Purpose Wealth Management

Download the following presentation for an introduction to the fundamental concepts that drive our investment philosophy:

Investment Presentation

Markets reward investors for the capital they supply. Companies compete for capital, and millions of investors compete to find attractive returns. This competition quickly drives prices to fair value, ensuring that no investor can expect greater returns without bearing greater risk.

Active money managers attempt to beat the market via speculation - either by looking for pricing "mistakes" or by attempts to predict the future. Empirical evidence shows that all too often, active management is costly and an exercise in futility. Therefore, hiring a manager to speculate is ill-advised; Your guess is as good as theirs...

The futility of speculation is good news for the passive investor. It means prices for public securities are fair and that persistent differences in average portfolio returns are explained by differences in average risk. It is certainly possible to outperform markets, but not without accepting increased risk.

In short, markets, not money managers, drive returns. Focus on market risk, not market "masters."

Evidence points to an undeniable conclusion: Returns come from risk. Gain is rarely accomplished without taking a chance, but not all risks carry a reliable reward. Financial science over the decades has brought us to a powerful understanding of the risks that are worth taking and the risks that are not. These are commonly known as return premiums.

Portfolio diversification is best when framed explicitly in terms of exposure to each known source of expected return. The primary risk premiums include the following:

• Equity Premium - difference in return between stocks and fixed income
• Size Premium - difference in return between small company stocks and large company stocks
• Value Premium - difference in return between value stocks and growth stocks
• Term Premium - also known as the maturity premium, difference in return between longer maturity bonds and shorter maturity bonds
• Default Premium - difference in return between lower credit-quality bonds and risk-free bonds

Higher expected returns are associated with each risk premium because markets rationally discount prices to reflect underlying risk.

Diversification is the most essential tool available to investors. It enables them to capture broad market forces while reducing the excess, uncompensated risk arising in individual stocks.

Successful investing means not only capturing risks that generate expected return but reducing risks that do not. Avoidable risks include holding too few securities, betting on countries or industries, following market predictions, and speculating on "information" from rating services. To all these, diversification is the antidote. It washes away the random fortunes of individual stocks and positions your portfolio to capture the returns of broad economic forces.

A key aspect of diversification is the expectation of lower volatility for a given level of risk, resulting in better compound growth of invested capital. In other words, the whole is greater than the sum of its parts.

Structure, or asset allocation, determines most of the performance in a diversified portfolio. Investors choose asset classes to play different roles in a portfolio, and their appetite for risk guides their allocation.

Capital markets are composed of many classes of securities, including stocks and bonds, both domestic and international. A group of securities with shared economic traits is referred to as an asset class. There are several asset classes, all with average price movements that are distinct from one another. Investors can benefit by combining the different asset classes in a structured portfolio.

A full range of asset classes includes small and large stocks, domestic and international, value and growth, emerging market countries, global bonds, real estate, and even municipal bonds. Because asset classes play different roles in a portfolio, the whole is often greater than the sum of its parts. Investors have the ability to achieve greater expected returns with less price fluctuation and more consistency than they would in a less comprehensive approach.

However, because no two investors are alike, there is no single "optimal" asset allocation. Each investor has his or her own risk tolerances, goals, and life circumstances that dictate the weightings of core and asset class portfolios. In general, the greater the proportion of stocks a portfolio holds, especially small cap and value stocks, the more "aggressive" is its risk and the greater is its expected return.

Equilibrium-Based Investing (EBI), a passive strategy that helps clarify the debate between active and passive investment management, provides the foundation of our philosophy.

• Emphasizes security selection and market timing.
• Undermines asset class exposure to keep up with “promising” securities.
• Generates higher fees, trading costs, and tax consequences due to increased turnover.

• Emphasizes asset class returns.
• Allows commercial benchmarks to define strategy.
• Sacrifices transaction costs and turnover in favor of tracking benchmarks.

Passive Management - Equilibrium-Based Investing:

• Emphasizes returns driven by dimensions of risk identified by academic research.
• Allows financial science and economic logic to define strategy.
• Minimizes transaction costs and better-captures returns through passive trading and engineering.

We use passively-managed, low-cost portfolio components, primarily funds offered by Dimensional Fund Advisors (DFA) and The Vanguard Group. Funds from other companies are used when appropriate.

Equilibrium-based "Core" funds from DFA typically serve as the primary component for the equity asset classes of our portfolio recommendations. Index funds, primarily from Vanguard, are typically used for asset class exposures where equilibrium-based funds are either not available or not appropriate.