When you are dealing with investment portfolios we are talking about matters of opinions vs matters of fact. Our goal when we construct portfolios is to leave as little up to chance as possible.
After all, the fewer variables there are the better we can predict the outcome. So how do you eliminate variables in an investment portfolio? You need to simplify your thinking. We simply investment portfolios into 3 fundamental buckets.
The War Chest – The bucket that we have for peace of mind
The Growth Strategy – The money you have set aside for long-term investments
The Aspirational Strategy – The money you have allocated for higher-risk strategic investments
Today we are going to take a minute to look at what factors we take into account when customizing an investment portfolio for a client.
What is an investment portfolio?
Before we dive into our three buckets let's define what an investment portfolio is.
Your investment portfolio is a combination of all the assets on your balance sheet that you invest money into.
This includes the following.
Equity In Your Business
Rental Real Estate
Public Market Investments
Private Market Investments
I see many families make the mistake of thinking about their investment portfolio as the assets that an advisor manages. This is a sub-optimal thought process because, at some point in time, your largest asset was or is your business.
Why wouldn’t we include this in our investment portfolio?
Now that we have a definition of an investment portfolio let's dive into the 3 buckets your assets can fall into.
Bucket 1 - The War Chest
You have done the hard thing and won the money game. When you win the money game you want to protect what you have and make sure you never lose it. The assets that you need for peace of mind we would bucket into the war chest.
Now how do we determine what investments and how much goes into the war chest? My favorite answer:
It Depends.
These 3 questions will help determine what needs to go into the war chest.
How much does it cost to live my lifestyle?
How heavily am I relying on my investment portfolio to fund my lifestyle?
What are my known needs in the next 5-7 years?
Why are these the magic questions? First, our war chest is the money we need to have no matter what. Typically in this bucket, we will put 5 to 7 years' worth of your living expenses. The reason this is the case is most market cycles happen in a 5 to 7 year time frame. We want to have assets that no matter what is happening in the market we never have to sell investments at a loss. This war chest is our peace of mind.
What types of investments go into our war chest? These are typically investments that we are generating yield from and have little to no volatility.
Money Markets
Municipal Bonds
Corporate Bonds
Government Bonds
Private Credit
These are the types of investments we will look to place into bucket one.
Now that we have our war chest let's move on to bucket 2.
Bucket 2 - The Growth Strategy
The next bucket we look to fund is our stay-rich money. Remember if you are reading this you probably have won the money game or are on your path to winning the money game. Our job isn’t to get you rich again our job is to keep you rich.
The way we do that is by focusing a portion of the portfolio on Growth. How do we determine what we should have in bucket 2?
How much does it cost to live my lifestyle?
How heavily am I relying on my investment portfolio to fund my lifestyle?
How much risk am I willing to take?
Note that the first two questions are the same as bucket one. Without knowing these fundamental answers it is nearly impossible to build a tailored portfolio. The key to bucket 2 is risk. The reason we have 5-7 years of living expenses in our war chest is to allow us to let our growth assets have time to grow.
75% of the time the market goes up in value, but this means that 25% of the time it does not. We never want to get over our skies and end up needing money in bucket 2 in a year the market has dropped. Think about the great financial crisis of 2008-2009 or COVID in 2020. This was a time to rebalance into equities, not a time to need cash from bucket 2. Those who stuck with the course ended up in a much better place than those who panicked.
What type of investments go in bucket 2:
Diversified Public Equities
Public Real Estate Equities
Public Alternative Investments
Each bucket will be specific to you. Make sure you have a portfolio that is tailored to your needs.
Bucket 3 – Aspirational Strategy
The last bucket we fund is the aspirational bucket. This is the money that you don’t need to live your lifestyle. If we combine buckets 1 and 2 we should never need to use any money that is in bucket 3 to fund the life you want to live. This is the money that we are trying to get outsized returns with and are fine putting at risk.
How we decide on bucket 3 are these questions:
How much does it cost to live my lifestyle?
How heavily am I relying on my investment portfolio to fund my lifestyle?
Can buckets 1 and 2 support my lifestyle in perpetuity?
Once you have answered these questions we can back into how much we have left for bucket 3. Now we have a decision to make. This decision is client-specific. How much of my excess do I want to put at risk?
Are you going to buy another business?
Do you want to invest in Venture Capital or Private Equity?
Some entrepreneurs want to protect more assets and have less in bucket 3 and others want to invest their entire bucket 3 into more deals or businesses. Remember there is no right answer to the exact amount that can go into bucket 3 but there certainly is a wrong answer.
The Wrong Answer:
You overfund bucket 3 and risk money you need for the chance to make additional money that you don’t need to meet your goals.
So what types of investments go into bucket 3:
Private Equity Investments
Venture Capital Investments
Private Real Estate Deals
Buying a Private Business
Each one of these types of investments has a higher expected rate of return than buckets 1 and 2, but know that these buckets come at risk that 1 and 2 do not have.
So remember your investment portfolio should be specific to you. There is no one-size-fits-all all.
Financial advice for entrepreneurs is unique. Ensure your investment portfolio is designed around you.
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Our goal at Moment Private Wealth is to help you reach your ideal outcome. This is why we help construct portfolios for business owners. It isn't enough to know what tools to use but you need a team to help you implement.
If you are an entrepreneur who is concerned about your portfolio, schedule a call, and talk with a Moment founder.
Not sure what questions to ask, check out this video on 10 questions you should ask when interviewing a financial advisor.
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*Moment Private Wealth offers information on tax and estate planning that is general in nature. Tax and Legal advice are not provided by Moment Private Wealth. Consult an attorney or tax professional regarding your specific legal or tax situation.
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