Recently I asked a portfolio manager that managed a large institutional portfolio what the expected return was for a specific risk adjusted portfolio. The answer I received was typical of a conventional Wall Street bully. He stated we expect this portfolio to earn 4% above the Treasury bill rate (risk free rate). This is a pure guess and does not reflect academic research on the asset classes held within the portfolio. Their ‘guess’ was what they predicted the market would do over the short term. This was their ‘bet’ on a forecast with what seems like convincing ‘evidence’.
This is typical of a Wall Street bully trying to convince investors that their special knowledge will lead to superior returns.
If you do not have an expected return and expected volatility (risk) for any portfolio you are about to invest in you are gambling and speculating with your money. NOT Investing.
Prudent portfolios should be designed with the use of research, data and statistics. The academic principles available to all investors, uses data that is statistically significant. This means that the data goes back far enough to make the analysis relevant and should help investors over the LONG term. This research tells us to ignore any short term ‘noise’ or downturns like we are experiencing right now. The academic research tells us that over the long term equities are the greatest wealth creation tool on the planet.
Our research also tells us that to control risk we must add high quality short term fixed income. As we age our tolerance for risk will/may often decrease. Therefore as we age we will/may add more fixed income described above. This means a 35 year old might have a portfolio with 75 to 85% equities with the balance in fixed income. While a retiree might opt for a more conservative 50% equity portfolio. As you might guess the portfolios with higher levels of equities will earn more but will experience more losses during down markets.
This means that long term does not mean the same thing to a 35 year old as it does for a retiree.
The higher the level of equities in a portfolio the greater amount of time it will take to recover from a substantial downturn. This is where the process of rebalancing will benefit investors. At specific intervals we will rebalance back to your original portfolio mix. If equities are down we will sell fixed income and buy equities. If equities are up we will sell equities and buy fixed income. This allows us to automatically buy low and sell high. Over the long term this proves to be very effective in smoothing out our returns. Of course, past performance is no guarantee of future results. I believe if investors stick with these academic principles their results will grow their wealth over the long term.
In addition, it takes the ‘guess work’ out of investing thereby improving results and at the same time reducing anxiety (fear).
For most if not all investors following these principles will require the help of an investor coach/fiduciary adviser. Remember as I stated in past messages investors are people and people will often allow their emotions to make their decisions. This is one of the main reasons do it yourself investors end up with very disappointing results.
So…fire your broker/agent and hire an investor coach/fiduciary adviser.