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You should know (and agree with) your advisor’s investment philosophy. Learn how we approach investing for our clients.
Look at any two financial advisors, and you will find fundamental differences between the philosophy, expertise, transparency, and scope of service. The source of these differences lies in the firm’s investment philosophy, which determines the investment methodology used by the advisor.
The investment philosophy directly impacts how an advisor will design, invest, and manage a given client portfolio — and the performance that is expected or tolerated.
Other critical decisions are also impacted by the investment philosophy, such as:
As an "Investment Advisor Representative" (IAR), a wealth advisory firm charges management fees as a percentage of the investment assets they oversee or provide counsel on. It’s of paramount importance to know and understand the investment philosophy your financial advisor is using to build and manage your portfolio — for both performance and peace of mind.
An investment philosophy is the way a firm thinks about markets, how they work (and sometimes do not) and the types of mistakes they believe consistently drive investor behavior.
Put simply, an investment philosophy is the set of core beliefs that an investor uses to determine optimal investing strategies for unique and dynamic circumstances, and that can be referred to in order to generate new strategies that meet evolving needs or unsatisfactory performance.
An investment strategy is more narrow. It puts into practice the firm’s investment philosophy, often in the context of a client’s unique goals, assets, and needs.
Investment objectives can be characterized by three factors: safety, income, and capital growth. Personal objectives directly inform a portfolio’s design, and be appropriately mixed to meet unique needs, comfort, and goals. The portfolio mix will necessarily change over time as life circumstances and needs change.
Rather than investing in the market as a whole, which anyone can do for virtually free, a majority of the recommended equity positions within our clients’ accounts consist of individual stock positions and sector ETFs.
The use of individual stocks is commonly misconstrued as necessarily carrying greater “risk” (expounded upon below) and oftentimes considered a poor fit for more conservatively invested accounts.
Our methodology challenges this notion.
The carefully curated collection individual stocks we research, track daily, and selectively recommend to our clients are mostly large, reliably profitable, time-tested businesses that – due to their quality and consistency – have historically held value and maintained profitability growth better than the overall market in periods of severe volatility, while also historically outperforming the overall market across long-term cycles.
We believe that, between the thousands of businesses and assets worldwide, some are a better fit than others within a given strategy and – with appropriate levels of professional analysis – should be treated this way when possible.
Minimizing the risk of insolvency – or the risk of your assets being worth $0 or thereabout – means purchasing and holding shares of only the highest-quality companies that have proven defensive value resilience and steadily growing profitability over time.
Put simply: We don’t invest in highly speculative companies or junk.
It is important for any healthy portfolio to maintain a diverse, broad collection of assets across a range of market sectors. However, diversifying too broadly adds its own high degree of “risk.” It’s equally as important that a portfolio be intentionally allocated within sectors and geographic regions that best best fit each specific account’s goals.
Many investment advisors and academic theorists preach that the only appropriate investing method is purchasing mutual funds and ETFs that contain the worldwide market, or something nearly as specific – glorifying diversification for its own sake as the most important factor to limiting “risk.”
Within the scope of professional investment advice, we generally reject this notion.
We don’t necessarily chase short term gains, be it from stocks’ explosive gains, or following the lure of “deep value” by purchasing even historically high-quality stocks while in a sharp downturn. Our focus is delivering superior long-term returns over time by purchasing high-quality assets at a fair price as a foothold for long-term investment, backed by upward momentum, and continuously tracking those assets to assess everything from overpricing to fundamental business downturns.
Brilliant years offset by dismal ones is the business of day traders and speculative hedge funds. We stick to the perspective of our portfolios’ performance over market cycles, not days.
Scattered seasons of home runs, steals, and strike-outs can make an All-Star. A career of consistently strong batting averages makes Hall of Famers. We choose the steady hand.
While understanding academic research, we fundamentally object to the common tenets of “efficient markets theory” and so-called “modern portfolio theory” (commonly-embraced academic throwbacks to the 1970s).
