What Portfolios and Castles Have in Common

To build a strong castle, choose the right building block.

When I visit a castle in Europe, I am awestruck by the magnitude of it. Imagine what it took to create such a beautiful structure! I think about the scope of the planning done without computers and calculators. To achieve this feat of construction, there were many steps, including site selection, architectural design, materials selection and procurement (without the help of diesel trucks), and finally, all the furnishings and finishes—staircases, windows, decor, and more. Even the gardens were planned and planted meticulously. It seems an impossible achievement, yet there stands the castle in all its glory, all because someone centuries ago designed and selected the right building blocks.

Portfolio construction is not as complex as building a castle, but I follow a similarly meticulous planning process to create a portfolio for a client. I carefully consider the client, their goals, risk tolerance, tax bracket, life stage, etc. Once the design is in place, I then carefully select the building blocks available. To extend the castle analogy even further, think of the design as the asset allocation and the building blocks as the securities that are available to construct the portfolio. Portfolio design is a disciplined process that seeks to optimize the right balance of risk and return. 

Earlier this week, I sat down with Leila, a new client, to share my recommendations for her investment portfolio. After we walked through the overall all proposal, she noticed that several of the building blocks were funds from Dimensional. Leila asked a simple question: "What is your relationship with Dimensional?" Funny how one small question can launch a thousand thoughts!

The first thing that came to mind was that I may not have been clear about my role as an independent advisor—that I am not beholden to any fund provider, but instead, I am free to choose from a vast universe of funds when advising my clients. That was the simple answer. What came next was a flood of thoughts specifically about Dimensional. Why do I prefer some of Dimensional's funds over others? And why, when choosing building blocks, do I choose any vehicle over another? Here are just a few thoughts to help Leila, and you, understand what drives my decisions when choosing the right components to construct each portfolio:

I trust a history of success and innovation.

Dimensional Fund Advisors (Dimensional) laid the groundwork for how almost all financial professionals invest today. David Booth, Dimensional's Executive Chairman and founder, recently published an article titled, The 50-Year Battle for a Better Way to Invest. I knew a lot about the firm's history, but Booth's narrative affirmed my admiration for all that Dimensional has achieved over the past four decades. Back in 1971, Booth and his partner, Mac McQuown, created the first indexed portfolio—and upended the industry. "Fifty years later, $9.1 trillion is invested in index mutual funds and exchange-traded funds (ETFs)," writes Booth. "This represents 51% of the total $17.9 trillion in equity ETFs and mutual funds. Six of the original academic consultants Mac hired to work on that first index fund went on to win Nobel Prizes." Four of them have worked at Dimensional. A weighty accolade, indeed.

I believe in focusing on 'sources of return.'

While many others strive to 'seek alpha' by choosing specific stocks with the hopes of 'beating the market' (whatever that actually means!), Dimensional focuses on capturing growth across the global economy through various 'sources of return.' Dimensional created 'small cap' as an asset class, arguing that these stocks were underrepresented in portfolios and offered diversification and expected return benefits. Once that was proved correct, they introduced other asset categories, including 'value,' 'growth,' and 'momentum.' All of these categories are used widely today and are the basis for many popular ETFs and mutual funds. From a financial planning perspective, I believe 'sources of return' are critical building blocks.

I prefer an evidence-based approach to investment strategy.

When I was a new advisor (eons ago!), I learned that most fund companies sold investment products through wholesale and retail channels. Wholesale means selling to advisors (like me), and retail means running ads on TV and at sporting events to sell to consumers (like you). I came into the business with an MBA and a background in corporate finance. I had watched analysts wade through footnote-laden documents explicitly designed to sway investors to dissect and decode each company's financials and uncover the facts. Dimensional's strategies help cut through this marketing by putting the science of financial markets that I learned in business school and in business into practice. Their investment solutions are based on Nobel-winning research in evidence-based investing, and Modern Portfolio Theory

No one I know holds the kind of wealth needed to build a Castle Burg Etz (pictured above), yet everyone I know is striving to build a 'castle' of their own in the form of life-long financial security. Whatever your goals may be, the key to investing success is choosing the right structure and using the right building blocks. The final step is bringing them together in a strategy that puts the power of markets to work for you. 

At KFA, our menu of building blocks is carefully curated and continuously evolving. A handful of Dimensional funds are on the list. So are funds from Vanguard and American Century, both of which deliver efficiency in the market at lower prices. We often use actively managed funds with enormous bond-buying power, such as Baird Aggregate Bond Fund and BNY Mellon Fixed Income Fund. No matter which options we choose, our selections are based solely on the unique needs of the client and our due diligence and experience with the fund provider. 

As I shared with Leila, building a strong 'castle’—a portfolio designed to grow and protect your wealth over the long term—requires tremendous discipline. It's the best way I know to resist being sidetracked by every shiny new object and to consistently work toward your goals. It's hard work, but it's a castle that's well worth the effort.  

Related: Stay Out of the Red Hot Housing Market!