How and Why We Build a Portfolio the Way We Do
Investments Series
Building a portfolio isn’t about picking the hottest stock or finding the next big thing. It’s about assembling a “team” - different components that play different roles, some of which perform well precisely when others are struggling - and then managing that team with enough discipline to let it work over time.
That’s the philosophy behind how we approach investment management. And it starts with understanding what the pieces are and why they’re in the portfolio.
Stocks and Bonds: The Core Relationship
At the foundation of most portfolios are two asset classes: equities (stocks) and fixed income (bonds). Most people understand stocks. Bonds are less intuitive - and the relationship between them is something worth understanding.
In a majority of market environments, quality bonds can generate a reliable return, but their more important function is what they tend to do when equities fall.
When stocks decline sharply, central banks typically respond by cutting interest rates - which causes bond values to rise. During the tech bubble, when stocks fell a well-positioned bond allocation gained The combined portfolio experienced a much more modest loss than an all-equity investor would have felt. That’s the diversification working as designed.
It’s also worth noting that it doesn’t always work that way. In 2022, both stocks and bonds lost money simultaneously when inflation spiked and the Federal Reserve raised rates rapidly. When interest rates rise sharply, bond values fall. That year was unusual and painful precisely because the traditional hedge failed. But understanding why it failed - and why it’s expected to work in most environments - is part of what we do.
“Hedge the Known. Diversify the Unknown.”
This quote, from David Kelly - a well-respected economist and investment strategist at JP Morgan - is one of the most useful frameworks for thinking about risk: you hedge against known risks, and diversify against the unknown ones.
This distinction matters practically. Before the inflation surge of 2022, the conditions that would cause it were visible to careful observers: massive stimulus injected into an economy already recovering from COVID, combined with a Federal Reserve keeping interest rates near zero. Inflation wasn’t guaranteed, but the setup was there. Knowing that, we could take steps to reduce interest rate risk in client portfolios - shortening bond maturities, for example, so that rising rates would do less damage.
What you can’t hedge against is what you don’t know. Nobody anticipated a global pandemic in early 2020. These are the unknown risks - and the response to them is diversification, spreading exposure broadly enough that no single event can destroy the portfolio.
Returning to David Kelly, when asked what keeps him up at night, his answer was telling: what he doesn’t know about. If he knows about a risk, he can hedge it. It’s the unknown risks that require a different kind of preparation.
Building Your “Team”
We think about portfolio construction the way a sports team builds its roster. You want proven performers at every position, with different strengths that complement each other. You follow people for a long time before you trust them with the assignment. And you prefer consistency and discipline over flash.
We work with a range of established investment managers - equity managers, bond specialists, and balanced funds - evaluating each not just on recent performance but on their process, their consistency, and how they’ve behaved in difficult markets. We’ve followed certain managers for five to ten years before putting them in the portfolio. A great recent track record isn’t enough; we want to understand how they got there and whether they can do it again.
Our preference is for active management over purely passive approaches. Active managers - people who actively research companies, talk to management teams, and make deliberate decisions about what to own - are usually more expensive than passive index funds. But we believe the cost is justified for clients whose situations require more than simply tracking the market. Someone approaching retirement with a concentrated stock position, specific income needs, or significant tax considerations needs active management of those realities, not a passive index.
The analogy we use: in a 100-yard dash, a significant head start doesn’t guarantee victory against a world-class sprinter. Similarly, lower fees don’t automatically produce better outcomes. What matters is the total result, and we believe that active management - done well - delivers that.
When something unexpected happens, a well-reasoned portfolio tends to hold up better than one assembled without a clear framework.
A Note on Alternatives
The investment landscape includes a wide range of products beyond stocks and bonds - private credit, private equity, non-traded real estate, structured products, and more. These are often marketed aggressively, particularly when a specific category is performing well.
Our posture toward alternatives is cautious and deliberate.
The most important characteristic we look for in any investment is liquidity - the ability to sell when circumstances require it. Many alternative investments are illiquid by design. A client who puts money into a private credit fund may find, when they need the money back, that the fund may have limited or suspended redemptions. The documents will say something like “it is our intention to allow redemptions” - but intention is not a guarantee. We’ve seen this play out in real estate investment vehicles and private credit funds under market stress, and it’s a difficult conversation o have with a client.
This doesn’t mean we categorically avoid alternatives. There may be specific situations - certain tax circumstances, particular income needs, appropriate levels of net worth and sophistication - where they make sense. But we approach them the same way we approach everything: with a long evaluation period, thorough understanding of the risks, and a clear answer to what they’re doing in the portfolio that something more liquid couldn’t do.
The investment business always has a new exciting thing. Our job is to evaluate it on its merits, not its momentum.
Rawe Financial is a family-owned financial advisory practice in Northern Kentucky, helping individuals and families build and protect wealth at every stage of life. If you have questions about your investment strategy, we’d welcome a conversation.
Disclosure
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.
Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.
Investing in alternative investments may not be suitable for all investors and involves special risks, such as risk associated with leveraging the investment, utilizing complex financial derivatives, adverse market forces, regulatory and tax code changes, and illiquidity. There is no assurance that the investment objective will be attained.
Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.
All indices are unmanaged, and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.