Put simply: Assets are bought and sold in public markets by human beings, and human beings’ decisions are inherently often-irrational, and therefore disciplined forecasting tends to maintain a long-term performance advantage over “mob” trends – which almost always underperform the overall market.Those pockets of inefficiency are our hunting ground.
With markets being as inefficient and irrational as the collective mob of buyers and sellers, those market movements have also created identifiable patterns over time. Alongside our diverse collection of data making our in-house analytical methods, we take these useful historical patterns into account over short, medium, and long-term perspectives.
If any asset’s value grows at 10% annually it will double its value in 7 years (or, at 7%, double every 10 years) – $100 becoming $200; $200 becoming $400, etc.
For example:
Since 1926, the S&P 500’s value has grown an average of ~10% annually (see what we did there?) – this period includes the great depression and every other “black swan” volatility disaster since. Meaning – since 1926, the S&P 500’s value has nearly doubled every 7 years (assuming all assets were bought and held)
Add to that the power of a sound, time-tested strategy of mostly cherry picking the fundamentally-determined strongest, time-tested companies in the stock market at fair prices, determined to likely be a strong starting-point for long-term growth.
Most of our stocks pay regular dividends (or profits returned directly to shareholders), and have a long-term record of increasing those dividends year-over-year – including in market downturns. This often multiplies the windfall from disciplined holding through volatility.
Here’s an example:
If you buy a share of XYZ stock at $100 that pays a 2% dividend quarterly, you’ll receive what amounts to $2 annually (assuming the price stays at $100). If XYZ is later worth $200, and the company still intends to keep paying its 2% dividend, you will be making $4 on your $100 investment – so essentially a 4% return on your original investment, automatically.
Now here’s the fun part.If XYZ increases their dividends, and ends up paying a 4% dividend when the share price reaches $400 – that’s $16 per share in your pocket.
You paid $100 for that share.
That amounts to a 16% annual return on that original investment, just from the dividend payment.
And, no, that’s not an uncommon scenario. (although obviously hypothetical and certainly not a guarantee)
Companies that consistently grow dividends have rewarded the disciplined investor – our philosophy enjoys these rewards.
Unlike consistently-growing dividends, inordinately high dividends are commonly used by companies (and collective real estate funds, etc) expecting little-to-no forecastable growth and/or have experienced fundamental business downturns as an incentive for investors to purchase or hold shares.
These high dividends often represent a massive portion of a company’s profits and cashflow – if not funded by incurring new debt – and therefore further undermine their fundamental health.
We do not pursue these high dividends because we value a company’s fundamental strength and the outlook for long-term growth above short-term returns – whether those returns be from high dividend income or attempting to “time the market” over volatile periods.
Put simply: There’s always a catch, and “high dividend” assets are often not worth the underlying risk.
Toth Capital-designed investment portfolios are simultaneously targeted for long-term relative outperformance and peace of mind, and utilize a risk-appropriate blend of individual stocks, bonds, and exchange traded funds (ETFs).
We adopt a “Tactical Buy-and-Hold” strategy that targets the purchase of high-quality individual assets at agreeable entry points targeting long-term, volatility-resistant growth and selective diversification. The specific investment decisions are guided by each account’s risk/ volatility tolerances and market cycles.
All of our investment activities operate according to a unifying philosophy consisting of three core pillars:
We provide appropriate advice that is fundamentally connected to each client’s individual goals, as well as their personal tolerances and preferences regarding volatility and risk. This is both unique and important.
Importantly, U.S. law mandates that every investment advisory client is assigned a risk tolerance identifier. This determines the amount of loss an investor is willing to handle for their investment decisions.
It is indeed important to evaluate and document your risk tolerance when someone else is making investing decisions on your behalf. The unfortunate reality, however, is that most “risk scores” are arbitrarily set and therefore negatively impact outcomes and performance. This is because “risk tolerance scores” are almost always determined using a standardized list of questions and set prior to any informed discussions between the client and the advisor.
