How Individual Investors Get Organized and Manage Their Portfolios Like a "Pro"?
Investor toolkit, overlooked concepts of investing, and organizing information and acting on it
Recently, I received a note from a new subscriber, who came to me after reading one of my very first investment writings on social media:
He told me he is an individual investor and has retired. As he has lots of free time, he has been reading books and studying investment management and financial analysis in the last few years. He wants to actively manage his portfolio by adopting the “Pro’s way” of managing investments.
He wants to know how to get organized and focus on the important tasks of actively managing his portfolio in the face of vast information from the media, the internet, and various platforms.
This question makes a perfect sequel to my earlier article! Thank you!
I will approach my subscriber’s question in this way:
What toolkits do professional fund managers have to convince potential investors to invest in their funds and strategies?
What are some overlooked/misunderstood concepts of investing?
How do we organize and synthesise information and act on it?
I want to preface that “Pros” are not necessarily much better than ALL individual investors. You may have heard of the famous bet that Warren Buffett made with a hedge fund manager back in 2008 that an S&P 500 Index Fund would beat a hand-picked portfolio of hedge funds over 10 years. The hedge fund manager who accepted the bet admitted defeat even before the contest wrapped up!
An individual investor using appropriate index funds can beat the pro, provided she stays vigilant on several basic investing principles and develops an appropriate investment process and strategy.
I would like to emphasize investing is a highly individualized experience that takes into account an investor’s goals, risk profile, and values (beliefs), so there is no one-size-fits-all.
Let’s dig deeper!
Professional Managers Toolkits
All investment managers have a presentation deck (a pitch book) to tell investors about their investment process, what is unique about them, and why investors should invest with them. The deck includes sections on:
Investment strategy and investment universe - is this a long-only, long/short (hedge) in publicly-traded equities and bond markets, private equity, private credit, venture capital, real estate, infrastructure fund, etc? Do they use stocks, bonds, or mainly ETFs and even options?
Investment approach—are they fundamental investors focusing on researching a company’s, industry’s, and country’s fundamentals, market valuation, management, industry competition, macroeconomic policies, etc., or are they quantitative or technical investors, focusing on price patterns, historical asset relationships, modelling (usually lots of computing), technical analysis, and flows / volumes? Some investors combine both—called “quantamental managers.”
Investment style—are they value, growth, size, momentum, dividend, low volatility, or quality-focused?
Investment philosophy—are they long-term holders or day/ high-frequency traders? Are they diversified or concentrated?
Leverage—hedge funds typically have gross exposure (long and short or just long) of over 100% of their book. They borrow securities on leverage funds (sell short to gross up their exposure) or buy securities on margin from their prime brokers.
Risk management strategy—do they cap the weight of each position, sector, country, asset class, etc., and do they target their portfolio volatility say, not over 20% p.a., or within 8 to 12 % p.a. (like a hedge fund)?
Fund track record, previous track record, and fund information
Team and experiences
For individual investors, I would suggest they be more specific, systematic, and articulate in their investment process.
Evaluate each of the above points to see how you would tell someone else how you invest. The more you teach, the better you understand!
For example, you may be an individual investor who is more risk-aware and prefers a more stable, income-oriented portfolio, likes to be more balanced between asset classes, uses mainly ETFs for core positions and adds a few thematic stocks, and goes for value investments, holding these positions for a long time.
By articulating your investment style, philosophy, approach, investment universe, and investment objective, what you will put into the portfolio becomes much clearer.
Create an investment agreement for yourself, and lay down how you would manage your money if you were your client 🙌!
Overlooked Concepts in Investing
I would like to share three overlooked or misunderstood concepts in investing that our investors resonate with.
Each is worth pages of whitepapers and presentations to explain, but I will be as succinct as possible!
First, a value stock to us is not one with low multiples such as low price-to-earnings or low price-to-book ratios but one with a high margin of safety. The questions we ask are:
What expectations of growth and profitability are being priced in?
What is the intrinsic valuation of a company or business you invest in (listen to Warren Buffett’s explanation of intrinsic valuation)?
The intrinsic value of any business is the number if you were all-knowing about the future and converted all the cash the business will give you between now and judgment day discounted at the proper discount rate, that number is the intrinsic value of the business [, i.e. intrinsic value is the present value of all future cash flow of the business.] ~ Warren Buffett
To paraphrase his example of Aseop whether or not you should give up a bird in hand for two birds in the bush (future), the questions to ask are: how many birds do you think there are in the bush, when will you get them, and how sure are you?
Once Buffett knows the intrinsic value, he will purchase a business at a price below the intrinsic value, hence the margin of safety.
Second, risk is not volatility (fluctuation of price around its historical mean) but the permanent loss of capital. Risk is closely related to value in the sense the higher the intrinsic value, the lower the intrinsic risk.
