The portfolio-building process started in my previous blog  continues. Now it’s time to start selecting the materials—the investment blocks—for the model clients we visited previously.

Remember Jim and Sue Smith

Here’s a quick refresher on Jim and Sue:

  • Married, both in in their 50s.
  • Both to receive Social Security; Jim also has a pension from an employer.
  • Investment accounts with several firms, including employer retirement plans, individual IRAs, Roth IRAs, and non-retirement accounts.
  • Unsure of their overall asset allocation or of all the different investments they hold.


Measure the materials by assessing risk

When you’re building a house, it’s all about measuring the materials correctly. When you’re building a portfolio, it’s about taking measure of your risk level. How you feel about risk plays a big role in determining your allocation. Nobody likes to lose money, but being too conservative can be an expensive trade off.

Let’s return to Jim and Sue. Like many clients, they’re not clear about their overall asset allocation, especially spanning all their various accounts. (That’s not uncommon.) And they haven’t given much thought to “risk tolerance.”

That’s where my asking questions often helps. I really want to know how they think when they invest. I’ll ask how they made their investment choices: Was it based on performance? Investment costs? Other considerations? How did they react when the markets went down in 2008? Did they sell many of their holdings, sit tight, or something in between?

We’ll discuss their feelings about risk when the markets are good versus when they’re not so good. It’s common for clients to feel they can handle more risk when the markets are roaring. They tend to forget how uncomfortable it felt when the markets went down. Conversely, they tend to stay out of the more aggressive positions—which they need for growth—when downturns occur.

With the information gathered through this discussion, we can determine how much risk they can—and should—take. (Our investor questionnaire can help you with this, too.) It’s important to be honest about those feelings so they’ll stick with the plan through good times and bad.

Sue and Jim agree that, when it comes to risk, they’re moderate investors, so their target allocation would be 70% stock and 30% bond investments.

I’d recommend they become more conservative as retirement approaches and even through retirement. To determine when to make these adjustments to the portfolio, I follow a glide path methodology similar to this one. It’s generally a good idea to reduce stock exposure by 5% every 3 years until you reach a 50/50 allocation.

Now we have all the information needed to analyze their likelihood of success for meeting their goal to retire in 10 years.


Select the pieces that fit the measurement

When putting the portfolio together, based on what we now know, we want to be sure Sue and Jim have stock and bond holdings with the right mix for their risk tolerance and goals, that those holdings are broadly diversified, and that their costs are low.

The asset allocation provides the framework for the investment bricks and mortar. Now that the structure is in place, we can start the portfolio assembly process. More on that in my next blog.