Periodically I am invited to review a portfolio of investments and I challenge myself to discover that person’s investment philosophy purely from looking at their portfolio. Then I compare my answer to theirs. Eventually I abandoned the challenge because my answer was always different to what the investor said they were doing.
Recently a new client forwarded their portfolio for my appraisal, and for old time’s sake I thought I would rekindle the challenge and attempt to discover their investment rationale. Again, I failed. Like many portfolios, there were too many funds to wade through, and I couldn’t fathom what drove the returns. Was it skill, or was it luck?
I often see opportunism or FOMO (Fear of Missing Out) represented in portfolios. Fund choices driven by sectors that were once hot. For every successful fund there are others that have lost money or underperformed. The more decisions made about which investments to buy or sell, the greater the probability of getting it wrong.
Still too many investors believe their goal is to ‘beat the market’. This is unrealistic when you consider that most professional fund managers consistently underperform the market over the long term.
A realistic objective would be to achieve inflation beating returns over the long term. This can be achieved through investing in a simple low-cost global tracker fund. You don’t need the additional risk of making geographic or specific sector calls. To be a successful investor you only need remember 3 golden rules.
These are (1) invest in equities for the long term (2) be suitably diversified and (3) make sure you choose when to sell.
There’s a lot of academic research showing how higher equity in portfolios delivers higher and more sustainable returns over the long term. This is increasingly important to understand as more people rely on their own savings and investments when they reach retirement.
Diversification means different things to different people. At a high level it means holding a range of asset classes like equities, property, and cash. Then there’s diversification within asset classes. Some fund managers try to balance performance and diversification by only holding 25 – 30 different shares in their funds, whereas a global equity index fund might hold more than 11,000 different shares. Who’s right?
Warren Buffett (the world’s fifth wealthiest person) famously bet the S&P500 index over a 10-year period against any Hedge Fund Manager who accept the challenge. Hedge Fund managers are supposedly the brightest of the bright but only one was brave enough to take on the challenge. It lost.
Making sure you choose when to sell means holding sufficient cash (or near cash) so that when markets crash, you don’t have to sell investments at a loss. When younger and still working the amount of cash you need to hold is relatively small, but when you reach retirement, you might need closer to 5 years expenditure in cash.
I’ve mentioned that few managers beat “the index” and that most underperform. Statistically investing in the “index” serves most people better. Not just them, but their beneficiaries too. I have advised too many widows who have inherited portfolios with no idea what they’re invested in or why.
I challenge people to explain their investing philosophy to their beneficiaries left behind to manage things if they died. Very few can, and fewer still are confident the portfolio would fare well after they’ve gone. Little wonder then that Warren Buffett has instructed those in charge of his estate to invest 90 percent of his money into the S&P 500 for his wife after he dies.
One thing I’ve learned about advising the bereaved is that these conversations must not wait until after someone’s death. Having conversations that lead to a shared philosophy enables couples and families to live life more confidently, knowing there’s a sustainable plan even when things go wrong.
If you make simplicity your goal, how simple could you make it? This quote from Einstein drives the philosophy of my own portfolio “everything should be made as simple as possible, but no simpler”.
Article written by Dennis Hall for Exeter Living Magazine.