Asset Allocation for Cautious Investors

In today’s world, where politics take up the majority of news cycles and there is an ongoing war of words between the two major political parties, I decided for this letter to replace our often used phrase “conservative investor” with “cautious investor.” I believe this is a good description for the majority of affluent investors, those who have accumulated a larger sum of money through savings and investments over the years. For this majority, the preservation of wealth is a priority. However, these investors are also looking to increase their wealth. The primary method for meeting this dual desire is asset allocation.

It is important to remind everyone that each of our clients’ wealth varies. It is our job to build a portfolio that will produce the required rate of return to satisfy each individual client’s needs and long-term goals. This cannot be accomplished without effort. It is somewhat easy to determine a required rate of return. It is not easy to build a portfolio that can earn this requirement at any given point in time. Once the initial portfolio is built, maintaining it through time takes constant awareness of the changes that occur and the need to address these changes with modifications to the portfolio.

Weighing the benefits expected from any change in a portfolio should be approached with caution, as any change creates the possibility of not one, but two errors. What we sell may produce more profit to someone else, not us. And our replacement may decrease profit for our portfolios. Every portfolio manager knows this, and must have a legitimate basis to make these changes.

Before we recommend an allocation I wanted to share some words from two individuals who helped shape our philosophy towards asset allocation and making decisions under uncertainty. The first is Dr. Benjamin Graham, whose writings I’ve shared in these letters many times over the years. The second is Edward C. Johnson II.

First up is Dr. Graham, and a passage taken from his excellent book The Intelligent Investor:

We have already outlined in briefest form the portfolio policy of the defensive investor. He should divide his funds between high-grade bonds and high-grade common stocks.