Building Portfolios with Realistic Returns FRAT VidEx

Building Portfolios with Realistic Returns in Mind

May 26th, 2009, By ChuckC at http://TheMarketsUpChuck.com

A portfolio needs to be designed to accomplish specific and realistic goals and objectives in order to be successful. Unfortunately, since the advent and domination of Modern Portfolio Theory, true investing principles are being ignored in favor of a more statistical approach. Instead of constructing portfolios with precise rate of return targets that are achievable based on practical real world attributes, we asset allocate. To me, this means over-diversifying into way too many so-called asset classes that are too over-generalized to be of true value. First, stocks are classified by size as if all companies of a certain capitalization are the same. Then they are further generalized into so-called value or growth based once again on certain statistical measurements related mostly to price action. This is often very misleading because actual characteristics of growth or value are related to fundamentals not price volatility.

As operating businesses, public or private companies will go through phases of business growth and development, relative to their industries, that define their investment attributes. For example, young fast growing companies rarely pay a dividend. When in the fast growth phase they tend to utilize all their capital resources to fund their continuing growth. Therefore, they dont pay dividends and attract investors seeking appreciation rather than income. As a company matures and its rate of growth begins to slow, the business has excess capital that it can distribute to shareholders as dividends. Of course there are other uses of capital that a firm may deploy such as buying back stock or making acquisitions, etc. My point is that as companies are in these different phases, they offer different rate of return characteristics and components to current and potential shareholders.

Most importantly these phases of growth have specific and identifiable ranges of growth and therefore return potential associated with each phase. Therefore, as long as an investor keeps valuation in perspective, a portfolio can and should be constructed to accomplish specific goals based on precise return targets. Portfolios can be more intelligently designed than just throwing a bunch of mud on the wall and hoping for the best. As an investor, you can and should know exactly what returns within reasonable ranges that your portfolio is capable of achieving on your behalf. You can and should also be cognizant of how much comes from growth and how much from income (dividend). This weeks blog is dedicated to successfully designing portfolios that accomplish precise goals. Todays FRAT™ Videx™ reviews a few key ranges of return probabilities.

The author manages portfolios owning UTX.

Perhaps the greatest benefit of living in a capitalistic society is the opportunity we have to generate multiple sources of income as passive investors in exciting businesses. We can and do work hard for our money, and our money in turn can work hard for us. Remember, as this blog has previously pointed out: Investing is most intelligent when it is most businesslike. Invest as a business owner, not as a gambler. This week I will be covering realistic rate of return expectations that well run businesses are capable of generating.

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