This means that any investment advice that might impact the client’s understanding or perceived level of risk tolerance is not reflected in the design and management of their portfolio. It also leaves out consideration of “risk tolerance” between different accounts with different goals in the portfolio. This blanket approach can leave money on the table or increase risk.
Put bluntly, “risk tolerance” is oftentimes little more than an easy way for a financial advisor to drag and drop clients into impersonal portfolios and cookie-cutter allocation buckets, and avoid regulatory hassle. It makes life easier for them, but it will almost definitely reduce the quality and performance of the portfolio for the client.
To us, this is unacceptable. We see “risk tolerance,” not as an arbitrary “score” preceding investment advice, but as the first exercise and an ongoing detail of personalized investment advice.
In doing so, we approach and define risk tolerance into its two key parts:
“Volatility” is the inevitable ebb and flow of assets’ prices as they’re traded in an open marketplace. Derived from fundamental characteristics, historical pricing, and/ or reasonable expectations, all traded investments have measures of volatility that may or may not translate to future results.
“Risk,” on the other hand, is generally the odds of losing money by way of selling low – whether by necessity or desire – or an investment becoming worthless.
More often than not, true “risk” manifests from the lack of quality advice. Toth Capital Management mitigates these factors of true “risk” as much as possible by providing appropriate advice that is connected to personal investment objectives, true risk tolerance, and active investment management.
We help clients minimize risk from volatility in these situations:
“Risk tolerance” generally relates to volatility. In broad terms, assets that appreciate less aggressively tend to be less volatile than more aggressive assets with values that often fluctuate more dramatically.
Our first step in constructing any customized portfolio is intentionally accounting for expected volatility – or even capitalizing on it – and minimizing risk.
There are as many reasons to blend types of investments as there are investors. A few examples are:
Each of these represent very different “risk tolerances.” Recommending the right one is the cumulation of a deep mutual understanding between each advisor and an investor’s full financial situation, future needs, expectations, and the intentions of each individual account.
This is why we never assign anyone an arbitrary “Risk Tolerance Score” before putting a financial plan and investment strategy in place.
Each of our clients’ portfolios are actively managed. This means each portfolio contains assets picked specifically at the time of trading and maintained according to the ongoing plan, rather than being linked directly to a market index. Put candidly, it does not take an investment professional to passively manage a portfolio made up of market indexes. With countless fintech solutions available, anyone can do this for themselves at nominal cost and with little effort. A Registered Investment Advisor management fees are a percentage of the clients’ investment portfolio values. At Toth Capital, we believe that rigorous, professional, and ongoing investment analysis is fundamental to delivering exceptional performance and earning our fees. Full stop.
The source of this is the many studies that have shown that significantly 90%+ of actively managed investment portfolios underperform the market overall, and over any given timeframe. Given that most financial advisors are inexperienced, underinformed, undisciplined, and/or amateur investors, this is hardly surprising.
Therefore, we view this as a practitioner problem, not a practice problem.
We primarily analyze individual stocks for the purpose of establishing relative valuations that we determine are 1) fairly or underpriced; 2) contain certain factors of upward price momentum; and 3) have strong indicators and consistent earnings growth, both past and anticipated.
To do this, we utilize a diverse blend of specialized research and analysis resources to track factors such as technical trends (tracking charts), fundamental status (corporate financial data), outside analyst earnings expectations, ongoing market cycling, and macroeconomic trends.
Most individual stocks we recommend also pay a dividend, or payment to shareholders. This does not mean we target the largest dividends, as large dividends are often used by struggling companies to prevent shareholders from selling.
Importantly, we target companies with 1) an extended history of regularly increasing their dividends year-over-year, throughout good and challenging times, and 2) which are expected to have continued dividend growth.
