How to Invest Like a Pro

In September 2010, I was quoted in the on-line edition of Financial Advisor Magazine in an article titled Pension-Style Investing Limits Individuals. Despite the title, I believe just the opposite is true. I think many individuals would do well to emulate pension plans.

In order to get a good combination of growth and income, institutional money managers have traditionally held a moderate allocation between stocks and bonds. With responsibility for so many participants, it’s reasonable to take a middle of the road course. According to the article, some pension plans shifted strategies and got too aggressive when the economy and markets were doing well. Now, they are turning overly conservative to the detriment of plan participants. I don’t know if this is true or not, but I think most plans will continue a balanced approach. Nevertheless, the typical 60%/40% mix of stocks and bonds of the past would be a good starting point for many individuals.

Of course, you have the luxury of adjusting your allocation for your personal circumstance. Even so, I would advise not to stray far from this traditional mix. To supplement any other pensions, social security, or other income that you will have during retirement, your task is to create your own pension income. There are only marginal benefits by being more aggressive. Likewise, being too conservative could make it difficult to achieve long-term security. Thus, you should take a cue from the professional pension managers and maintain a sensible and steady course.

Pension plans are run very cost-efficiently because they have economies of scale to secure minimal transaction costs. They are also the biggest users of index investing to keep costs low. It’s interesting to note that institutions, with lots of resources to perform security analysis, make extensive use of passive investments. On the other hand, individuals who could benefit most from indexing are slower to come around to this methodology. If the “smart money” recognizes the value of index investing, maybe you should as well. Fortunately, you can imitate the pros and drive costs down by using index funds and ETFs.

As you might expect, pensions are extremely diversified, as they have the resources to spread funds into many assets. Here again, you can accomplish the same result with index funds and ETFs, because they cover the entire universe of publicly traded securities in a particular asset class or sector. By combining several index funds and ETFs, you can purchase and own the entire stock and bond markets. When you think of it, you can’t get much more diversified than that!

There is one area where I encourage you to depart from pension-style investing. Pensions often employ alternative strategies and invest in illiquid assets. These might be fine for large pools of institutional capital, but you can ignore so-called “alternative investments.” Basic stock and bond funds – with maybe a low-cost real estate fund added for further diversification – can provide you with all you need to get the job done.

If you anticipate the need for steady supplemental income from your portfolio in order to support your lifestyle throughout retirement, you can take another cue from pension plans. Instead of coping with fluctuating cash flow disbursed from interest and dividend paying securities, or buying products engineered for income (at a high cost) such as annuities, you can simply sell some funds (when needed) for distributions. This method is called the “total return method for drawing income,” which is very similar to the way pensions disburse monthly income.

To achieve your ideal portfolio, you should learn from the experts and think of your own portfolio as a pension plan that you are responsible to manage. In that way, you will be more inclined to take a balanced approach, keep your costs to a minimum, and reduce risk by diversifying into all important areas of the economy. These simple steps can provide a good combination of growth, stability, and security. Moreover, when the time is right, you can generate your own pension check to not have to rely on anyone else. Though you may never have as much money as a pension plan, now that you know how - there is no reason that you can’t invest like the pros.