ComposedPro's Investment Methodology

ComposedPro's investment methodology stems from the belief that investors are best served by focusing on the things they CAN control, and less on the things they cannot.  We believe the optimal strategy for long term investing success is one that focuses on lowering both FEES and TAXES.  

If you are saving for retirement, and your plan for saving includes accounts both INSIDE your employer (401k) and OUTSIDE (IRA or brokerage), then we call this an Employer-Coordinated Portfolio™.

The steps that ComposedPro takes to create a personalized investment plan for you are:

1. Define the goal 
2. Gather unique information
3. Create a holistic investment plan
4. Focus on investment expenses (lower FEES)
5. Fine-tune asset location (lower TAXES)
6. Monitor and rebalance

Steps 4 and 5 are truly unique for your situation.  We go the extra mile to create a tailored plan just for you.  More details = better results.

STEP 1:  DEFINE THE GOAL

ComposedPro adheres to goals-based financial planning, so the selection of a goal or goals is the first step in our process.  Whether you are planning for retirement or some other aspiration, we will help you reach that goal with a personalized plan.  We need to define the following for each goal:

1. The after-tax amount needed for the goal.
2. The date when your need will start.
3. How many years you will need the amount.

STEP 2:  GATHER UNIQUE INFORMATION

The next step in the process involves gathering your unique information.  This requires us to collect information including, but not limited to:

1. The current accounts you have that will be used for the goal.
2. Accounts you may be eligible to open that could be used for the goal.

STEP 3:  CREATE A HOLISTIC INVESTMENT STRATEGY

Now it is time to start your investment plan.  ComposedPro invests across twelve asset categories.  Some asset categories are riskier than others, and ComposedPro invests its clients on a glide path that each gets more conservative over time   Please see below for a visual depiction of our glide path.

You can see that the glide path gets more conservative over time in an attempt to 'lock-in' any gains that may have accumulated. This is appropriate as you prepare to make withdrawals from your portfolio to fund your goal.  The Glide Path is most concerned with the END not when a goal starts like other firm's glide paths.   A financial plan with a longer need (such as a plan for Retirement) should not be treated the same as a financial plan that has a shorter need (such as a plan for Education).  For example, a normal glide path focused on when a goal starts instead of ends might have you invested at a 50% higher risk / 50% lower risk by the time retirement hits.  But what if your retirement need is for 30+ years of spending?   A 50 / 50 portfolio might not be appropriate at the start of retirement in this case because the portfolio must support withdrawal needs over a very long period.  

So, we are more concerned about the END of your financial plan.  Your Effective Years Until End are determined by the following formula:

The number of years until the first goal in your financial plan starts

PLUS

A discounted number of years that you need your after-tax goal amount

We add in the number of years you will need your after-tax amount because an amount needed for 30 years should have a more aggressive allocation than an amount needed for only a few years.  We discount this figure because of the time value of money (i.e. a dollar needed in 30 years is worth less than a dollar needed a few years from now).  If you would like to learn more, please read our article on how we calculate your Effective Years Until End.

Your Effective Years Until End determines your portfolio's current investment allocation.  Below are the details of how you would be invested across asset categories at various effective years until END on the glide path:

Glide Path By Asset Category

Want to change our suggested allocation?  No problem, we let you slide to a more or less risky allocation if you wish.  This will become your selected Investment Strategy.  All Investment Strategies will follow a glide path, meaning they will shift to become gradually more conservative as time passes.  

Once you have selected an allocation for your portfolio we are now ready to get into the details and personalize your investment plan.

STEP 4:  FOCUS ON INVESTMENT EXPENSE (LOWER FEES)

Your investment plan now starts to become unique, because your situation is unique. We first look to any accounts you have with limited investment options, such as your 401(k).   We analyze all the options available and classify them as GOOD, ACCEPTABLE, OR BAD.

GOOD investment options are those that have:

1. Low Fees - we set fee hurdles that each investment option must satisfy to be classified as having low fees.  Some investments are more expensive to invest in than others so we assign different hurdles that each investment must satisfy.  For example, investing in US Large Cap Equities is typically less expensive than investing in Non-US Emerging Equities.  So a US Large Cap investment option with a 0.15% expense ratio may not qualify as a low fee, whereas an investment option in Non-US Emerging Equities with the same 0.15% expense ratio may qualify as a low fee.
2. Performance as Expected - we next make sure the investment option being analyzed is highly correlated to its benchmark.  We determine each investment option's beta and r-squared to assess whether it performs as expected.  Beta tells us how much investment option's price may move with a movement by its benchmark.  We require each investment option to have a beta between 0.9 and 1.1.  This means that a price change in the benchmark should translate to a similar price change in the investment option. R-squared tells us the percentage of an investment option's movements that are explained by movements in its benchmark.  In other words, it tells us the reliability of our beta calculation.

ACCEPTABLE investment options are those that have Performance as Expected but do not have low fees.  Acceptable investment options are only used when necessary. For example, we may invest in an acceptable investment option if there are no other GOOD options available, but we still need to invest somewhere to get you properly allocated.

BAD investment options are those that do NOT perform as expected and are NOT low fee.  We never invest in bad investment options.

After we invest your accounts with limited options, we use your accounts with unlimited options (such as an IRA outside your employer) to invest where your 401(k) or other limited-option accounts may be lacking.  We use commission-free ETFs at the custodian where your account is held where possible.  If your custodian does not have a commission-free ETF that we qualify as low-fee, then we may recommend an ETF that requires a commission to be paid.

