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The Zero-Budget Portfolio

By Meb Faber, co-founder, Cambria Investment Management
Tuesday, January 17, 2017

Happy 2017... You're probably going to fail this year!
According to Statistic Brain, only 9% of Americans are successful in achieving their New Year's resolutions. That figure more than quadruples 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 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 portfolios 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 only thing we can control is the process itself.
So why not make a well-executed process our goal and let the outcome take care of itself?
If you find this idea reasonable, then the logical next question is, "So what is an effective New Year's investment-process resolution?"
I'm going to suggest we borrow one from private equity group 3G Capital.
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.
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, which usually leads to massive layoffs, new budgetary restrictions, and an overall shift in corporate culture. And the subsequent "payoff"? Big profits.
Let's apply this concept to your portfolio... Take out a piece of paper. Write down what 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. If 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 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.

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'll significantly boost 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 longtime holdings that haven't performed for years, yet remain in our portfolios for any number of reasons. 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 his current portfolio, often consisting of 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 no idea what their current portfolio looks like, or how to expect it to perform in the future.
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. Here is a simple overview that should take less than an hour:
Schedule a time for a portfolio review.
2.   Start with a blank slate, and outline your ideal portfolio today. Aim for 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, coworker, or a spouse. Just like sharing your New Year's resolution to lose weight, your chance of success is much higher if you are held accountable.

If you bring 3G's mindset to your investments, then I believe that by this time in 2018, you'll be very pleased with the results.
But regardless of which approach is right for you, don't let this New Year's pass too far by without using it as an opportunity to help your portfolio. After all, as the old saying goes, "If not now, when?"
Meb Faber

Further Reading:

"Instead of relying on predictions, you can be ready for anything in the markets this year," Dan Ferris writes. Right now, Wall Street analysts are showing signs of fear. But you can sleep well at night if you prepare your portfolio for whatever lies ahead. Read more here: Five Ways to Prepare for Any Market Environment.
"Stocks have just hit new highs," Steve writes. "And that tells me stocks could have another strong year in 2017." Don't let your instincts work against you... New highs are far from a reason to panic. Learn more about this bullish sign for the markets here: Two Reasons Stocks Can Soar in 2017.

Market Notes

Apple (AAPL)... consumer electronics
Walt Disney (DIS)... entertainment
Comcast (CMCSA)... cable TV
Scripps Networks Interactive (SNI)... cable TV
Sirius XM (SIRI)... satellite radio
DISH Network (DISH)... satellite TV
Take-Two Interactive (TTWO)... video games
Shopify (SHOP)... e-commerce
Global Payments (GPN)... digital payments
E-Trade Financial (ETFC)... online brokerage
TD Ameritrade (AMTD)... online brokerage
Bank of Montreal (BMO)... Canadian bank
Royal Bank of Canada (RY)... Canadian bank
Blackstone (BX)... financial services
PNC Financial (PNC)... financial services
American Express (AXP)... credit cards
La Quinta (LQ)... hotels
Southwest Airlines (LUV)... airline
General Motors (GM)... cars
TrueCar (TRUE)... automotive pricing
Progressive (PGR)... car insurance
American International (AIG)... insurance
Dover (DOV)... industrial conglomerate
Mosaic (MOS)... fertilizer
Southern Copper (SCCO)... copper
CSX (CSX)... railroads
Canadian National Railway (CNI)... railroads
Quest Diagnostics (DGX)... medical testing

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