An Investment Plan for the Truly Fed Up

From the Charleston Mercury, Aug. 23:

“The deck is stacked.” “The game is rigged.” “The system is unmanageable.”

No, these words were not spoken by another loser in Las Vegas. Instead, they were written by Ron Lieber, columnist for the New York Times a few weeks ago. Mr. Lieber’s article, “A Financial Plan for the Truly Fed Up,” was one of the most e-mailed for over a week.

It’s not surprising. Many people are upset. They’re fed up with Wall Street and they’re fed up with feeble or non-existent investment returns.

Lieber cites the recent frequency of “unfortunate” events including funky trading programs at Knight Capital, the “London Whale” debacle at JP Morgan and the LIBOR scandal as reasons why some people want nothing to do with big banks. Mr. Lieber isn’t the only one. Neil Barofsky, the former special inspector general of TARP, has just released a new book entitled “Bailout.” In it, Mr. Barofsky details his experiences and argues that the Treasury Department has worked with Wall Street firms to increase their profits at the public’s expense.

At the same time, returns on most equity indices over the last five years have been flat or negative, while the cost of living has increased 2% per year. And, what about those other concerns, like inflation and living longer?

O.K. So you’re fed up. Understandable. But, it’s not time to give up. You need to get returns that exceed inflation. Here’s a format to consider:

Group your investment portfolio in two pieces, Strategic and Alternative. The strategic piece would consist of long-only investments in stocks and bonds, utilizing mutual funds and/or ETFs. The alternative piece may consist of stocks, bonds and alternative assets and may hold both long and short positions, both liquid and illiquid depending upon your situation.

The strategic portion of the portfolio should be seen as the “core” piece representing the majority of your portfolio, say 70-80%. This portion is driven by the risk, return, and correlation of the equity and fixed income asset classes within. Hence, it incorporates a higher beta, or correlation with the market (and when we say market, we mean both the stock market and the fixed income market).

The alternative portion of the portfolio should be seen as the “satellite” piece representing the minority portion of your portfolio, say 20-30%. This portion is not driven by the usual market forces – it may employ hedge-fund type risk management components and strategies that are designed to protect the downside and participate in the upside – hence less reliance on beta and more reliance on alpha (defined as the value added by the investment manager).

Combining the “core” and “satellite” pieces gives you an overall portfolio that should enable you to participate from your market or beta-like exposure but also will protect you by your alternative/absolute return/alpha-seeking exposure. Of course, your overall asset allocation must be reviewed regularly. And both the strategic and alternative portfolios require ongoing rebalancing to adjust to targets and to take advantage of opportunities to increase return and/or reduce risk.

Yes, there are solutions for those ready to embrace them.

Les Detterbeck is one of a small number of investment professionals in the country who has attained CPA, CFP(r) and CFA designations. His firm, DWM Financial Consultant Group, Inc., a fee-only Registered Investment Adviser, has offices in Charleston/Mt. Pleasant and Chicago. Les may be contacted at 843-577-2463 or les@dwmgmt.com.