By: Adam S. Drake, CFA and Kenneth E. Karr, CFP
“Investments can serve one of three basic functions; Growth, Risk Reduction, and Inflation Protection.”
Yogi Berra, while sitting down at a pizza restaurant, was reported to have said, “You better make it four slices. I don’t think I could eat eight.” Replace “pizza” with “asset allocation pie chart” and we think Yogi was actually on to something. Ask any investor to think about asset allocation, and pictures of pie charts sliced into numerous colorful slivers come to mind. While there are benefits to viewing asset allocation this way, there are also major drawbacks. One benefit is that an investor can see all the asset classes they’ve covered (large caps, small caps, international, bonds, etc.). The drawbacks are: it is difficult to know if the proportions are correct, slices can limit flexibility within specific asset classes, and too many slices can be confusing. But the biggest criticism is that current pie charts don’t tell what purpose the investments are serving. Said another way, what function does an investment serve in your portfolio? To remedy this confusion, we have created the concept of Functional Investing TM.
Functional Investing is a new perspective, not a change in underlying investment philosophy, although we think the concept will guide us as
portfolios evolve. It’s really a tool for Highland Investment Advisors and for our clients. Let us explain. Portfolio holdings aren’t just there to fill up a pie chart. Our view is that investments can serve one of three basic functions: Growth, Risk reduction,
or Inflation Protection – G.R.I.PTM for short. Growth assets are primarily stocks, both international and domestic, which seek capital appreciation. Risk reduction assets include cash, bonds, hedged strategies, insurance, and annuities. These are the primary means we use to adjust risk in clients’ portfolios. Inflation Protection assets include commodities (agriculture, metals, precious metals, and energy), international and domestic real estate, and Treasury Inflation Protected Securities (TIPS). These assets aim to protect purchasing power over time.
Some assets listed above serve dual functions. For example, TIPs are a type of U.S. Treasury bond that can help reduce risk while simultaneously providing inflation protection.
Stocks themselves are inflation hedges since companies may be able to pass along price increases caused by inflation. This could lead to higher profits and ultimately higher stock prices, giving shareholders a buffer against inflation.
Functional investing helps us meld the financial planning objectives of our clients with a portfolio appropriate for their goals. G.R.I.P. ensures that the portfolio allocation is thorough, thoughtful, and is designed around a client’s purpose for investing. We believe every portfolio should have representation of Growth, Risk reduction, and Inflation Protection assets. The application of Functional Investing allows Highland Investment Advisors to more effectively formulate an appropriate investment strategy around your wealth management plan.
Ken Karr, CFP and Adam Drake, CFA are partners at Highland Investment Advisors, LLC, a registered investment advisor (RIA) providing investment management and financial planning since 2006. Based in Milwaukee, WI, the firm serves clients in eight states and manages investments for individuals, retirement plans, not-for-profits, and independent investment advisors. They can be reached at 414-755-2309 or firstname.lastname@example.org