Why investment process quality is key to investing success + our 5-step approach

Why investment process quality is key to investing success + our 5-step approach

It’s natural to feel anxious about investing. Investors all want to make the best decisions when it comes to their money and wealth management—decisions that will help your portfolio grow bigger without excessive risk. However, the investment decision process can be overwhelming, given the many available options and pitfalls.

Investing is a key part of a financial decision, and a well-built investment process can lead to better outcomes and more stable returns in the long run. Below is an outline of how WealthStep helps WealthStep Direct clients and WealthStep Retirement Plan participants in the background.

An investment process is essential for long-term portfolio growth

While the prevailing advice to “stay the course” and “stick to the plan” is generally sound during volatile markets, primarily if your “course” and plan are properly defined, it’s easier said than done. From so-called experts who claim to predict market moves, to headlines and current events, investors often find themselves anxious and pulled in many directions when it comes to investing.

If you’re like most people, you may struggle to separate emotions from your investment decisions. You might swing from optimism and excitement to nervousness and fear, and then back again.

Many investors struggle to separate emotions from investment decisions. This ongoing, reactive cycle is nerve-racking—and it can lead to poor financial decisions. The physiological tendency of electrical activity in the brain is to shift during periods of concern from the large part of the brain responsible for thoughtful decisions, to the tiny part of the brain responsible for the fight, fight or freeze responses. In the absence of a process connected to a long-term plan, process and financial behavior coaching, the tendency to shift to emotional investing is much greater.

Having a prudent investment process in place before emotions run high is key. As financial advisors, having a professional process allows WealthStep to design the WealthStep.com investment recommendation process and portfolios based on facts, research, historical evidence, a set of decision criteria and decades of experience, rather than short-term thinking and fear. For investors, knowing there is a vetted process helps deter emotional decisions which often times don’t produce the best results.

Whether your aim includes maximizing savings into your retirement account, reduce taxes in taxable investment accounts outside of retirement plans, putting your kids through college, or making work optional and securing your own retirement, a proper investment process is a critical element of an effective strategy to achieve short and long-term goals, which may also include using the Planning/Saving advice of WealthStep.com.

Building the foundation of an investment philosophy

A sound investment process starts with a set of guiding principles, which we refer to as the “investment philosophy.” These principles serve as a framework for making choices when it comes to your investment strategy. At WealthStep, the philosophy that shapes our process is based on decades of experience, respected research, and industry’s best practices.

With this philosophy as a roadmap, there’s always a clear path to follow—regardless of what the markets are doing, what the pundits are saying, or what your emotions are telling you. In other words, an investment philosophy cuts through the noise and provides a strong foundation for a disciplined, institutional-quality investment process.

The key drivers of our investment philosophy are:

Client-centric approach

The entire investment process starts with you in mind and impacts the designing and implementing an investment menu for your retirement plan or WealthStep Direct investment options. From there, you choose the investment portfolio that best fits your life stage and/or other needs, and we provide education about the portfolios, investor behavior and more through education videos.

Structured decision-making

Building your investment portfolio should never be a guessing game. Studies indicate that investors should prioritize decisions based on their impact on results. The questions which guide our investment policy guidance and decision-making (in order of importance) are:

1. What is the time horizon of the investment strategy? – How long until retirement or until spending begins?
2. What is the distribution need from the portfolio? – How much will you need to withdraw and when? This also relates to time horizon(s).
3. What asset classes should be considered? – What proportion will be in the portfolio: stocks, bonds, or cash equivalents?
4. What will be the mix between asset classes? – What is the ratio of stocks to bonds and other asset types?
5. What sub-asset classes will be considered? – Which types of bonds, foreign vs domestic stocks, alternative investments (if any) and other sub-asset classes will improve the risk/reward profile?
6. Which investment managers will be selected? – What are their long-term capabilities, based on their people, process and performance?

When WealthStep designs portfolios, we avoid overly concentrated positions in a single security. Our portfolios tend to be highly diversified—across sectors, market capitalizations, geography, and investment styles.

Committee oversight

The role of the WealthStep Investment Committee is to build long-term, tax-efficient (where applicable) portfolios through 5 key actions:

1. Asset Allocation: After guiding you to an appropriate stock/bond mix policy, we determine an optimized mix of investments for you within the stock and bond categories.
2. Investment Selection: We choose high-quality, experienced, specialist, disciplined investment managers to manage each asset class within portfolios.
3. Rebalancing: We carefully monitor and adjust your portfolio’s target allocation to prevent market movements from causing your portfolio to stray too far from your policy stock/bond mix, i.e. your appropriate risk profile.
4. Tax Efficiency: For taxable portfolios, we minimize your tax burden within legal guidelines, with tax-efficient investment vehicles, tax loss harvesting and “asset location,” along with other strategies.
5. Ongoing Monitoring: We continuously evaluate the risk profile and underlying investment managers within the portfolios using an institutional-quality due diligence process, and continue to refine and improve our processes.

• Manager changes: Key personnel departures, especially “star” managers, whose talent the investment decisions relied heavily upon.
• Process issues: Problematic shifts in investment process or style, which may increase risk or reduce overall client diversification.
• Organizational changes: Structural changes that restrict research resources or modify the original strategy for reasons other than benefitting the end-investor.
• Strategic shifts: Removal of an asset class that has a reduced expected diversification benefit, or a temporary asset class used towards long-term goals.

The WealthStep Investment Committee

WealthStep’s Investment Committee consists of multiple members that meet several times per quarter to perform investment analysis, reviews, and due diligence. The committee includes multiple investment advisors with MBA’s, CFP’s, and other designations, each with decades of experience. WealthStep also utilizes independent outside research from well-regarded independent investment research firms, to compliment WealthStep’s internal research.

