There is no perfect portfolio
While the financial industry often tries to sell a “holy grail” on asset allocation, I’m pretty convinced now in my own DIY investing journey there is no single, universally-accepted perfect portfolio.
Today’s post unpacks that notion a bit thanks in part to this recent post by Ben Carlson: Creating the perfect portfolio.
There is no perfect portfolio
Bigger brains than I have, have been discussing (optimal) asset allocation for decades and those discusions won’t end soon…
You may recall an important premise of diversification in the first place with some context:
Diversification is the approach of spreading your investments around so that your exposure to any one type of asset (or stock) is limited. Diversifying your portfolio is one of the best ways to manage risk. Instead of hand-picking your own potential winners and by doing so you’re trying to avoid picking your own potential losers, diversification calls for holding a variety of different assets to help increase your chances of long-term investment success.
If you keep all your money in one asset class, whether that is stocks, some bonds, or even some real estate, you expose yourself to risk – a diversified portfolio, on the other hand, spreads your investment risk across various asset classes to reduce risk. The thinking is, if one asset class drops in value, the other asset class(es) may buffer your portfolio or could even rise in value, offsetting overall losses.
Diversification is one of the most fundamental strategies for building an investment portfolio these days focused on long-term growth, but it’s not perfect.
Some financial experts have regarded 60/40 (a mix of 60% equities and 40% fixed income) as a perfect portfolio or at least an “overall asset mix as a starting point” – but I’ve never been convinced of this myself.
I was always very skeptical of 60/40 in my asset accumulation years for these reasons:
- My investing timeline, was measured in decades, not years. While many experts have suggested that it’s important to have at least 60% invested in stocks, I always felt that percentage should have been much higher – because saving and investing for retirement and being in retirement itself can last for several decades, and investors will need to increasingly rely on stocks to limit the risk of outliving savings and fight inflation.
- Also, from what I have seen from various studies that folks still rely on (myself included at times) like the 4% rule, those studies involved lots of bonds. For the 4% rule, a 50/50 asset mix was used. I personally haven’t been convinced bond-returns will be as generous in the coming decades as they have been. Any DIY investor with such a large allocation to low-yielding bonds moving forward, expecting fixed-income returns in the future like the past, is likely to be disappointed including fighting inflation. In fact, I’ve read in some articles that “it will be mathematically impossible to replicate the strong returns that bonds have delivered over the last 30 years.” Ouch.
- Finally, another more recent critique of the traditional 60/40 pension-like portfolio is it fails to consider alternative asset classes: what about some real estate or precious metals or other? Of course using alternatives has some risk, yes, but risks are where the rewards are. You don’t invest in bonds or fixed income for wealth creation – at least I didn’t years ago at the start of my investing journey. Bonds are more like parachutes for your portfolio when equities flat-out fail from time to time.
BlackRock has been on record to say 60/40 can still work but alternatives must be considered – this is just one example of the bigger brains I referenced above.
There is no perfect portfolio
Image source: Pexels.
In theory, I’m aligned to Ben’s thinking, everything on paper makes sense:
- The younger investor should be closer to 100% stocks for growth, and
- The older investor or newly minted retiree like me should be closer to a 60/40 asset mix for more safety.
But we don’t live life in academic papers and those papers only tell us our history – not what will or will not happen in the investing future.
At the end of the day, at least for this year as we start retirement, we’re OK with the risk trade-off:
- With 90% equities in our portfolio, that portfolio spins off annual dividend and distribution income we can live from, and
- With 10% cash/cash equivalents, that money is there for all near-term spending needs, wants, with some buffer built-in not if, but when existing frothy stock market does in fact go down 10%, down 20%, or even more. When they go down and by how much and for long I simply do not know…
To borrow a thesis from Vanguard:
“Building an investment portfolio starts with choosing the right mix of assets based on your goals, timeline, and risk tolerance. That’s where asset allocation models come in. These diversified strategies balance growth and stability to help you reach your financial goals.”
This means you can have 100% stocks in your asset accumlation years and maintain close to 100% stocks in your retirement years too – as you wish.
