Envision Your Financial Future

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Importance of Time Horizon

The most important decision that an investor makes is how much to allocate to stocks vs. bond/cash. An investor’s time horizon is a critical factor in determining the appropriate asset allocation mix. The significantly higher volatility of stocks makes stocks less suitable for funds that are needed soon, whereas, in the long run, stocks are likely to produce better returns even in worst-case scenarios. Investors with longer time horizons face the “Investor’s Dilemma.” Investors must choose between accepting higher volatility from stocks in the pursuit of higher returns or accepting lower returns from bonds in the pursuit of lower volatility.

Monte Carlo Modeling

The decision as to how much to allocate between stocks and bonds is not an all-or-nothing proposition. Long-term cash flow modeling (a.k.a. “Monte Carlo” modeling) provides helpful context for the asset allocation decision. Envision Financial LLC utilizes a proprietary Monte Carlo cash flow modeling tool to assist clients in evaluating the sustainability of retirement spending and provide context for the asset allocation decision.

Diversification

Within the framework of the target asset allocation, diversification of investments is recommended to reduce portfolio volatility. A combination of passive (index) funds and actively managed funds is employed. Passive funds attempt to mirror the performance of market indexes (e.g. S&P 500, Russell 2000) by replicating or sampling such indexes. The passive nature of these funds results in lower fund operating expenses, which is important since cost is one thing that investors can truly control. While the goal of actively managed funds is to “beat” certain market indexes, many fail to do so after deducting fund operating expenses. The rationale for the passive approach is that investors can earn market returns while incurring lower expenses. In less efficient markets, active managers may produce incremental returns that justify their expenses. Also, active managers with unique styles can enhance returns relative to volatility by producing low correlation relative to market returns.

Systematic Rebalancing

Portfolio allocations are reviewed regularly relative to targets and systematic portfolio rebalancing is intended to promote a “buy low, sell high” philosophy and mitigate emotional impulses to “chase” the market based upon momentum (which may result in buying or selling at the least opportune time).