Secrets to Building Wealth

This weekend, Matt Marmorstein and I attended the Annual Urology Association conference.  We attend medical conferences to meet doctors who represent a large percentage of our clients and assets under management.

The question we are often asked at these conferences is how to build wealth?   Keep in mind that many veteran doctors earn upwards of seven figure incomes and still struggle to develop a successful investment strategy to achieve financial independence. 

Most have stories of failed investments, and some deposited large amounts of money.    Many expressed frustrations with sub-par returns with their brokerage accounts with little communication from their advisors.  One urologist this weekend who has more than $4M invested with his advisor told us he can rarely reach his advisor by phone or meet in person.   

In my book, I outline several keys to developing a successful investment strategy to achieve financial independence.  Today, I will focus on one key that is:

• Staying current with market conditions

One of our first steps with a new client is reviewing their current portfolio.  There are many reasons why people change their advisor that includes poor services, changes with the company, or the client has moved to a new location. One consistent theme is dissatisfaction with the performance of their account. 

Since no one has a crystal ball to accurately predict the future, your investments need the ability to adapt to changes.  Flexibility is the ease of selling at minimal costs and delays when market conditions or events are negatively impacting your investment. Real estate, for example, has been a good investment for many but has very little flexibility, especially when market conditions change, such as in 2008.  The ability to adjust your investments with economic events provides the ability to adapt to sell should situations work against you or buy more if the investment is doing well.  The key to investments is flexibility, which is the ability to fix a mistake and cut your losses.

The stock market offers the greatest amount of flexibility to sell or buy at a moment's notice.  However, the most valuable aspect of the multi-billion-dollar stock market is the ability to keep your portfolio current with economic events and market cycles. 

Recently, we were asked to analyze a prospective client's investment portfolio.  Their concern was the underperformance of their account during the past several years.  It was apparent that the portfolio manager subscribes to "Modern Portfolio Theory."   

Modern Portfolio Theory (MPT) was introduced by American economist Harry Markowitz (8-24-1927 to 6-22-2023) in his paper, "Portfolio Selection", which was published in the Journal of Finance in 1952.  He was later awarded the Nobel Prize for his work on MPT. 

He offered many theories on investing and had an impactful career.  The key aspect of MPT is diversification adjusted for risk.  His opinion was that investments are either high risk and high return or low risk and low return.  Markowitz believed that investors could achieve the best results by creating a diversified portfolio blending both classes of investments according to the risk tolerance of the investor.

Typically, one that subscribes to MPT holds their allocations for years, making little changes even as market conditions change.  The rationale is that when asset classes or investments decline, they assume the investments will recover sometime in the future during the next cycle.

However, there are many aspects to MPT that can be challenged.  The first is owning underperforming investments reduces the portfolio's current period total return.  There is no guarantee these investments will recover and provide superior returns in the future to make up for the prior period's underperformance. 

The second is MPT does not consider market trends and cycles.   In the case of this recent prospect, their account had large allocations in four key areas:

• International and emerging markets

• Small Cap

• Municipal bonds

• Corporate bonds

Below is an Asset Class Performance chart of trailing periods up to March 31, 2024.  As you can see under the column titled "5-Year Total Return", the client's asset classes are all in the lower tier of total return.  Below are the 5 Year total returns of these categories:

• Small Cap: 8.1%

• World ex-USA: 8.0%

• Aggregate Bonds: 0.4%

• Municipal Bonds: 1.6%

• Emerging Market: 2.6%

This compares to the S&P 500's total return of 18.5% for the same period. A significant compromise in the client's total return for the past five years.

Worse is that these same classes of investments have remained in the lower ranking in total return for almost every period for the past ten years. 

The question I ask is how long one holds onto underperforming investments and tolerates average or worse returns.  More importantly, what is the loss tolerance of those investments declining in value? When will the underperforming investments be replaced with investments with better perceived future performance?

Our investment selection places a high priority on momentum.  For example, is the momentum of the economy growing or contracting? Is the investment trending in a positive momentum or declining?  Are there better investments with stronger momentum?  In short, are institutional investors buying these investments, and are the security prices increasing in value?

We have not allocated to emerging markets and international since 2015.  The primary reason is these assets classes have yet to exceed the S&P 500 in total return and we don't perceive any changes soon.

Another underperforming asset class with poor momentum is bonds.  We have been writing about the risks of corporate, government, and municipal bonds for years concerning when interest rates will begin to rise 2022. When the Federal Reserve began its campaign to slow inflation by increasing interest rates, investor who didn't reduce their allocations to bonds suffered significant losses.  Most notable were banks, hedge funds, and institutional investors that lost billions holding bonds, with some being forced into bankruptcy.

Times change, and with those changes, so should your investments.

What Does This Mean to Me?

The investment industry is changing dramatically with the onset of technology and AI developments. The larger financial firms re-direct your calls to computer answering programs and after that to national call centers.Good luck trying to reach your advisor directly.

Another area of change is more reliance on MPT with computers managing your investment portfolio and less reliance on individual investment teams.  For most institutions, the theory of a diversified portfolio holding just about every asset class (kitchen sink theory) is safer for the client and reduces the institution's risk of lawsuits. 

We manage the Up Capital Management model portfolios with a focus on momentum.  Our goal is to keep our portfolios current with our perceived market conditions.  We maintain a favorable view of the US economy and stock market.  We believe America will remain one of the strongest economies and its currency in 2024.  We challenge the analysts who believe the Federal Reserve will lower interest rates soon and certainly not five times this year.

As a result, we currently have no direct investments in asset classes that include international, emerging markets, small capital markets, and bond funds without interest rate hedges.  We hold allocations in large-cap companies technology; when the US economy and market conditions change and, so will our portfolios.  

Lastly, as a company, we are committed to being available for you at any time.  When you call, we will answer.