BY KENT KRAMER, CFP^®, AIF^®, Chief Investment Officer, Foster Group

I confess, I love my wife’s carrot cake recipe! She makes it for my birthday every year. The recipe results in a cake that is moist, and the frosting is so creamy that even a non-frosting fan like me can’t resist it. Importantly, based on my tastes, the cake does not contain any nuts. To some folks, that’s carrot cake heresy; to me, carrot cake heaven.

Good recipes are the foundation of many things we enjoy eating. The recipe specifies the correct amount of each ingredient, which is critical to the flavor and texture of the food and whether we will have a good experience eating our meal.

Investment portfolios also consist of recipes and ingredients, and getting both correct is important for a good investment experience.

The recipe for a portfolio is expressed in its broad asset allocation. Much academic and industry research has been done on the importance of asset allocation. These studies almost all indicate that well over 75% of a portfolio’s expected risk and return will be determined by the asset allocation, or for the purposes of our discussion, the recipe.

The financial goals of an investor (our “taste preferences”) combined with financial science (how ingredients interact) form the basis of a portfolio’s asset allocation or recipe. How much of the overall portfolio should be held in cash and very stable bonds or CDs? What percentage or dollar amount of the portfolio will be invested in US stocks? Foreign stocks? Among the broad asset classes of stocks, are there specific amounts being designated to small companies, value companies, profitable companies? These broad asset classes represent the types of ingredients most portfolio recipes include and, generally, are the primary determinants of what an investor should expect.

As an investor, you may also choose to include asset classes like Real Estate or alternative investments in your portfolio recipe. You may choose to exclude certain elements that you don’t like. Perhaps you prefer not to invest in more speculative assets, like options or commodity futures. You may have an aversion to certain companies or industries for personal, values-based reasons. You can have a very successful portfolio without these being a part of your overall asset allocation recipe. As previously mentioned, I greatly prefer my carrot cake without nuts!

Coming up with the right recipe, the best combination of ingredients, goes a long way to creating a good cake. But the general recipe is only part of the story. If the recipe calls for almond extract in the frosting, which brand provides the best almond flavor? Will you use a less expensive, imitation almond extract, or will you use the real thing? And among the brands offering the real thing, is there one that tastes better than the others?

The same is true in the actual assembly of your portfolio. If your recipe calls for 25% US stocks in the overall portfolio mix, which stocks, or managers of US stocks, are expected to provide a better combination of risk and return? For each asset class recipe decision, there will be at least one or more specific ingredient decisions that need to be made. While these specific ingredient decisions in the portfolio will have less impact than the overall asset allocation recipe, they are still important and will have an influence on the success of the portfolio.

At Foster Group, truly caring for our clients means taking the time to learn what’s in their hearts and using proven methods to help them pursue their goals. So, our investment process starts with understanding the needs, tastes, and preferences of our investors. Our team is regularly evaluating which asset allocation strategies offer better combinations of expected risk and return based on academic evidence and actual experience. Additionally, we are always researching specific investments and managers to see which ingredients will ultimately make it into our client’s actual portfolios. This three-step process, understanding tastes and preferences, recipes, and ingredients, provides a readily understandable framework for good meals and good investment experiences.

All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. There are no assurances that an investor’s portfolio will match or outperform any particular benchmark.

PLEASE NOTE LIMITATIONS: Please see Important Disclosure Information and the limitations of any ranking/recognitions, at www.fostergrp.com/info-disclosure. A copy of our current written disclosure statement as set forth on Part 2A of Form ADV is available at www.adviserinfo.sec.gov. ©2019 Foster Group, Inc. All Rights Reserved.

Kent Kramer    View Bio