Clients of ComposedPro will never pay a commission on accounts managed by ComposedPro. 

STEP 5:  FINE-TUNED ASSET LOCATION (LOWER TAXES)

The final step in our investment process is to smartly place assets in the accounts where they belong.  We generally place investments according to the framework below.  First, let us discuss the benefits of smart investment placement.  Certain investments may be better placed in specific types of accounts.  At the most generic level, taxable bonds might be poorly placed in taxable accounts because they throw off interest income that would be taxable each year.  Taxable bonds could be better placed in a tax-deferred account to avoid income tax today.  Smart asset location may help you over the long term and may improve your outcome.  See below for how ComposedPro fine-tunes asset location across your portfolio.

• Tax-exempt accounts - place investments with the highest expected return or a high expected return that are also tax-inefficient. Investments could include Non-US Emerging Market Equities or US High Yield Bonds.

• Tax-deferred accounts -  place investments with a medium-to-high expected return that are also tax-inefficient.  Investments could include US Corporate Bonds or Non-US Developed Bonds.

• Taxable accounts - place investments with a higher expected return that are also tax-efficient and always tax-exempt bonds. Investments could include US Large Cap Equities or US Municipal Bonds.  Any cash in the portfolio is also attempted to be held in taxable accounts because we prefer tax-advantaged accounts to be fully invested.

Please see our discussion on Asset Categories to see how ComposedPro tries to place each within your portfolio.

Smart investment placement through the framework above allows us to create an Asset Location Heat Map™ and a Smart Location Score™.

STEP 6:  MONITOR AND REBALANCE

With all the steps now complete, we can then start the monitoring process.

ComposedPro examines your portfolio weekly to determine if a rebalance is necessary. We perform a detailed rebalance review anytime portfolio drift exceeds 10% and then determine whether rebalancing transactions are necessary.  We calculate your portfolio drift as the absolute variation of each asset category from its target allocation, divided by two.  For example, please see below:

Any time your portfolio drifts more than 10%, a rebalance review is triggered to determine if rebalancing transactions are necessary.  We review drift at least monthly, and not more frequently than weekly.

Please note that the following situations may limit our ability to minimize drift:

• Designating some investments as Do Not Sell
• The lack of acceptable investment options available within an employer or other limited-option accounts.

That wraps up the ComposedPro Investment Methodology.  The result is an efficient portfolio created by ComposedPro focused on lowering fees and taxes.  A smart, efficient portfolio gives you a better chance to reach your goal.

Disclosures:

Assumptions, Limitations and Inherent Risks

Please note that higher tax-deferred balances could result in higher required minimum distributions (RMDs) in retirement.  This should be considered when implementing any contribution recommendations or other such strategies that seek to optimize across tax-exempt, tax-deferred, or taxable accounts.  If you are seeking to minimize RMDs, a contribution strategy that recommends a higher tax-deferred balance in your portfolio may not be appropriate.  Please consult your tax advisor when implementing any strategy that attempts to lower income taxes.

Clients may not realize the benefits of asset location or other strategies discussed herein. Factors that affect an asset location strategy include, but are not limited to, market performance, the relative size of each account included in a financial plan, the equity exposure of the portfolio, the frequency and size of deposits into the various accounts, the tax rates applicable to the investor in a given tax year and future years, and the time elapsed before the liquidation of any of the accounts becomes necessary.

Nothing herein should be interpreted as tax advice.  ComposedPro does not represent in any manner that the tax consequences described herein will be obtained or result in any particular tax consequence. Please consult your tax advisor as to whether ComposedPro's asset location strategy is a suitable strategy for you, given your particular circumstances. The tax consequences of asset location are complex and uncertain. You and your tax advisor are responsible for how transactions conducted in your account are reported to the IRS on your personal tax return. ComposedPro assumes no responsibility for the tax consequences to any client of any transaction.

In addition to the assumptions described in the documentation above, all of our recommendations are based upon Modern Portfolio Theory (“MPT”) - the theory that returns can be maximized for a given level of risk through portfolio construction.  By introducing assets that not perfectly correlated with one another (i.e. diversification), portfolio risk may be reduced without a proportional decrease in return.  Limitations of Modern Portfolio Theory include:

• Changing market assumptions – MPT relies on market assumptions that need to be updated over time. Correlation between assets is never stable and fixed; they tend to change together with the changes in the universal relations, existing between fundamental assets.  Expected return and risk assumptions may not be realized.
• Some degree of reliance on past performance – MPT uses mathematical calculations on expected values, based on past performance to measure the correlations between risk and return. However, past performance is not a guarantee of future performance. Taking into account only past performances leads to overpassing newer circumstances, maybe not having existed during the time when the historical data were compiled.
• Irrational investors - MPT assumes that investors are always rational and risk-averse – this is not always true, and the field of behavioral finance seeks to explain these diversions from rational thought.
• Less than perfectly efficient markets – MPT assumes all investors have access to the same information at the same time. In reality, markets are not perfectly efficient.

There is a risk that the options in the employer plan may have changed by the time we give our recommendation.  Market conditions could change that impact our determination of whether a particular employer plan investment option is a GOOD option.  

ComposedPro's investment methodology might rebalance client accounts without regard to market conditions and on a more frequent basis than the client might expect.