Creating portfolios is now more and less complicated. Here’s the bottom-line.
I would like to let you in on a little research I have been doing. It has to do with identifying what matters in creating investment portfolios today. The other side of that is, of course, determining what does not matter, given the dramatic changes in how markets work
versus a decade ago.It is also vital to identify and avoid retirement-killing features of your portfolio. Given the stage of the stock and bond cycles we find ourselves in, they are everywhere. That’s why separating what is valuable from what is not is so critical now. First, a quick background.
So easy, a caveman can do it?
One of the biggest changes in the way we invest today is how simplified it all is. Robo-Advisors like Robinhood, Betterment and their peers make it very easy to get started. They also boil investment success down to a tidy process you can do yourself. Pop your money in an S&P 500 Index Fund, go Rip Van Winkle for 20 years, and wake up to riches beyond your dreams.For some people, the possibility of that is all they need. That, and the decision by Schwab and other big brokers to eliminate commissions on equity and ETF trades has essentially taken the obvious costs out of investing.
The costs you don’t see
Now, as I have written in this space before, there are other costs of investing, which get papered over by all of the hype that surrounds the modern investment era. Taxes are one. Lousy investment performance versus what you need to reach your goals
is a bigger one.As you get closer to actually using your wealth, say, in retirement, the stakes are so much higher. That calls for a bit of a “reset” in thinking. Even if it does not lead to any changes in how you are investing for retirement or in retirement, it is worthwhile. Regular oil changes help keep your car out of trouble. Similarly, regular confirmation of your investment portfolio’s game plan keeps you out of trouble, financially-speaking.
From the investment lab
Now, for some insights on that research. My team and I created a set of 11 “simple” benchmarks. These are not for investment purposes. Rather, they are a baseline for comparing other portfolios to. As an active manager, I don’t plan to invest in them directly. However, they are proving to be an excellent “road test” for some of the ongoing portfolio construction work we do at our place. So, I figured I would give you a progress report on what we are finding, and why I think it is important.The crux of if it is this: any portfolio or fund can be compared to an array of basic allocations of stocks and short-term bonds. The mission is not to make it a past performance contest.Rather, it is to map whatever strategy you are using to that array of basic benchmarks. That allows to see the tradeoff between reward and risk in your portfolio pretty clearly. Armed with that basic, visual knowledge, you can evaluate what parts of your approach are worth the effort, and which can be automated.
Here is that set of simple indexes we created. They are “simply” combinations of 2 popular ETFs. One is the first-ever ETF, symbol SPY. The other is symbol SHY, which invests in short-term U.S. Treasury securities. Specifically, those with 1-3 years to maturity.I did not use a more standard bond index because I am convinced that the future returns of those indexes (such as symbol AGG) will have no resemblance to those of the past 15-20 years. The mathematical probability starting from today’s low rates makes that a long shot. So instead, I imagine a world in which one would pair a stock portfolio with a security that doesn’t try to make profit on bonds. The goal of SHY is simply to add a little return over a money market account or CDs.In addition, the SPY is one example of the simplified stock portfolio. However, once the S&P 500 mania I have lamented in my articles finally comes down like a hammer, the World Index (symbol ACWI) will probably be a better substitute. We are looking at both in our “laboratory.”The simple “portfolios” are 11 different combinations of SPY and SHY. One is 100% SPY, and another is 100% SHY. The other 9 are combinations of the 2, from 10% in one and 90% in the other to the opposite of that. Here is what the long-term growth (since late 2002) looks like.
The day the music died, but the party continued
Here is that same set of 11, but from January 26, 2018 to now. I refer to this as the day the music died (a Buddy Holly tribute), but the party continued. This was the potential end of “easy” equity returns. We have had 2 severe pullbacks since. And, I think that while return is still possible in this stock market bull cycle, since early 2018, it has come with more risk attached. Should U.S. investors look abroad?
We did a double-take when we saw this one. For the past decade, the World Stock Index, which is about 60% weighted to the U.S. these days, has been in lock-step with a 70%/30% SPY/SHY combination. In other words, you could have invested 70% of your money in the S&P 500, sheltered the rest in short-term bonds, and been no better or worse off than if you had put all of your money in a World Stock Index fund!
Carefully manage risk in your retirement portfolio…or flip a coin: your choice
Again, this is the past. But its a decade of data. Markets change, and so do reward/risk tradeoffs. And for investors, I think that means you should actively account for the risk you are taking to pursue your goals.Otherwise, you might as well use a dartboard or a coin-flip to make your decisions. Or, trust your wealth to a fully-automated system that does not consider you at all. I will share more insights as we develop them. In the meantime, feel free to contact me if you want more information on concepts and data described here.Related: New Bull Market, Or Is The ‘Snow’ About To Hit The Fan?