Portfolio Development

Advanced Portfolio Development

  1. Understand Yourself

    1. Time commitment (research, monitor)

    2. Personal goals, concerns & financial situation

    3. Knowledge & experience investing

    4. Market conditions

    5. Time horizon to goals

    6. Risk tolerance

  2. Considerations

    1. Understand Passive vs. Active Investing

    2. Understand risk

    3. Understand market factors

    4. Focus on what you can control

  3. Develop a strategy (Active investing)

    1. Determine Market Conditions

    2. Average turnover time (return vs. time commitment)

    3. Diversity (risk vs. return)

    4. Focus (based on market conditions)

    5. Level (market, sector, or individual investments)

  4. Select investments

    1. Stick with quality

    2. Value: Buy & hold undervalued investments

    3. Quality stocks have historically outperformed quality bonds

    4. It’s not just what you make, it’s what you keep

    5. Don’t be emotional

  5. Review your strategy regularly

Strategy and Investing


The idea of strategy is the same no matter if you are talking about business, investing or warfare. A "strategy" is a plan to marshal limited resources for their most efficient and effective use to bring about a desired outcome.  

One of my favorite instructors Assistant Professor Peter Coughlan who used to teach at both Naval Postgraduate School and Harvard Business School would say that without focus you have no strategy.  A business that says they will do anything the client wants lacks strategy and will spend too much time on areas that don not yield a comparable rate of return to other areas. By focusing on areas that you are more efficient you can significantly increase your profit. 


The same is true with investing, to spread your investments across the entire spectrum of securities is the same as not having a strategy.  Financial institutions don't do this because it's a good strategy, they do it because it is easy and it limits their legal liability. By having an investment  strategy you can stop putting money into areas with low earning potential and focus areas that are undervalued and have more potential for growth.


Part 1: Understand Yourself

  • Time commitment (research, monitor)

  • Personal goals, concerns & financial situation

  • Knowledge & experience investing

  • Market conditions

  • Time horizon to goals

  • Risk tolerance



Part 2: Considerations

  • Understand Passive vs. Active Investing

  • Understand risk

    • Market risk, Concentration/ Diversification risk, Business Risk, Equity risk

    • Credit / Default risk, Interest Rate risk, Call risk, Inflation risk

    • Opportunity risk, Liquidity risk, Taxability risk, Currency risk

    • Reinvestment risk, Horizon risk, Longevity risk

  • Understand market factors

    • Political: Taxes & regulation

    • Economic: Efficiencies, labor, cycles, shifts, and international standing

    • Social: Public opinion, trends, and social causes

    • Technology: New, competing, and obsolescence

    • Competition: Barriers to entry, market saturation

  • Focus on what you can control

    • Planning

    • Research and understanding

    • Distribution of investments

    • The quality of your investments

    • How long you hold investments




Part 3: Develop a strategy


3.1 Average turnover time

  • Time commitment (goes up) --- Risk (goes down) --- Hold Time (goes down) --- Return (goes up)

  • Time for non-recurring research

  • Time for recurring monitoring of investments



3.2 Diversity (reducing risk)

Diversity is the core concept of portfolio development, but

While diversity reduces risk “FOCUS” generates profit

  1. vs. Equity vs. Alternative and High Risk Allocation

  2. Asset Class Allocation

  3. Market Sector Allocation (Industry)

  4. Market Cap Category Allocation

  5. International Market Allocation


3.2.1 Income vs. Equity vs. High Risk Allocation

  • Alternative Investments

    • Alternative investments are anything used as an investment that is not regulated as a security under the S.E.C.

    • These fall into three categories

  • Real Estate (Personal Real Estate & Unregistered Real Estate Ventures): Should not be done without a detailed market and unbiased cost benefit analysis vs. other investments.

  • Precious Metals (Physical Possession): Do to over advertising, high dealer markups, and transaction cost (auction, sales, shipping, insurance) profits are much harder to achieve and rarely a viable investment.

  • Collectables (Art, Stamps, Coins, Cards, Comics …): Anything sold as a collectable is likely worthless. Real collectables must be rare and have a lagging fluctuation directly proportional with the overall market and investor confidence.

    • Alternative investments require extensive research and should only be done with passion and understanding.

    • Alternative investing is only recommended if you are already in possession of the investment; you work in a related field; you have a hobby or strong interest other than making money (stamp or coin collecting); or you are using it for anterior purposes (your home, business, office building, vacation property …).

