The Digest | New Jersey Magazine
Issue link: https://magazines.vuenj.com/i/701166
The importance of diversification has been trumpeted for over a thousand years. Many centuries ago, a Rabbi recommended that investors have "a third in land, a third in merchandise, and third ready at hand." Advice on diversification and asset allocation didn't change until the recent past when Harry Markowitz in 1952 published the origin of modern portfolio theory "Portfolio Selection". It posed the thought that investors can use estimates of return and volatility to build optimal portfolios and enhance outcomes through diversification. This theory is the genesis for most portfolio discussions today, although investors are still struggling for a way to effectively implement it. Pension plans and other institutional investors have gradually taken a different approach over the last decade. Instead of creating portfolios purely on risk-adjusted return, they began focusing on matching their investment strategy to their goals. What they've found is that such a framework provides better perspective in regard to performance and decision-making as they progress toward their goals. Individual families can learn from this as well. Most investors have future objectives that they'd like their investment assets to meet— such as paying for college tuition, buying a vacation property, funding retirement, or leaving an inheritance. Goals-based investing can be very helpful in designing a plan to meet those objectives. The heart of goal-based investing is the concept of "bucketing," or segmenting investment assets into three portfolios that we refer to as liquidity, longevity, and legacy. The liquidity bucket holds three to five years of spending needs, the longevity bucket holds assets that will be necessary to meet the household's objectives over its lifetime, and the legacy bucket holds surplus assets that can be designated for inheritance or charitable purposes. There are four crucial benefits to this strategy: 1. It is dynamic. The liquidity, longevity, legacy approach makes it transparent where a household stands relative to its goals, and ties its investment decisions to the objectives in its financial plans. As the household gets closer to each specific goal, assets flow from the longevity portfolio into the liquidity EVALUATING PERFORMANCE AND FOCUS ON WHAT'S IMPORTANT B Y A N T H O N Y C R I S T I A N O portfolio, which appropriately de- risks the assets being used for those goals. 2. It is behavioral. Recent behavioral economics research shows that segregating safe assets into a separate portfolio can actually help investors make less emotional decisions regarding the remainder of their assets during periods of market peril. For example, by holding a liquidity portfolio (three to five years of planned spending in ultra-safe assets), investors might not feel VUE ON FORTUNE V U E N J . C O M 122