be quantified if done correctly. Also, this data needs to have an ebb-and-flow to the industry classification where the same data may have a direct relationship, or no relationship or somewhere in between. This phase has more influence in picking stocks where the portfolio rebalances about every 6 months versus quarterly and annually. It is best if you create a list of qualitative events and then give each position a numerical data point to either choose or weed out stock choices.

The third phase is Technical Analysis. This type of data is used more heavily within shorter rebalancing terms. Stocks chosen have strong fundamentals that lead into price and buyer driven appreciation. We are careful not to choose “what’s hot” but rather a good company with stock price fluctuations that are favorable for at least the quarter to two quarters. Essential point, there is a reason this is the 3rd phase. It doesn’t drive the decision-making processes on what stocks to pick, but it certainly adds to the efficiency of making sure all the equity positions have opportunity to appreciate.

The final phase is the Fluid Risk Assessment Matrix. This is a proprietary risk assessment tool that has been 20 years in the making utilized exclusively on the back end of every computer model. The asset risk score has several qualitative and technical parameters that creates high efficiency within our model portfolios. We created a series of algorithms that produce a Fluid Risk Assessment Score of the investment where your personal risk score is inserted with the asset’s risk score produces a perfect blended score to use in finalizing investment decisions. This matrix measures 10 Dynamics of the price of the asset, risk v. reward, risk assessment slope and other quantitative fundamentals.

We believe that this four-phase discipline helps choosing the right stock portfolio, but it will also help with increasing the efficiency of your current investments in your 401ks, IRAs or brokerage accounts. And if you are asking, “What about bonds?” We created a Fluid Risk Assessment Matrix specific to bonds. This sequence of algorithms could be as important as our Equity Matrix in assessing the amount of unaware risk. To have a high efficiency portfolio, each allocation must be running on all cylinders and all of those cylinders must run in sync. By creating a disciplined exit and entrance strategy of choosing your investments will perform exactly how you predict they will.