‘Investor alpha’ is a very powerful monetary technique for 2021


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This was the year of unpredictability.

The pandemic, including months of self-quarantine, is of paramount concern to people around the world. Many more surprises this year include the fastest bear market in history, civil unrest, a unique U.S. presidential election, the rapid development of a coronavirus vaccine, and the market that hits all-time highs despite scary headlines.

Nobody could have predicted how this year would turn out.

With so much uncertainty, the only strategy that will be particularly relevant to investors in 2021 is “Investor Alpha”. In principle, factor-driven alpha investment strategies are designed to manage risks within a portfolio and at the same time to achieve market-driven returns.

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Many people are familiar with Manager Alpha, or the extra return a successful portfolio manager can make above the index. However, with troubled markets and a steady stream of bad news, it would be wise for investors to focus on the alpha that they can personally generate by considering the following four concepts.

1. Tax efficiency: A tax efficient portfolio allows investors to keep more of their money. This can be achieved by using an appropriate “asset location” where investments are placed in different types of accounts based on their tax efficiency.

For example, fiscally inefficient investments such as real estate mutual funds and funds with high portfolio turnover or high income may be better suited for tax-deferred retirement accounts. Conversely, tax efficient investment strategies such as exchange-traded funds that passively track an index and generate modest income levels may be better suited to a taxable account.

Another way for investors to minimize their tax liability is to maximize their contributions to tax-privileged accounts. This includes 401 (k) plans, individual retirement accounts, Roth IRAs, or a triple tax-free health savings account. If one has college-bound children, it may also include a 529 college savings account that offers tax-free growth and tax-free withdrawals on qualified federal expenses, as well as the option of a tax credit or deduction for contributions to income status plan. Paying attention to taxes in addition to investing can add significant wealth to wealth over time.

2. Savings rate: Over the past decade, the S&P 500 index has posted an attractive annualized return of 13%, a few points above the historical long-term average of 10%. While all investors are looking for continued strong performance, it is advisable to plan for the possibility of lower future growth.

The market moves in cycles and can experience years of relative underperformance. For example, the S&P 500 averaged -3% per year for the decade ended February 2009.

One step investors can take when planning a low-yielding environment is increasing their savings rate. Far more exciting is picking a winning stock or watching the market hit all-time highs. However, simply putting more money away can help you achieve your financial goals more reliably.

3. Automation: One of the hardest things about investing is controlling your emotions. When the market collapses, many investors want to sell everything and switch to cash. On the flip side, with the market soaring, many feel the urge to chase soaring stocks and take ill-considered risk.

Introducing a degree of automation into your own investment process is a great way to keep emotions in check and to keep your investment strategy on track. Investors can easily implement this strategy through their employer’s 401 (k) plan, which automatically subtracts money from each paycheck and investing it in the market. Investors can also sign up for “automatic escalation” of contributions to ensure they are contributing more money with ease each year. The same automations can be set up in a brokerage account in collaboration with your financial advisor.

Another automation is the realignment process, which involves adjusting the weighting of a portfolio as an investment rises or falls over time. When a portfolio is rebalanced, the investor is buying or selling assets in order to maintain their original asset allocation. They also sell high and buy low, which is a way to lock in profits and invest the proceeds in assets that are underperforming. Rebalancing can be set up so that it can be set up at set times throughout the year or as soon as an investment reaches a certain percentage threshold in relation to the rest of the portfolio.

4. Portfolio fees: Two of the major recent breakthroughs in the world of investing have been the democratization of investment solutions and the significant reduction in fees across the industry. Today, US investors can operate in almost any market in the world for a minimal fee. This exposure can be achieved in many ways, including easily accessible exchange traded funds or low cost mutual funds.

A worthwhile exercise for all investors is to search their existing holdings to see if they can swap expensive legacy positions for new, inexpensive investments. While fees are definitely not the only consideration, or even the most important factor, when accumulating wealth, paying significantly more than the industry average can lower your returns over the course of your investment life.

As we near the end of the year, people can only guess what 2021 holds in store for society and markets. If we have learned anything from the past year, none of us own this crystal ball that can help us predict the future. However, investors can take comfort that focusing on the elements they control is enough to achieve their financial goals.

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