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Portfolio construction

In constructing a portfolio for our clients, we use a scientific process to ensure there is an appropriate balance between sleeping well (no stress) and eating well (maximising returns).

How the others do it…

Unlike many other financial planning groups, we do not outsource this task to a research house to construct 5-6 “pre-prepared” portfolios. In this model, the client is matched to the portfolio, rather than a portfolio matched to the needs of the client. You, the client, are effectively shoved into a pigeon hole which is very useful for streamlining processes for the financial planning firm but doesn’t take any notice of the fact that we all have different needs and goals that we are setting out to achieve.

These pre-prepared portfolios will vary from year to year based on the state of the economy, interest rates, inflation, which way the wind is blowing, and perhaps even whether the research analysts footy team won on the weekend; who knows.

We don’t believe anyone has a crystal ball so see the fees involved in having these portfolios prepared as an unnecessary expense (that you, the investor, will end up paying for anyway).

How we do it…

Your investment portfolio needs to be constructed based on your past experiences with investing, the goals that you have told us you want to achieve and your tolerance to risk.

Whilst we do get you to complete a risk tolerance questionnaire, this is only one part of the puzzle.  It is also up to the adviser to gauge your tolerance to risk through your goals and other information that you provide to us.

Once we have a good understanding of your goals, tolerance to risk and what rate of return you need on your investments to achieve your goals we can set about constructing your portfolio.

The three-factor model

The process that we use is based around the research performed by two academics named Eugene Fama and Ken French. This research states that the expected return of a portfolio is mainly determined by three factors.

Firstly, stocks tend to beat bonds (in other words shares earn greater returns than term deposits) and whilst there is higher risk associated with stocks, investors are rewarded for this through a higher return. The first step is to decide how much of your portfolio is invested into shares and property as opposed to fixed interest and cash.

The second factor identified was that size matters (ladies, please stop laughing). The research highlighted that smaller companies tend to outperform larger companies. Again, the study revealed a higher level of risk associated with the smaller companies, but the extra risk provided an extra reward.

So, once we’ve determined how much of your portfolio is invested into shares, we then work out how much to allocated to smaller companies as opposed to larger companies.

The final factor identifed was that cheap companies tend to outperform expensive companies (or in more technical terms, “value” companies tend to outperform “growth” companies”). The reason for this is partly to do with risk and part to do with mispricing.  Travis is working on an article that explains this issue in detail which will be available shortly.

The final step in this process is to determine if value companies should be included in your portfolio and for the more assertive investors we even go further and discuss emerging markets but this subject is outside the scope of our discussion here (refer to “name of article” for more information).


In summary, as investors we all have to bow to one univeral rule; if we want higher returns we have to be prepared to accept higher risks.

Our role, as your adivser, is not to look into a crystal ball and identify the next Google or predict which asset sector will outperform all others in the next 12 months, because frankly we can’t and no one else can either.

Our role is to assess how much risk is appropriate for your portfolio, that will allow you to achieve your goals, yet not lead to any sleepless nights.

What happens when the wind changes direction?

So what happens if the stockmarket drops by 15%, if interests rates rise by 0.5% or if another war breaks out in the middle east?


The only time your portfolio changes, is if you change.

If your goals change (you want to go on an overseas holiday every year in retirement instead of every second year) or your tolerance to risk changes then changes need to be made to your portfolio. If everything else remains constant, then there isn’t a great deal of work to be done which is why we don’t charge high ongoing fees.

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