What methods and strategies does your money manager use for your portfolio? This is a question that most investors cannot answer.

Most managers out there are using what I call a “static model based approach” which has been developed using principles of Modern Portfolio Theory (MPT) and Asset Allocation.

Modern Portfolio Theory – MPT: tries to maximize portfolio return for a given level of volatility (sometimes called risk).  The idea is that at any given time different asset classes will be performing better or worse than other asset classes and by having a mix there will be reduced volatility while still getting the same long-term performance.

Asset Classes: the three most basic asset classes are stocks, bonds, and cash (stocks = equities, bonds = fixed income). Those three asset classes can be broken down into smaller sub-categories or sub asset classes. Example: stocks can be broken down to: foreign, US, growth, value, large cap, small cap, technology, consumer staples and on and on.

How it works for you as the client: The money manager or others within the firm (more often others) create various model portfolios typically using mutual funds or ETFs. Client fills out risk questionnaire, which matches them with a particular model. Client’s portfolio is built out to mirror the model and then rebalanced on some set time schedule, usually annually, semi-annually, or quarterly.

Below are examples of 100% equity portfolios, using the above methodology. Using mutual funds or ETFs the manager creates portfolios based on static percentages using many or few categories of stocks. As you can see the number of asset classes/holdings can be as few as two, or infinitely many. The key is to keep the holdings the same, and rebalance to the set percentages (not necessarily equal) at regular intervals.

Example 1: 50% – US Large Cap 50% – Foreign Large Cap

Example 2: 25% – US Large Cap 25% – Foreign Large Cap 25% – US Small Cap 25% – Foreign Small Cap

Example 3: 10% – US Large Cap Growth 10% – US Large Cap Value 10% – Foreign Large Cap Growth 10% – Foreign Large Cap Value 10% – US Small Cap Growth 10% – US Small Cap Value 10% – Foreign Small Cap Growth 10% – Foreign Small Cap Value 10% – US Mid Cap 10% – Foreign Mid Cap

Is this MPT ingenious? Yes. Is MPT too conceptually complex for average investors to implement? No. Can the average investor successfully implement a strategy like this? No; year after year countless studies continue to show that the vast majority of investors may comprehend these investing concepts, but are unable to implement them successfully.

Drawbacks: There are several drawbacks and critiques to be made of MPT, I will make one. The theory is based on the assumption that the future results will be the same as the past results.

My take is that if an investor has the mental and emotional discipline to stick with a plan, then they may consider using the principles of MPT and Asset Allocation to self-manage as an alternative to hiring a professional at 1-2.5% (not counting fund expenses) that is using the same principles. Keep in mind that there are countless other investment methods and strategies out there. It is just my experience that most of the money managers are using a variation of this methodology.

Understanding these principles is important for all investors.

Wyatt do you use the above outlined approach to manage client’s portfolios? No, I use an approach I refer to as tactical portfolio management. I will detail my approach in the future.

I often ask folks about their current and past money managers. Whether they are prospective clients or it comes up amongst acquaintances in general conversation; I consistently find that people do not really know much about their money managers or how they operate.

These holds true among self-managers too. I will learn that someone is a self-manager and ask them about their investing strategy and nine out of ten times they are unable to articulate in any decipherable way what their investing philosophy or strategy is.

I plan to occasionally write posts about money managers. These posts will range from how various firms are structured to how various managers collect fees, and most importantly how they create and implement recommendations for their clients.

I am using the catchall term of money manager, because the list of what these professionals refer to themselves as is very long. There are financial advisors, financial planners, wealth advisors, investment advisors, wealth managers, investment counselors, financial advisers, and investment advisers to name a few. Others refer to themselves simply as money managers.

The list of how they refer to themselves is endless, and sadly there is little set standard for this. A professional at Northwestern Mutual may refer to himself as a financial advisor, but only sell insurance products and do no portfolio management at all. Another professional working for Morgan Stanley may refer to himself as a financial advisor and do portfolio management, but sell no insurance products.

I personally refer to myself as an Investment Adviser, but could just as easily use one of the above mentioned titles.

One thing a money manager can’t just throw around though, is a professional designation such as CFP, CFA, and CPA. Those designations require meeting certain requirements, passing tests, and paying a board annually to renew the designation. There will likely be a post in the future covering professional designations.