Portfolio Management 101
[Mar 10, 2012]
Most financial advisors, fund managers etc, are experts at helping you manage your money, or at least they want you to believe so. Some are pretty good, others not that good. Nothing really special with that.
The standard process of these advisors is something like this:
- Risk – they are mandated to somehow determine the level of risk you are looking for.
2. Asset allocation – both long-term strategic as well as short-term tactical allocation
3. Product selection – what to actually invest in
Yes, I might be oversimplifying and you might disagree on the details. But regardless of what you think about this process, I believe there are some much more fundamental things that are completely ignored by 99.9% of the advisors. I also believe that if you get the basics right, you are much more likely to get some good results. I suppose you agree on that as well.
So let’s have a look at these fundamental things. In order to make any investment in your portfolio, you surely need to check past performance. And in order to evaluate any portfolio management at all, you need to keep books in a good way. Hence, proper portfolio accounting is absolutely essential when managing a portfolio.
This should be the starting point for any portfolio manager. But what in turn are the basics of portfolio accounting?
Well, here’s what I think should be first two most fundamental things:
First of all, you need to select the main unit-of-account for your books. Most people select the national fiat currency by default, but this is too important and at least you should motivate your choice. An international investor might want several unit-of-accounts, but also these should be selected carefully.
The national currency might be useful as a means-of-exchange. And you need to keep books in this currency also for tax purposes. But you don’t have to use it as basis for your decisions. As you already know, there are completely objective reasons for choosing gold as unit-of-account, rather than the monopolist fiat currencies.
But the choice is ultimately yours. The next step would then be:
- Accounting principles
Most people take the national accounting principles by default as well. But you only have to follow the rules when reporting to the authorities. You don’t have to use the official accounting principles for the accounting you base your decisions on.
But what is important when it comes to accounting principles? Well, there are two ancient accounting principles that will help you avoid both the risk of overstating your assets and understating your liabilities. I reckon you can see the point in avoiding that, right? They are:
The Law of Assets – an asset must be carried in the balance sheet at acquisition value, or at market value, whichever is lower.
The Law of Liabilities – a liability must be carried in the balance sheet at its value at maturity, or at liquidation value, whichever is higher.
Unfortunately, many current accounting principles, like the IFRS, are almost the exact opposite of these ancient principles. No wonder we read almost every day about people having overstated the assets and understated the liabilities.
But you don’t have to run into that trap of official accounting. You can be smarter than that when doing your own portfolio accounting. Why not keep your books in accordance to both the officially mandated and the ancient principles, if possible?
When you have gotten as far as to select a unit-of-account and accounting principles, Ii think you are ready for the more common steps involved in portfolio management:
4. Asset allocation
5. Product selection
Or whatever process you find suitable, I’m sure there are many other ways.
To sum up, I believe you should ask yourself what unit-of-account and accounting principles you want to follow. These are questions a good advisor should ask you? So now you have some questions to ask your financial advisor as well. After all, remember they often charge you according to the performance measured in the national fiat currency.
I hope this in the end will bring a lot of extra value to your portfolio management. Good luck!
[We are planning to launch a GOLDEN PORTFOLIO service that will help you to manage your portfolio with gold as the main unit-of-account, and also look at your portfolio using different accounting principles. The typical charge would be 1/100 of a gold ounce per month, or about US$19.99 per month. In case you are interested, please let us know by sending us your email address.
This will speed up the process and we will keep you informed on the development. The more people that want this the faster we will work. Help us share this information. Let’s do this together. Thanks!]
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