    • Alternative investments are often large buy necessity and skew the diversity of a portfolio, therefore they should:

      • Included alternative investments as part of the overall portfolio, but not included in the diversification % breakdown (e.g. if 40% of your assets are in real estate you so be it, but don’t invest additional money in real estate related securities for diversity; an active investor may still buy real estate securities if an unbiased analysis shows this as an undervalued sector)

      • Assume 30% in fixed income means 30% of your securities portfolio not your overall investment portfolio (i.e. if 40% Real estate and 60% securities. 30% fixed income is 30% of 60% making fixed income 18% of the overall investment portfolio).

      • This holds true if you own a business making up a large portion of your investable assets, avoid investing additional money in related industries.

  • Income

    • 100%: An investor with zero tolerance for risk may insist on a 100% income portfolio, but this is just a reaction of fear and not logical, like cowering from a thunder storm.

    • Xx%: The generally accepted rule for a conservative investor is 1% of income investments for every year of age. E.g. a 35 year old would have 35% and a 70 year old person would have 70% income.

    • 00%: On the other hand we have illustrated that an investor with more than 10 year time horizon is mathematically better off with an all equity portfolio.

  • High Risk

    • I do not recommend doing both alternative and high risk investing unless your otherwise financially secure.

    • Equity in excess of need can be allocated to “High Risk” investments

    • Otherwise High Risk should be limited to 0%-5% depending on desire, experience and risk tolerance.

    • High Risk Investments:

  • Micro Cap (<300M), Nano Cap (<50M),

  • OTC (Not listed on exchange), Penny Stock (<$2/share)

  • State Registered, Un-registered (Private Holdings / Private Equity)

  • Equity

    • Traditional Equity investments should probably be the majority of your portfolio

    • Equity = 100% - Income – Alternative – High Risk

    • Equity investments diversified and sub-divided into various categories and classes as discussed below.


3.2.2 Asset Class Allocation

  • Aggressive (Equity)

  • Growth (Equity)

  • Growth & Income (Equity)

  • Income (Income)

  • Cash Equivalent (Income)



3.2.3 Market Sector Allocation (Industry)

  1. Communication

  2. Consumer Discretionary

  3. Consumer Staples

  4. Energy

  5. Financial

  6. Healthcare

  7. Industrial

  8. Materials

  9. Services

  10. Technology


NOTE: Income investments have different “sector” allocations that will not be covered in this text


3.2.4 International Diversity


  • International can be invested as an overall index, by world region, by foreign stock exchange, currency, country, or individual stocks.

  • Since it can be difficult to keep up with international economics, politics, news, and trends it is recommend you keep this allocation small until you get more failure with investing and can keep up with international issues.

  • International regions don’t have the same cyclical economic patterns as domestic U.S.A. markets creating unnecessary risk for uninformed investors.


Common International Regions and Markets

  1. United States of America

  2. UK: England, Ireland, Bermuda, Canada, Australia

  3. EU: France, Germany, Switzerland, Netherlands

  4. Asia: China, Japan, India, Hong Kong, Singapore, S. Korea

  5. Latin America: Mexico, Brazil, Colombia, Chile

  6. Developing Countries


International Recommendation Ranges

Portfolio Objective          International Recommendation

All-equity                                            0%-25%-40%

Growth                                                0%-20%-35%

Balanced toward Growth             0%-17%-30%

Balanced Growth & Income        0%-15%-30%

Balanced toward Income              0%-10%-25%

Income Focus                                    0%-5%-20%


Regional risks are inherent to international investing, including those related to political, economic, social, and currency exchange.



3.2.5 Market Cap Diversity

  • Large (10B+) Blue Chip & Fortune 500 Companies

  • Mid2B-10B

  • Small300M-10B


High Risk Investments:

  • Micro Cap (<300M), Nano Cap (<50M),

  • OTC (Not listed on exchange), Penny Stock (<$2/share)

  • State Registered, Private Holdings



3.2.6 Mutual Funds and ETFs


Mutual Funds and ETFs are great ways to diversify your portfolio.  In fact, they are almost a necessity in creating diversification.  They can be broad across the market or narrowed by asset class, market sector, sub sector, market cap category or international region.


Funds are offered by prospectus. A prospectus contains more complete information, including investment objectives, risks, charges and expenses as well as other important information that should be carefully considered before investing or sending money. Your financial advisor can provide you with a prospectus.



3.3 Investment strategy and focus (based on market conditions)


  • Diversity Reduces Risk WHILE Focus Generates More Profit.

  • Using active investing with limited focus you can increase profits significantly without significantly increasing risk.

  • Using focused investing under various conditions with unbiased researched you can both increase profit and decrease risk at the same time.

  • E.g. the overall market is stable but two sectors are overvalued while one is undervalued.Moving funds from the two over valued sectors will decrease your risk while putting those funds into the undervalued sector increases your chance for profit.




