The Huffington Post recently ran an article that drew heavily from Warren Buffett’s annual letter to shareholders. The spin: Warren thinks normal humans shouldn’t try to beat the market; they’re better off investing in a broad stock index (such as the S&P 500) as well as some bonds, and not touching that for years. This would work great if normal humans were robots devoid of emotions.

Don’t Forget Risk Tolerance, Warren

The author of the Huffington piece — and perhaps Warren B. himself — are overlooking one very important consideration: Buy-and-hold strategies are hard to stick to when prices start to move decidedly downward. This is why many do-it-yourself investors, who don’t have an independent advisor such as LNWM, have a history of selling low and buying high.

It’s a lot easier to stay invested through thick and thin, if your investment portfolio returns stay within your risk tolerance level, throughout your investment horizon. Say you can’t stand to lose more than 25% in any one year. Can you create a portfolio that meets that standard? Probably not, if you focus on returns, which is what many people do.

This is why here at LNWM we start with a risk target for each client portfolio and then strive to optimize the long-term returns for that specific level of risk. We believe this is the best way to help clients stay the course and achieve their investment goals.

Where Buffett and LNWM Are In Sync

The “buy-and-hold a broad index” approach to investing can be valid, but it’s also quite limited. At LNWM, we use index funds for certain asset classes where we don’t believe active management can add value. But we’ve also seen that active managers with expertise in specific categories can enhance a portfolio’s overall risk-adjusted returns over time.

What we think Buffett is really saying is this: don’t invest outside your level of knowledge and competence. If you can’t reasonably assess future returns from an asset, don’t fall for the hype and buy anyway.

In fact, Buffett‘s advice is very much in keeping with LNWM’s investment philosophy:

• Only invest in what you understand. LNWM’s has an Investment Strategy and Research team whose sole focus is investment research and portfolio construction, and we hire managers with deep knowledge of the asset classes they specialize in.

• Don’t let market pundits or televised talking heads sway your allocations. At LNWM, we seldom veer from our strategic asset allocations, designed to help clients meet their investment goals over a full market cycle (roughly 10 years) or longer.

• Ignore day-to-day fluctuations in stock prices. LNWM has a decidedly long-term focus that allows us to help clients ride through events such as the May 2011 flash crash and the 2008 market plunge. We help clients fight the urge to sell stocks during a period of downward volatility.

• Avoid unnecessary trades. LNWM makes every reasonable attempt to limit transactions in order to keep costs low for our clients.

• Remain diversified. Risk management through diversification is the cornerstone of LNWM’s investment process – we start with, and design portfolios around, risk targets rather than chase returns.

LNWM’s approach to helping clients reach their financial goals is actually pretty similar to what Warren Buffett advises. Our approach goes further, however, by providing:

• Strategies to minimize tax liability.
• Access to top-tier active management, including alternative investment funds.
• Reduced asset-management fees through LNWM’s size and ability to negotiate with managers.
• Recordkeeping that allows for accurate and timely portfolio reviews.
• Advice on multi-generation wealth management, including the creation of trusts and estate plans.