Put simply, our fundamental investment thesis is this:
Across years and market cycles, purchasing shares of cream-of-the-crop businesses at a fair (or better) value, with a high likelihood that they continuously pay and raise dividends as their share prices increase over time — and holding those shares through market rises and downturns — tends to result in consistently desirable capital returns.
It’s important to recognize that not all stocks that meet these requirements will meet expectations. This is why active monitoring and ongoing analysis is so critical.
As unforeseen circumstances arise, and expectations shift downward, our investment analysis also extends to considering whether an underperforming stock’s value is sitting anywhere between “likely weakening” for the long term, or a “bargain” that’s primed for a bounce back. This helps inform decisions on when to replace certain holdings with potentially better investments, realize losses to mitigate the tax liability of other investments’ realized gains, continue to hold, or even purchase more shares in the dip.
Whatever the case, the foundation of our investment strategy is the same:
Some of what’s under the hood.
Most Toth Capital-managed portfolios are primarily made up of individual stock positions. These are mostly large companies with a long history of positive earnings growth over the past 10+ years. Most pay and consistently grow quarterly dividends, and are based in the U.S.
As a part of our “Tactical Buy-and-Hold” and risk mitigation strategies, these businesses are extremely insulated from risk of insolvency, have shown the ability to maintain steady positive growth, and consistently maintain higher-than-average earnings per share. Together, these investment traits reduce risk, and ensure our clients’ stock portfolios consist of only top-tier assets and maintain resiliency through market downturns. Any individual stock position is generally held below 5%; typically between 1-3%.
The primary use of individual stocks is to identify and participate in growth with a diverse collection of the world’s best businesses. While diversification is a vital part of any high-quality investment portfolio, being over-diversified with all businesses simultaneously necessarily dilutes the performance of these top companies. Our strategies balance these extremes.
Exchange traded funds and mutual funds are “baskets” of securities, generally consisting from dozens to thousands of positions.
Funds used in our clients’ portfolios tend to be of lower expense – oftentimes near zero expense, such as in the case of funds directly tracking broad indexes (e.g. S&P 500, Nasdaq 100, Dow Jones Industrial Index, etc.). These are frequently used to give exposure to certain sectors of the economy, fixed income investments, real estate, and, in certain cases, for higher-risk strategies.
Economic Sectors: These are to add diversification into the portfolio within either economic sectors where certain portfolios would not generally include – or lightly represent – individual companies (e.g. micro-cap, biotech, transportation, emerging technologies, international developing markets etc).
Fixed Income: These funds give exposure to fixed income securities, such as bonds (corporate debt) and treasuries (sovereign/ government debt). These kinds of assets are oftentimes best “laddered” – or held to maturity, when principle is returned to the lender, and then reinvested in other debt instruments. Due to the high volume of trades needed to practice this and similar debt strategies, and the unique benefits of broad diversification therein, funds oftentimes offer these at very low expense.
Real Estate: Real estate exposure is oftentimes a portion of a well-diversified investment portfolio, particularly through pooled securities called real estate investment trusts. Exchange traded funds are a useful tool for aggregating these funds for enhanced diversification.
Leveraged Investments: Used less frequently, these funds utilize “leverage” (derivatives, covered/ uncovered options contracts, etc.) to enhance the price movement of their underlying assets.
For example: SSO is an exchange traded fund that targets moving 2x the daily price changes of the S&P 500 (if the S&P 500 is up 2%, SSO is up 4%; true also in the inverse). These both enhance gains on the upside, while also adding risk of compounding enhanced losses on the downside.
International: These funds lend exposure to specific or broad international economies, adding the diversification of market participation in corporate stocks, bonds, and government debt worldwide.
Tom is a wealth manager and founder of Toth Capital Management, based in Reston, Virginia. He lives with his family and is active in his Loudoun and Fairfax county communities. If you see him in the wild, it might be at a local storytelling event, coaching his daughter's soccer team, or cheering in the stands at a Nats game… you’ll hear him in any case.