The Investment Management Process

As Crash Davis said in the movie Bull Durham, "baseball is a simple game: you throw the ball, you hit the ball, and you catch the ball." The same could be said for investment management:

• You determine how much money you need to accumulate, and by when.
  
  
• Given your current and expected future savings, you determine the minimum rate of return you need to earn on your portfolio to achieve your financial goal.
  
  
• You decide on an asset allocation strategy that maximizes the probability of achieving this goal while taking on the least possible risk.
  
  
• You select investments to implement this strategy.
  
  
• And you check performance at appropriate intervals to make sure you're on track to achieve your goals.

Sharp eyed readers might note that this approach differs somewhat from others they may have seen, which start with your goals and risk tolerance (which in turn determines your asset allocation strategy), and proceed to tell you how much more you have to save. Our approach is indeed different; specifically, we assume (and research, such as Prospect Theory, seems to support) that most people find it easier to change their asset allocation (and underlying risk tolerance) than they do their level of savings.

The reasoning here is straightforward: everyday, all around us, we see lots of people for whom staying in the middle class - by which we mean ensuring they have health insurance, a house, and have saved enough for their children's college and their own retirement - is very much a struggle. When you give most of these people a choice between saving more (from what!?) or wanting less (!), they throw up their hands and say there must be another way out of this. And many people find it, in the form of taking on more risk in their portfolio in the hope of earning higher returns. Anyone looking for evidence of this need look no further than the explosion of interest in high tech stocks we experienced in 1997 through 2000.

For a more extensive discussion of the issues we have raised here, please continue on to our free section titled: How Much Do You Need to Save?

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