There are four factors that drive your long-term investment results:
1. Your asset allocation
2a. The price you pay
2b. Your costs
2c. Your patience and persistence
I list these as 1, 2a, 2b, and 2c because asset allocation is the most important of these factors. In fact, academic research suggests that up to 90% of portfolio returns are determined by asset allocation over time.1
In other words, what matters most to your long-term investment performance is not about finding the next moonshot. Instead, what matters most is really about getting the right mix of stocks, bonds, real estate, commodities, private equity, cash, and so on.
However, in a time of overwhelming choices, many investment companies have taken asset allocation to the extreme, often employing 10 or more different asset classes in a single portfolio. Their idea is elegantly simple: Risk can be reduced, without sacrificing return, by adding more and more asset classes.
Unfortunately, while the asset allocation pie chart is seductively colorful, the returns can be less than attractive.
As an advisor who works with millionaire families, I do not believe this is the best way to build long-term wealth.
I see three main problems with this approach to investment approach:
It creates unnecessary complexity
It layers fees on top of fees
It encourages poorly timed changes
When people think of asset allocation, they often ask what should they invest in. Examples of these questions include: “What do you think of gold?” or “Do you like emerging markets?” or “Where do you think bonds are headed?”
And while these questions are a part of constructing an asset allocation, there is one question that is equally important but never asked: “What should I not invest in?”
Preserving and growing wealth doesn’t have to be complex. In fact, it can be quite simple, and fortunately, we have some long-standing investment principles we can lean on. Here are some of the guiding philosophies that we use when working with our high-net-worth clients:
Allocate as much as possible/appropriate to equities of industry-leading, high-quality companies with durable competitive advantages, strong cash flows, and experienced management teams.
Maintain a price discipline that allows you to buy assets at relatively attractive prices. All asset classes go through cycles. Figure out how to use them to your advantage. If you can’t do it, hire a professional.
Be conscious of your costs – transaction costs, taxes, management fees, etc. If you are paying a 1% advisor fee plus a 0.25% manager fee to own a portfolio of municipal bonds that yield 3% it will be tough to keep up with your 5% spending rate.
The best portfolio is the one you can stick with through thick and thin. Returns are not free, and the price of admission is volatility. Your risk tolerance is unique to you, so be careful taking investment cues from those playing a different game than you.
1 Ibbotson, R., Kaplan, P. (2000). Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?
Hey, I’m Rob Edwards. Thanks for reading this month’s column.
As a nationally recognized advisor, I have one goal: To help clients make more thoughtful and intentional money decisions so that they can enjoy the best version of their life.
In working with high-net-worth families, I know that with more money and prosperity comes complexity and the potential for making mistakes.
So, whether you’re asking questions about saving for retirement, transitioning your business, or how your money can make the greatest impact, my team and I are here to help.
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