Summary

• This article summarizes an easy to do way of investing that will help you stay organized, manage your risk and keep your profit potential high.
• One of the biggest problems for investors is not feeling organized and systematic, which in turn causes investing mistakes.
• By breaking your total portfolio into “slices” or “buckets” or “sleeves” you can easily manage your risk and always feel organized.
• Not everyone has the same asset allocation, but everyone can use the same tools. It’s up to you which slices you use.
• As the kids say, “you do you.”

This article replaces 3 articles which were good, but, I think hard to follow along with. Here, we’ll cover how to keep organized, manage risk and maintain high profit potential. 

You might have heard the term “buckets” or “sleeves” or “slices” for building a total portfolio. They all mean the same thing. We will use the term “slices,” but could just as easily use the others. 

A slice of your portfolio is just what it sounds like. If you think of your portfolio like a pie chart, then quantifying what each slice is becomes easier. Let’s take a look at a step-by-step approach for creating an investing framework. 

Who Are You As An Investor?

Before we talk about investment pie, slices and bites, we have to determine what type of investor you are. There are really two types as defined by Buffett’s mentor Benjamin Graham: 

• Intelligent Investor – you are a defensive investor seeking to protect wealth, generate decent returns and minimize frequent decisions. 
• Enterprising Investor – you are an offensive minded investor seeking to generate wealth through outsize returns and are willing to manage your asset allocation more frequently. 

I don’t think it’s quite that clear cut. I think we are each a percentage of those two basic types. That’s why I break things into 3 types of investors: 

• Aggressive = you are an enterprising investor earning and investing an income from work, looking to beat the market by as much as possible and willing to take on more risk to do it.
• Moderate = blend of both intelligent and enterprising investor (most of us).
• Defensive = you are an intelligent investor in retirement or close to retirement, looking for returns that beat inflation and approach stock market returns with but with less risk than the stock market.

It is up to you to decide who you are as an investor. 

If losing 30-50% of your portfolio in a given year will drive you Fried Green Tomatoes, then you can not be an aggressive investor. 

If making high single digit returns is not enough for you, then you can not be a purely defensive investor. 

From my point of view, most people are half and half. I’m probably 3/4 enterprising and 1/4 intelligent. 

By defining what type of investor you are, you can use the “slices” approach to making your investment pie, that best suits you. 

Investment Pie

We have all seen our investment portfolios broken into pie charts on our brokerage statements or a spreadsheet. It looks something like this: 

But, what does that really tell you? I think it is helpful to think of your investment pie as slices, slices of slices, and then bites. 

The first slices of your pie are the big pieces. The overlying strategic model behind your portfolio. My approach to investing includes 3 strategic slices for your investment pie: 

• Cash and short-term fixed income holdings.
• Core Holdings (usually ETFs, but also a few Closed-end Funds)
• Tactical Holdings (wide range of securities)

By defining who you are as an investor, you can use this approach to managing your money consistent to your goals, finances and risk tolerance.

Let’s look at each of the big slices.

Your Cash Slice

Your first decision is how much cash to hold at any given time. This is your most important decision as it impacts both risk and reward.

• Higher cash levels act as a hedge against risk.
• Higher cash levels reduce potential return.

In general, you want to have low cash levels, however, in times of market turmoil, you will want to have higher cash levels for a short period of time, generally 2 years or less.

Here is an example of how to determine your cash slice:

Your investment nature does not change with the markets. Rather, we simply try to increase or decrease our cash holdings depending on markets within the construct of our investment nature.

So, it is important that you understand your own nature. That will require a look at your finances, goals and emotions.

Ultimately, being unemotional when investing is important. That makes a sincere emotional self-evaluation important.

If you panic when your account is falling, then you want to compensate by having a plan that is probably a little heavier in cash as a rule, i.e. defensive investor, and requires less trading, i.e. more core holdings and fewer tactical holdings. Let’s look at core and tactical holdings concepts.

Your Core Slice

Core holdings will generally be large cap stocks, mid cap stocks and very broad theme stocks. Generally you will hold ETFs for some or all of your core. 

