By Ember E. Martin, CFP®
It seems that every investor is looking for the perfect portfolio and every financial advisor claims to have it. But is there a perfect portfolio? Sadly there is not. Just as there is no perfect house or perfect car, there is no one perfect portfolio for everyone. Each person’s situation is unique, so one person’s “perfect portfolio” may not be perfect for someone else.
Just as your “perfect house” is defined based on your preferred location, lifestyle, and family size, the portfolio that is best for you is defined by your unique goals, risk attitudes and capacity, and time horizon. That doesn’t mean, though, that there aren’t portfolios touted as being optimal for everyone.
The All-Weather Portfolio
Some advisors create what is often called an “all-weather portfolio” for their clients. It is a portfolio whose allocation has weathered the historical ups and downs best when back-tested over the past 30-40 years. Such an allocation is necessarily over-weighted to bonds and other less risky assets to better weather bad periods For those that can’t stomach short-term market movements, it looks something like this:
This exact portfolio was highlighted by hedge fund legend Ray Dalio in one of his books. Dalio is considered the world’s leading hedge fund manager and is not the only one who has conceived of an all-weather portfolio.
The 3-Part Portfolio
Alternatively, while the all-weather portfolio is popular, a simple 3-part portfolio of 40% U.S. stocks, 20% international stocks, and 40% diversified bonds has performed better over the same periods—albeit with greater ups and downs. Which is superior? It depends on the investor’s goals and time horizon. The greater return it takes to achieve an investor’s goals, the greater the risk that must be taken.
The all-weather portfolio may be better for someone seeking stability, while the 3-part portfolio may be better for someone seeking growth. Held sufficiently long enough, the expected returns of any given diversified portfolio will likely result within a percentage point or two (in long-term annualized returns) of the expected return for the portfolio. Most honest investment professionals would say that’s the best you can hope for. And in fact, most investors goals can be achieved with such returns.
The Efficient Frontier Of Portfolio Construction
In light of this, I would say that the perfect portfolio is really the ideal portfolio allocation for a given set of investor expectations. To understand this better, it helps to look at the efficient frontier of portfolio construction. This is simply a set of portfolios with any given level of risk that optimally returns the most efficient expected return over the long term. This is what it looks like:
The all-weather portfolio was designed to weather inflation as well as deflation in both bull and bear markets, and it does that well. Due to its lower overall risk profile, it would fall farther to the left on the efficient frontier. The all-weather portfolio may be perfect for some investors, but others would be unhappy with the more volatile returns of such a portfolio construct. Here is a comparison of annualized returns by decade of the all-weather portfolio, a traditional 60% stock and 40% bond portfolio, and the S&P 500 index.
How I Can Help
As you can see, there is no perfect portfolio. Your portfolio should be designed to meet your own unique needs and not compete with some arbitrary benchmark. Your goals and their required returns are paramount. It is important to beware of panacea or ‘silver bullet’ concepts and instead seek to construct a portfolio that will allow you to reasonably achieve the returns needed to reach your personal goals.
When looking to balance risk and reward to create a portfolio that will reach the desired long-term returns that you want or need over your specific time horizon, it helps to work with a professional. Someone experienced in investing and portfolio construction can balance out your competing priorities and help create a portfolio that is uniquely suited to you. If you don’t already have a professional like that in your life, we at Vested Wealth Advisors can help. Just Schedule a free 15-minute introductory phone call online or reach out to me at 844-548-2887 or info@vestedwealthadvisors.com.
About Ember
Ember E. Martin is founder and managing principal at Vested Wealth Advisors, an independent financial planning firm. With over 20 years of investment managing and financial planning experience, plus his CERTIFIED FINANCIAL PLANNER™ (CFP®) credential, Ember strives to help his clients live a high-quality life through customized advice and an unmatched level of personal service and confidentiality. Ember has become known for providing personalized guidance, creative solutions, and results-driven services that go beyond what many have come to expect from traditional financial advisors. When he’s not working, Ember enjoys sharing life with his high school sweetheart, Donna. You can also find him cooking, reading, traveling, hiking, playing chess, and spending time with his two teenage daughters, Lucie and Truly. To learn more about Ember, connect with him on LinkedIn.