 Risk and return measures

Managing risk is crucial, rather than chasing fads or investments with recent strong returns. This ensures that while volatility is unavoidable, your investment portfolios are not overly concentrated in a small number of securities and are designed to have reasonable levels of risk for each stock/bond mix. WealthStep considers different types of risks, including investment risk, the impact of volatility relative to the timing of spending needs, behavioral risks, and more, to create a well-designed portfolio and education videos suited to your needs. We also measure, monitor and manage risk as part of our portfolio evaluation, rebalancing, and investment manager due diligence processes.

Tax efficiency

For taxable portfolios, we use tax-loss harvesting to offset gains and reduce your tax burden, and other tax-efficiency strategies to further enhance your overall returns. For taxable investors, it is the after-tax return, or personal balance sheet that is most important, rather than focusing entirely on high-return seeking investments that may have significant tax costs that can materially offset the published pre-tax returns.

Investment theories and practices

Modern Portfolio Theory (MPT) and Efficient Market Hypothesis (EMH) are two fundamental concepts in investment finance, that WealthStep’s Investment Committee incorporates into the process. MPT helps create diversified portfolios that maximize returns for a given level of risk, while EMH suggests that markets reflect all available information, making it hard to consistently beat the market. Together, these theories form the basis for many investment strategies focused on strategic asset allocation and risk management. They emphasize diversification and acknowledge the difficulty of consistently outperforming the market.

 Asset optimization and diversification

Asset optimization focuses on arranging your investments in a way that aims to get the best possible returns for a given level of risk. It involves strategic (not tactical) selection of assets to fit your financial goals and risk tolerance, rather than attempting to time the market. Timing the market requires two perfect decisions: When to get out, and when to get back in. Studies show that disciplined investing more often leads to better results in the long run, vs. attempting to guess the market’s movements.

Asset optimization goes hand-in-hand with diversification to reduce risks, manage volatility, and enhance returns. Spreading your investments across different types of assets with different return patters or “correlations” —like stocks, bonds, real estate and many other sub-asset classes—reduces risk and tends to increase the stability of returns. This way, if one investment performs poorly, others may perform better, reducing fluctuations and balancing the overall outcome.

Rebalancing

Over time, asset allocations drift from their target percentages due to market movements, which alters the risk/return profile of a portfolio. Rebalancing restores the original asset allocation and “resets” risk to the intended target level—a key risk control that can also boost returns. Rebalancing involves regularly reviewing portfolios at the stock/bond mix level, as well as the sub-asset class level. We set different rebalancing parameters for each sub-asset class based on their projected volatility. This could mean trimming overgrown, higher-risk assets and reinvesting in undervalued sub-asset classes that may be poised for higher returns. This also means optimizing after-tax returns, and using tax-loss harvesting to offset investment gains (so you pay less in taxes overall).

Mix of active and passive

Simply put, active management aims to outperform the market, while passive management seeks to match it. While some advisory firms feel strongly about only using one or the other, WealthStep uses a mix of active and passive investment strategies for portfolios built by WealthStep, to give you the best of both worlds. For taxable assets, passive investing works to minimize taxes through lower security turnover and reduce capital gains distributions. For non-taxable assets, a combination of core passive investments and some active strategies are often appropriate.

Putting it all together: The investment management process

It’s WealthStep’s experience that well-designed and prudent processes increase the likelihood of success over time. The following is WealthStep’s 5-step investment process:

1. Analyze your current situation

The first step is for you to assess your financial status, with help from WealthStep.com’s Saving/Planning online advice, or through a financial planning project. This should include reviewing income, expenses, assets, liabilities, existing investments, and the timing and level of future spending goals. Understanding your goals and planning as a starting point provides a clear picture of your financial health and identifies areas for improvement, which is essential for selecting an effective investment strategy.

2. Design the optimal portfolio

Next, determine an appropriate stock/bond mix portfolio that fits your financial goals and plan, while also considering your risk tolerance, and investment time horizon. Portfolio designs by WealthStep involve selecting a mix of sub-asset classes that balance potential returns with acceptable levels of risk, aiming to maximize long-term growth while managing volatility.

3. Formalize investment policy

The stock/bond mix you choose is your personal “Investment Policy.” Your company’s retirement plan Committee maintains an Investment Policy Statement (IPS), and WealthStep Direct clients also receive an IPS, which outlines your investment objectives, asset allocation strategy, and guidelines for managing the portfolio(s). This document serves as a roadmap, ensuring consistency and discipline in investment decisions, and providing a framework for evaluating performance. For individuals, it is often appropriate to update your stock/bond mix, i.e. risk profile, over time as your needs and goals evolve.

4. Implement policy

Next, you communicate your Investment Policy, i.e. portfolio choice, to your retirement plan recordkeeper (in the case of retirement plans) or to WealthStep Direct (in the case of portfolio managed outside of your retirement plan), and WealthStep manages the portfolio according to the parameters established in the IPS. This step reflects the culmination of our Investment Committee’s research process and careful selection to ensure that investments are made in line with the strategy, aiming to minimize costs and maximize efficiency.

5. Monitor and supervise

WealthStep conducts ongoing reviews of the portfolio’s performance, compares it against the Investment Policy, and conducts rebalancing adjustments as necessary to adjust to significant market changes, to keep the portfolio aligned with the long-term objectives.

Don’t navigate the investment journey alone

Building and maintaining wealth is complex. A structured process helps form the foundation for long-term investment success. Having an expert team can make all the difference, whereas doing it alone can be risky—not to mention time-consuming and stressful. WealthStep is here to help make the process easier for you.