  1. Determine Market Conditions

    • Neutral: Stable, with no major pressure and just as likely to go up as down

    • Volatile: Unstable significant outside pressures and just as likely to go up as down

    • Undervalued: Below historic norms and more likely to go up than down

    • Overvalued: Above historic norms and more likely to go down than up

  2. vs. Equity Allocation

    • Stock market is overpriced move out of equities (normally to buy bonds)

    • Stock market is underpriced buy equities (normally by selling bonds)

    • When interest rates are expecting to go up: avoid bonds for short term investing

  3. Asset Class Allocation

    • Stock market is overpriced move from growth toward income

    • Stock market is underpriced move from income towards growth

  4. Market Sector Allocation (Industry): Move money from overvalued to undervalued sectors normally using sector mutual funds or sector index ETFs

  5. Market Cap Category Allocation

    • Sticking to large cap is the best most of the time.In an undervalued market moving some assets to mid and small cap will statistically improve performance.

  6. International Market Allocation

    • Unlike market sectors foreign markets can’t be counted on to follow cycles.

    • E.g. Japan soared in the 70’s and 80’s and even though it is fairly stable it hasn’t had outstanding returns for more than 30 years

    • You can put money into international indexes and securities when the U.S.A. markets are over-inflated or the U.S. dollar is expected to fall.

    • Other than as a buffer for the U.S. economy to invest in international securities you are better off buying individual stocks that are large cap, stable, and undervalued.


3.4 Level (Market, sector, individual investments)

Level refers to what level of detail you going to research and invest

  • Market

  • Sector, Subsector

  • Individual company stocks


Factors used to determine the level of your investment

  • Risk Acceptance

  • Market conditions

  • Time commitment




Part 4: Select investments

  • Stick with quality

  • Value: Buy & hold undervalued investments

  • Quality stocks have historically outperformed quality bonds

  • It’s not just what you make, it’s what you keep

  • Don’t be emotional

    • Avoid buying on momentum

    • Don’t jump to sell a down investment

    • Always evaluate based on price to fair market value


4.1: Stick with quality

  • Well established companies

  • Products and services you know

  • Dividend-paying stocks: Offer the potential for Current income, and Long-term capital growth


4.2: Stocks vs. Bonds

Since 1910

  • Even in the decades during the 1930s, the stock market basically broke even

  • 2009 marked the end of the second-worst decade for stocks - the stock market had an average annual return of about -1%

  • Even though 2009 was a year most investors want to forget, the U.S. stock market was almost 3 times its March 2009 lows five years later

  • Stocks delivered better returns than bonds or Treasury bills 85% of the time

  • Source: Ibbotson. Measured 77 rolling 10-year periods from 1926 to 2011. Returns include reinvested dividends.


4.3: Market timing can increase returns, but does have some risk

Investor Behavior Drives Investment Performance: We will use a generic diversified equity portfolio for ten year with a starting investment value of $10,000 as an example:

  • A typical diversified equity investment can be expected to average 7.2% return making it double in a ten year period. Ending with $20,000

  • On average in a ten year period avoiding the 10 worst days in the market would more than triple the average investment with a 12% return. Ending with $30,000

  • While missing the 10 best days would reduce your average return to only 4% making your final some approximately $15,000


4.4: Dollar cost averaging (Systematic investing)


Is useful as a passive investor or when you are uncertain about the market. Dollar cost averaging is a good strategy in a stable or uncertain market.  Active investors should not dollar cost average in over values undervalues or volatile markets.


Systematic investing / Dollar cost averaging

                Amount Invested            Price per Share                 Shares Bought

Month 1                               $100.00 $25.00                   4

Month 2                               $100.00 $50.00                   2

Month 3                               $100.00 $75.00                   1.33

Month 4                               $100.00 $100.00                 1


Dollar cost averaging mitigates risk but does not guarantee a profit or protect against loss. Such a strategy involves continual investment in securities regardless of fluctuating price levels of such securities. The investor should consider the financial ability to continue the purchases through periods of low price levels.


4.5: Don’t be emotional (It’s not what you make it’s what you keep)

  1. Avoid buying on momentum

  2. Don’t jump to sell a down investment

  3. Always evaluate based on price to fair market value


4.5.1: Addressing Mistakes

Three main reasons to sell investments:

  1. Change in fundamentals of investment

  2. Technical change (investment price exceeds reasonable value)

  3. Changing your goals

  4. Portfolio rebalancing


4.5.2: Don’t Rush to “Cut Losses”

  • If you bought a house five years ago for $240,000, would you sell it now for $200,000 if you didn’t need to move, just so you could “cut your losses”?

  • So why sell investments that are down but still meet your needs? You’ll just be “locking in losses.”


5 Review your strategy regularly

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