Other than those periods where you are raising your or lowering your cash slice holdings, your Core ETF holdings will not change much. You can hold these positions for years.

ETFs like the Invesco QQQ (QQQ) or iShares Evolved Technology are among my most recommended core holdings. 

Berkshire Hathaway (BRK.B) and Microsoft (MSFT) are individual stocks I often hold long-term with very little trading. 

Your Tactical Slice

Tactical investments are typically NON-diversified. This is where we find our sector, industry, regional and single-nation ETFs, as well as, small and mid cap stock picks. This is also where we will trade the shorter cycles in the stock market measured in months and quarters. 

How much you put into your Tactical slice depends on your nature and how much you want to trade. Generally speaking, if you are defensive by nature, then do not trade tactically.

Tactical trading is for aggressive and moderate investors. Aggressive investors might put 75% of their money into the Tactical ETF slice, while a moderate investor might be 25% or 50% tactical.

Tactical is where some people might also add “swing trading” or even “day trading” (if you like punishment). That’s a slice within your tactical slice. I don’t do much of it and neither should you. But, if you decide to swing trade, then make sure you limit the amount you do that with. A single digit percentage to start is very advisable. If you lose, it hurts less, if it grows, then you are trading more, but out of gains. 

Slices In Your Slices

Here is where it gets a bit tricky for folks. This is where real asset allocation occurs. Inside of your slices you have to decide what types of asset classes you can to be heavy and light in. 

Building your asset allocation is easiest with a pure fund based portfolio, mainly ETFs, but we use a few CEFs as well. And, certainly, if you have any enterprising investor in you at all, you will use some stocks as well. 

This is where you decide what each of your Core and Tactical slices will look like in comparison to the total stock market. 

I have advocated being overweight in 4th Industrial Revolution (which includes many subcategories), Decarbonization and some fintech. 

I have suggested being underweight pretty much everything else. 

Although we know that technology is over 40% of the U.S. economy now and influences almost everything, take a look at the S&P 500 sector weightings: 

This is why I do not own the SPDR S&P 500 ETF (SPY) or Vanguard 500 (VOO). The S&P 500 is always behind the curve. Here’s some easy proof by comparing SPY to the Invesco QQQ (QQQ) which is heavier technology and underweight several SPY sectors: 

And, that’s inclusive of the dot-com crash. Here’s what it looks like if you start in 2002. 

SPY and QQQ are both large cap indexes. You also have to decide on how much market cap exposure you want. I favor small and mid caps because they have grown the most. 

Small companies become big companies.” 

Peter Lynch

For many investors, overweighting mid caps might be the soundest strategy. Those companies grow more than large caps, often get sucked into the S&P 500 generating more support and are generally have much less failure potential than small caps which are earlier in their timeline.  

You also need to decide between domestic and international exposure. Most Americans are under 20% international exposure. I think that is too low. 

I am very bullish on emerging markets and think we need about 30-40% exposure there. That does not mean directly investing in emerging markets though. Many American companies get significant portions of their revenue from emerging markets, so, we can find and invest in those companies. That’s something for your bites…

Bites Of Investment Pie Slices

Inside of each slice are individually selected investments. This is specific security selection time. You have to blend ETFs, CEFs, stocks and option selling at this point. This is portfolio management. 

ETFs are the easiest to use, but you forgo some of the upside of stock picking. 

Stock picking does have the most investment upside, but, it also has the most risk because companies can fail. Sometimes markets change or there is a black swan event, but, usually if a company fails, it is because of bad management. 

Buffett and Munger also go on to talk about finding great management. This is a core theme for me. I try not to invest with idiots. Sometimes they fool me.

My first rule of investing in individual stocks is this: 

• if the stock does not have the potential to handily beat the stock market, then do not take the individual stock risk. 

Closing Investment Thought

There are different layers to investing. Most people just think about hitting home runs or getting a dividend with stock picking. 

The reality is that asset allocation controls over half and up to 90% of your risk and reward. Focus there. 

You reduce risk the most by being on the right side of the economic secular trends – see our 4-step process.

There are other ways to make money as well, but, those are generally harder and require a good amount of precision timing. If you aren’t comfortable with harder, then skip it.