9/2023

By Don Keeney, CFA, CFP®

An individual’s investment strategy can take many forms – from more traditional buy/hold portfolio management spanning all the way to speculative meme stock day trading. No matter what strategy one chooses to implement, it is important to have a plan in place prior to deploying hard-earned capital. The term investment strategy refers to a set of principles designed to help an individual investor achieve their financial and investment goals. At Cahaba Wealth Management, we believe that taking the time to understand our clients’ financial situations and building a holistic approach is by far the “better way”. Let’s investigate what this looks like.

An Investment Strategy typically involves three main components: Cash Flow Needs, Time Horizon and Risk Tolerance. If you are familiar with Cahaba Wealth Management, then you are surely aware of how important an understanding of these things is to the implementation of our strategy.  If you Google “components needed to create an investment strategy”, many of the generic responses include other components, such as fees and the tax efficiency of the investments. These are no doubt very important, but aren’t really a part of the strategy … they are more a part of the implementation of the strategy.

Cash Flow Needs

Unfortunately, many other financial advisers gloss over this important component. They often only ask basic questions such as whether you are working, when your expected retirement is, and, if you are already retired, what your cash needs are. While the answers to these questions are also vital to an investment strategy, we at Cahaba Wealth believe a deeper understanding of our client’s situation is necessary. Creating a financial plan (with an understanding of a client’s financial goals and aspirations) helps us outline upcoming cash needs that don’t fall into the “surface investigation” done by many others. Things like a future need for a new car, college expenses for children (or grandchildren), business expenses, family trips, and healthcare costs are all factored in to our cash flow projections. Having a plan for these types of future cash needs is essential to the design of an investment strategy.

Time Horizon

An investment time horizon is the period of time one expects to hold an investment before capitalizing on it. In conjunction with cash flow needs, time horizon considers (among many other items) the investor’s age, the time to retirement and the types of accounts that an investor has. For example, if the investor has a taxable account, a Roth IRA, and a 401(k) through work, the potential time horizon for each of those accounts may be different.

Generally speaking, the longer the time horizon, the more reasonable it is to take a higher level of risk. The reverse is also true – the shorter the time horizon, the less aggressive the investments should be.

Risk Tolerance

Risk tolerance is a measure of the degree of loss an investor is willing to endure within their portfolio. Age, investment goals, and income contribute to an investor’s risk tolerance. Stock volatility, market swings, economic or political events, and regulatory, or interest rate changes can also affect an investor’s tolerance for risk. If the prior two components (cash flow needs and time horizon) allow for a more aggressive investment strategy, but the investor is not able to emotionally handle the volatility/risk of that type of strategy, then the strategy is destined for failure! Ultimately, it is our job to create an investment strategy that the investor can stick to regardless of the movements in the markets.

An investor’s future earning capacity, the presence of other assets (such as a home, pension, and Social Security), and a potential future inheritance typically affect risk tolerance. Generally, an investor can take greater risk with investable assets when they have other, more stable sources of funds available. Regardless of this general rule of thumb, it is important to strike a solid and grounded balance between risk and the expected return of the overall portfolio. Understanding the unique mechanisms of an investor’s risk tolerance helps us choose an investment strategy that properly aligns their emotional and financial capacity. With this understanding, our hope is that the investor can handle market fluctuations with the expected return that is needed to accomplish all of their financial goals.

Appropriately combining these three components leads to a truly customized and highly functional investment strategy. A successful strategy ensures that all cash flow needs are met across the time horizon spectrum and that the investor is comfortable with the level of risk required to achieve their financial goals. It is important to note that all three components will change over time; none of them are static. As the investor’s financial situation, goals, income level, and family situations evolve, there is the potential that the investment strategy should change. Cahaba Wealth meets with our clients to review all of these components periodically, working to ensure their needs are being met now and into the future.

Don Keeney, CFA, CFP® is a financial advisor in the Nashville office of Cahaba Wealth Management, www.cahabawealth.com.

Cahaba Wealth Management is registered as an investment adviser with the SEC and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by the SEC nor does it indicate that the adviser has attained a particular level of skill or ability. Cahaba Wealth Management is not engaged in the practice of law or accounting. Always consult an attorney or tax professional regarding your specific legal or tax situation. Content should not be construed as personalized investment advice. The opinions in this materials are for general information, and not intended to provide specific investment advice or recommendations for an individual. Content should not be regarded as a complete analysis of the subjects discussed. To determine which investment(s) may be appropriate for you, consult your financial advisor.