To estimate your permanent loss of capital, picture different “stressed” scenarios such as wars, banking crises, bubble bursting, and an interest rate rise of 5% rapidly, and estimate the possible losses. Can you stomach that loss, and is what you are losing a big part of your assets?
Third, investing is more than picking a favourite stock or investment. It is also how you put all your investments together. In other words, asset allocation decisions amongst asset classes, regions/countries, sectors, factors (growth, value, dividend, etc.), themes, and alternative assets such as gold, oil, and real estate and how you optimize these positions become even more important.
A proper asset allocation allows one to diversify properly and hold the investments long-term, without the need to time the market or forecast the future (always a futile exercise). Occasional rebalancing makes sense if a certain part of your asset allocation moves out of whack with what you target or is getting too expensive.
The following chart describes what the market capitalization looks like among major global asset classes (a global market portfolio):
A recent study by Morningstar found the following:
Our annual study of dollar-weighted returns (also known as investor returns) finds investors earned about 6% per year on the average dollar they invested in mutual funds and exchange-traded funds over the trailing 10 years ended Dec. 31, 2022. This is about 1.7 percentage points less than the total returns their fund investments generated over the same period. This shortfall, or gap, stems from poorly timed purchases and sales of fund shares, which cost investors roughly one fifth the return they would have earned if they had simply bought and held.
Amongst all the investment strategies, the “Allocation” category sees the lowest gap between investor returns (weighted by cash flowing in and out) and the returns from their fund holdings. This points to the benefit of broader and more diversified funds rather than a more narrowly defined fund or strategy, like a sector-focused or a highly volatile fund.
Want more evidence of how missing the best trading days would impact your performance?
A recent Vanguard Investment Advisory Research Study found that for a portfolio with 60% US stocks (broad market) and 40% US bonds (aggregate bonds) from June 1996 to March 2024, a $100,000 investment would turn into $856,000 by holding the positions. By missing the best 5 days, the investment would become $659,000. Missing the 25 best days would give you $343,000, about 40% of what you could have made if you adopted a “buy-and-hold” strategy.
Gathering Market Information and Acting On It
As mentioned in my earlier piece, investment people spend a lot of time reading news and articles and analyzing financial numbers, trends, economic data, and charts.
I would say in a typical week of my investment job, 85% of the time is spent reading news/ reports and researching and writing up ideas and only 15% of the time is spent on investing, portfolio reporting, managing, and turning over positions in the portfolio.
Most investment people read Bloomberg News, the Financial Times, and Wall Street Journal/ Barron’s for financial news first thing in the morning. Then our days are filled with reading Wall Street analysts’ or company reports.
If you cannot get any analyst reports, you can gather good company/industry information by reading annual and quarterly reports and following a few good economic publications from the Federal Reserve, the IMF, Project Syndicate, etc.
I just sit in my office and read all day. ~ Warren Buffett
This is why understanding your goals and risk profile and setting up your investment approach, investment universe/ strategies, and asset allocation up front is important. Trading and timing the market, for most of you, is not your main activity. They are just not worth your effort. Diversification offers the only free lunch in investment.
The important task is to research and understand what you will put into the portfolio, why, and the weight of that investment, and have a solid idea of how much money you will make and how big your losses can be.
You don’t have to analyze hundreds of stocks. Build up the asset allocation that fits your goal, risk tolerance, and risk capacity, and then find a low-cost way to get exposure, such as exchange-traded funds (ETFs). There are now 10,000 ETFs trading in the world, and you can surely find one that fits your exposures.
If you intend to buy stocks, do a discounted cash flow analysis to know the company’s intrinsic value before you jump in. The lower the price you pay below the intrinsic value, the more the investments can potentially make for you.
Pay attention to macroeconomic factors and government policies including monetary, fiscal, and exchange rate policies (in some countries). According to Vanguard, asset allocation, not stock selection, is the main driver of portfolio returns and volatility.
Extensive research has shown that, if you have a diversified portfolio, a whopping 88% of your experience (the volatility you encounter and the returns you earn) can be traced back to your asset allocation. ~The Global Case for Strategic Allocation, Vanguard
In Sum
Before investing and creating an investment portfolio:
✔ Determine your investment objective, risk profile, capacity, and values and design a suitable investment approach to guide your investment universe.
✔ Establish clear investment principles including what are value and risk to you and what your asset allocation looks like.
✔ Research your positions from a bottom-up (company level) and top-down (macro) perspective and be diversified. Time in the market is more important than timing the market.
This is by no means your only guide to investing and is not meant to be investment advice. Investing is highly personal, and each person is a unique investor based on her goals, risk profile, and values.
With that said, I hope my investing approach serves as a reference point in your exciting journey of building wealth.
Your comments and feedback are valuable.
Happy investing!
Good thoughts here.
Reading all day is great like Warren Buffett noted.
I also think it’s extremely important to find a community of like-minded individuals that are on the same mission and also have some proof of concept.
It likely speeds up the process for you compared with trying to figure it all out on your own!