The Zero Budget Portfolio

Happy 2017…You’re probably going to fail this year!

Let me quickly add some context before I’m bombarded with venomous emails.

According to StatisticBrain, only 8% of Americans are successful in achieving their New Year’s Resolution. That figure triples when describing people who “never succeed and fail on their resolution each year.”

I would think the results are equally bad, or worse, when focusing in on New Year’s resolutions related to investing. Why? So many of our goals are binary in nature – did we beat the market or not? Did we hit our 12% goal or come up short? Did our portfolio grow enough to buy that new sports car?

One problem with this type of investment resolution is it focuses on a result rather than a process – the “payoff” rather than the “playbook.” But the reality is the only thing we can control is the process itself. So why not make a well-executed process our goal and let the subsequent outcome take care of itself?

If you find that idea reasonable, then the logical next question is “so what is an effective New Year’s investment-process resolution?”

In this short piece, I’m going to suggest we borrow one from private equity group, 3G Capital. And here’s the best part – even if you’re only moderately successful in its implementation, odds are you’ll see a major improvement in your portfolio by this time next year. And to the extent you apply this resolution regularly and vigorously, I believe you’ll enjoy the kind of big-return results about which few investors can boast – all without making big-returns your New Year’s resolution.

Your 2017 Investing New Year’s Resolution

3G Capital has an impressive resume.

Perhaps best known for leading InBev’s hostile takeover of Anheuser-Busch and Heinz’s purchase of Kraft, 3G is widely respected for its ability to transform a company’s profitability – and quickly. (A great book on 3G is Dream Big.)

Fortunately, how 3G accomplishes this is no secret. The strategy is called “zero-based budgeting.”

In essence, zero-based budgeting boils down to one critical hurdle: Every expense – old ones as well as new – must be re-justified every year, and wherever possible those expenses must be lowered.

To borrow our terms from above, the “process” of zero-based budgeting includes objective analysis of all cash-flows that usually leads to massive layoffs, new budgetary restrictions, and an overall shift in corporate culture. And the subsequent “payoff”? Big profits.

Warren Buffett has financed deals with 3G and is so complimentary about the company that he penned the following in his 2016 annual letter to Berkshire Hathaway shareholders:

“Their method, at which they have been extraordinarily successful, is to buy companies that offer an opportunity for eliminating many unnecessary costs and then — very promptly — to make the moves that will get the job done. Their actions significantly boost productivity, the all-important factor in America’s economic growth over the past 240 years.”

Now, there are countless applications of this principal that could make a difference in your personal finances. All you have to do is look at your credit card statement or checkbook, track where your dollars are flowing, then objectively reassess the merits of each expense with a critical eye. Think about how many expenses you routinely pay without ever second-guessing if you could find a less expensive alternative (or eliminate the expense altogether through some creative twist).

So, start at zero, and then ask yourself, “Would I add DirectTV for $3,000 today?”  For many of us, the answer to the question is different if you are continuing a service, or initiating a new purchase.  In behavioral finance this is called the endowment effect, where people ascribe more value to things simply because they own them.  But if you didn’t own that Big Green Egg, would you buy it again?  (Another way to do this is to cancel your credit cards so that any recurring services have to be repurchased.)

However, rather than focus on such personal finance applications in this article, let’s apply this concept to your portfolio.Take out a white piece of paper.  Write down what you envision your ideal portfolio would be today if you were starting from scratch.  Finished?

In essence, you’re forcing yourself to start with a mental clean slate. In a perfect world, how does your ideal portfolio look as of today, going forward? To the extent the actual holdings in your portfolio fit into your vision, they remain. Those that don’t get the axe.

A slight tweak of 3G’s hurdle provides us a litmus test we can use on our own portfolios:

“Every stock, bond, or other investment, you name it, must be re-justified right now. And if you wouldn’t add the investment to your portfolio based on an honest assessment of its prospects as they look today, then purge it from your portfolio immediately.”

A moment ago, I quoted Buffett, praising 3G as their methods “(eliminate) many unnecessary costs and…significantly boost productivity.”

Similarly, the go-nowhere investments loitering in your portfolio are a very real opportunity cost (and many times, real dollar cost) to your wealth. Therefore, by eliminating them, you too would be significantly boosting your portfolio’s productivity, and isn’t that the real goal you want to achieve?

The challenge is viewing our assets with genuine objectivity. So many of us have high cost legacy holdings that haven’t performed for years, yet remain in our portfolios for any number of reasons – we hate admitting we were wrong, we don’t want to incur a taxable event, perhaps the investment was an inherited gift with emotional value from a loved one, or maybe we just don’t want to go to the effort of re-vetting each holding. After all, proper due diligence isn’t something you knock out at the commercial break.  Also, many simply have a portfolio that their financial advisor placed them in many years ago.

But are any of those excuses legitimate reasons to continue owning a bad investment?  I can’t tell you how many times a prospective client has shown up with their current portfolio, often consisting of – and I’m not joking – dozens to hundreds of holdings and funds (what my friend Josh Brown calls “mutual fund salad”).  Many of these funds charge 1%, 2%, or even 3% or more in fees per year! These investors have such a huge mess for a portfolio that they have no idea what their current portfolio looks like, or how to expect it to perform in the future.

Your Plan Going Forward

If you don’t have a 2017 New Year’s investing resolution but you’re willing to try, I suggest you borrow the 3G Zero Budget approach to your portfolio.

If you like this idea, don’t nod your head in agreement then forget about it as you go on with your day. Instead, open your calendar right now. Schedule an appropriate amount of time for a portfolio review. Then, when it comes, take the time to write down your results. Something powerful happens when we force ourselves to capture an amorphous thought with the written word. It brings a powerful clarity that otherwise remains somewhat gray.  Here is a simple overview that should take less than an hour:

  1. Schedule a time for a portfolio review.
  2. Start with a blank slate, and outline your ideal portfolio today.  Err on the side of simplicity.
  3. Compare your ideal portfolio to your legacy portfolio.
  4. If they differ, be ruthless about purging the old holdings to reflect your ideal portfolio.
  5. Schedule a time to implement the changes.
  6. Write down your process, what big institutions call their “policy portfolio”, for how you will maintain the portfolio going forward (rebalancing, etc.).
  7. Share this plan with someone. It could be a friend, a co-worker, husband, etc.  Just like sharing your New Years resolution to lose weight, if you share your investment resolution your chance of success is much higher if you are held accountable.

There are obviously many more procedures you could add, but this will give you a decent start.

If you bring 3G’s mindset to your investments, then I believe that by this time 2018, you’ll be very pleased with the results.

For those of you who like this idea in theory but don’t have time to put in the required due diligence, or perhaps aren’t confident in your analytical ability, you can always outsource your portfolio to our Cambria Digital Advisor service. You can read all about our approach by clicking here.

Regardless of which approach is right for you, don’t let this New Year’s pass by without using it as an opportunity to help your portfolio. After all, as the old saying goes, “If not now, when?”