Just remember this 1-2-3 asset mix formula below. I suggest you revisit this formula as part of best practice financial planning every year when it comes to your goals, risk, timeline and therefore classes:
1. What are your financial goals – What is your money for? What is your “why”?
2. What is your investment risk – What level of risk or near-term losses are you willing to stomach? If stock market volatility keeps you up at night, your investing approach may need to be more conservative. You might want to consider taking on only the amount of investing risk you need to take on to meet or maintain your investing goals, and nothing more.
3. What is your investing timeline – When do you need the money? If you need to spend your money near-term, then a more conservative approach just makes sense – you need the money soon and you don’t want it gone. If you don’t need the money for years, then you can generally be more aggressive: money has the potential to grow when invested by taking on more risk.
I revisit this every year myself, so much so that I used to be closer to 100% equities a few years ago. I’m 90/10 today.
The sum of 1, 2 and 3 should help you arrive at your desired asset mix – your balance – whatever that balance may be. You can choose your investments to fulfill that balance, and revisit what is / is not in balance at least annually when stocks run or get out of favour.
Finally, I would be remiss as to not touch on this subject given so many DIYers here that follow My Own Advisor own dividend stocks or a basket of hand-picked stocks (payers and non-payers) as part of their own portfolio construction. Some of those DIYers, rightly or wrongly, have built their own portfolios with exclusively Canadian stocks. That’s right: no bonds, no fixed income, no U.S.-assets, no foreign stocks, etc. Nada.
There’s a more subjective risk tolerance to consider – your emotional risk tolerance. Consider how you react to money in general. In some exceptional cases, some DIYers that read and contribute here are hyper-focused on just Canadian stocks based on their established histories of delivering both dependable income in the form of dividend payments AND delivering long-term price appreciation AND being tax-efficient.
That’s win-win-win.
I own 20+ Canadian stocks at the time of this post for partly those reasons too – I/we have done so for almost two decades (!) but I’m less comfortable as I age with going all-in on just Canada as part of global returns. My investing experience has taught me ex-Canada growth around the world happens too.
I mention this because it’s important to acknowledge your own behaviour and tendencies and biases with investing. We all have biases. Experts have biases. Part of this bias means your tolerance for risk – the emotional risk – should match the investments you choose; otherwise, it will be very hard to stay committed to your investment plan and reach your goals. That’s the end game anyhow.
I’ll leave with you with these references and quotes from an investor, author, speaker I really like, Morgan Housel on his own personal finance confessions:
- “We own our house without a mortgage, which is the worst financial decision we’ve ever made but the best money decision we’ve ever made.” “On paper (paying off a mortgage with rates so low), it’s defenseless. But it works for us.”
- “Over the years I came around to the view that we’ll have a high chance of meeting all of our family’s financial goals if we consistently invest money into a low-cost index fund for decades on end, leaving the money alone to compound.”
- “We also keep a higher percentage of our assets in cash than most financial advisors would recommend – something around 20% of our assets outside the value of our house. This is also close to indefensible on paper, and I’m not recommending it to others. It’s just what works for us.”
Happy investing!
Mark
Further Reading and Other Considerations on Asset Mixes:
From Morningstar on cash:
“And it’s always important to keep some cash on hand to cover unexpected emergencies, such as job loss, car repair, appliance replacement, and so on. Most financial advisors recommend keeping at least six to 12 months’ worth of living expenses in cash as an emergency fund—even if you don’t end up spending it right away.”
And from Morgan Housel on cash and his bias:
“We do it because cash is the oxygen of independence, and – more importantly – we never want to be forced to sell the stocks we own.”
“Diversifying” is a very loose word with next to no actual accepted definition – which requires context in all cases. If you are going to do something in order to “diversify,” you have to start by saying what you mean by “diversification” and exactly what benefits you expect to get from it.
AND
AND, interestingly enough, close to 100% equities remains a modest consideration to enter retirement with but there is one asset mix with even slightly better odds than 100% equities and the traditional 60/40 mix…
Mark
Mark
My name is Mark Seed – the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I’ve reached financial independence and I’ve retired from the workforce in my early 50s. Now, I share my lessons learned for free on this site. Join the newsletter read by thousands every week.
