For many people – especially young adults – budgeting monthly expenses is a crucial step toward reaching their financial goals. Without a thoughtful process and sense of purpose, spending can get off track and priorities may not get funded. Put differently, a budget is just a set of goals supported by process to achieve them. In this way, managing an investment portfolio might be thought of as budgeting.

As with a spending budget, the first step is to carefully define your goals. While each investor has a unique mix of needs, their basic requirements can be broken down into three main categories: liquidity, income, and growth. In our process at Peloton, we break growth into four further categories: capital appreciation, equity income, relative value, and speculative.

  1. Liquidity. The values of liquid investments fluctuate very little, or not at all. Bank accounts and money market funds are two common examples of liquid investments. Because the return on liquid investments is very low, they are most useful to meet future planned (or emergency) expenses.
  2. Income. After you determine your liquidity needs, the next step is to decide whether you need income from your portfolio. We’ve written recently about our approach to bond investing, so we’ll just summarize: if you don’t expect to spend money in your investment portfolio for the next 10 years, you may not need to own any bonds.
  3. Growth. Common stocks, as well as similar instruments like REITs, offer investors the potential to increase in value over time. The natural deteriorating effect of inflation makes some exposure to growth investments appropriate for nearly every investor: preserving purchasing power over time is critical. At Peloton, we manage our exposure to Growth by using four sub-categories.
  • Capital Appreciation. Stocks in the category are considered core holdings – investments we expect to stick with from several quarters to many years. For a stock to be considered in this category, it must meet 3 of 4 criteria: it has a sustainable competitive advantage, its business benefits from a strong secular trend, it has strong management or shareholders, and the threat from regulation is minimal.
  • Equity Income. Equity Income investments are also considered core holdings in Peloton’s system. But in addition to providing the potential for capital appreciation, they also generate meaningful return for investors through dividends. Peloton’s Equity Income criteria include: positive sales growth, an above average dividend yield, and operating cash flow that supports future dividend growth.
  • Relative Value. Sometimes investment opportunities arise because a company’s stock is cheap and management has solid plan to correct that problem. The first criteria for a Relative Value investment is that the stock is trading at a significant discount to our estimate of company’s intrinsic value. We then must identify two or more actions management is taking to drive value higher – we call these potential “catalysts.”
  • Speculative. This last category is by far the smallest in Peloton’s system and at that, we only “speculate” on the future performance of a business, never on stock price alone. Companies in this category are often young, and may still be spending on growth to an extent that profits haven’t yet materialized. Stocks in the Speculative category aren’t for every investor. But for some, well researched, young companies provide attractive long term growth prospects.

Each investor has some mix of liquidity, income, and growth needs. Investing done well is tailored to each individual’s or family’s needs. At Peloton, we believe further defining, or “budgeting,” our growth investing into the sub-categories above helps us manage our clients’ portfolios toward satisfying their own unique goals.