But this apparently normal behavior somehow escapes the process of purchasing financial assets. And hence, an entire field of finance devoted to trying to understand why investors act the way they do while exhibiting perfectly rational behavior in other walks of life.

But I think investors behave the way they do because most fail to make a connection between buying say a box of Tide detergent versus buying shares in Procter & Gamble that makes that detergent.

And if we dig deep enough with anything we do or consume in our daily lives, there is always somewhere a connection between a product or a service and a business that delivers that product or a service. And that business, if publicly-traded, we can also own a piece of.

My younger daughter is all things LEGOs these days. I mean she spends hours building things like these…

And her gang is into it as well so we know she is not alone.

So then the discussion as usual leads to buying a piece of the LEGO making business. But she can’t because LEGO does not trade publicly.

But then that plastic that makes those LEGOs could be coming from a publicly-traded business. Or that oil that was dug up to make that plastic had to have a publicly-traded entity behind it. And so would the businesses that make those machines to injection mold these pieces or that steel that was used to make those machines or those semiconductor chips that control those machines and on and on.

So if she owned a diversified basket of global stocks, somewhere, somehow, she owns a piece of the supply chain that went into making those LEGO pieces. So she is all squared then.

Talk about supply chain, if you never came across this Milton Friedman video, well, you did now.

So the other day, I dug up some old notes and this one dates back to June 2nd of 2012. And that scribbling was all about yields – bond yields vs. earnings yield for a portfolio of global stocks. Earnings yield by the way is the inverse of price to earnings ratio.

So the 10-year Treasury bond yielded 1.5 percent at the time when global stocks were yielding 8.5 percent (price to earnings ratio of about 12). Global stocks here refers to the FTSE Global All Cap Index.

Stocks were a bargain then. How sweet of a bargain? The last time the spread was as wide was all the way back in 1962.

And yet investors were dumping stocks left and right, for some reason or the other and at the time, that reason appeared to be the Eurozone debt crisis. In just the April of that year (2012), U.S. investors sold a net total of 20 billion dollars worth of stocks. In May, they withdrew 26 billion dollars from the stock market.

All in all since 2007, investors withdrew some 530 billion dollars out of stocks and stock-type investments.

And where did most of that money go? Into the apparent safety of bank savings account and into bonds.

But that at the time could be considered as a reasonable behavior. Not right, not logical but reasonable. Investors were terrified of the slightest of turbulence. The trauma of the Great Recession was fresh in everyone’s mind.

And hence the equity risk premium. Stocks are risky because profits are not guaranteed. But if there was no risk, the earnings yield for stocks would collapse to meet that of bonds.

But earnings or profits for businesses can and do fall. And that causes the value of these businesses and hence the stock prices to fall. So the risk.

But in hindsight, that was THE time to plow everything you had into the markets.

And what was predicted at the time to be a great time to invest was indeed a great time to invest. I mean if you were anywhere close to the stock markets this past decade, you made money.

So where are we now? The bond yields are about the same but the earnings yield for stocks have basically cratered. That is, the equity risk premium got reduced.

And most of that reduction in the equity risk premium happened because of the expansion in multiples. I mean you were paying 12 times earnings for a portfolio of global stocks in 2012. Now you are paying 17 times that.

But then it sort of makes sense. Besides that small hiccup at the onset of COVID, we have basically forgotten what risk is. The Great Recession is a distant memory. The Dot-com crash of the early 2000s is like it never happened.

And hence the complacency.

What do I personally wish? I wish for a renormalization of interest rates. That’s assuming we know what “normal” is in the interest rate world. Maybe we are in a new era and maybe we never go back to the way things were but I think we must considering all the craziness that is out there in the markets these days.

I want things to reset a bit. I want the bond yields to grow and the equity risk premium to expand back up. So technically a double hit on the price of stocks.

Painful yes, in the short run but ideal for most of us in the long run. We rather take the medicine now than having to surgically remove a tumor later. Bubbles are painful when they deflate.

So if you are a millennial or a Gen Xer, you should get down on your knees and pray for a decade of flat returns. That’ll allow you to pump as much powder as possible into the markets while the bond yields normalize and the equity risk premium reflates.

None of it says that you sell your stocks. Because no one knows the future and you don’t want to get into the game of predicting the future. But if you’ve got a reasonable plan and a decent portfolio that fits that plan, you can tweak and make adjustments to that portfolio where and when necessary but you must stick to that plan.

That of course requires conviction and conviction only comes with knowing what you own is what you should own but once that’s done, all you can and all you should do is throw as much savings as possible into that plan and wait.

Thank you for reading.

Cover image credit – Tran Long, Pexels

Or does it?

First, because it is market-cap weighted, the biggest companies occupy too much of your portfolio if this is all you own. Nothing wrong with that but just to give you some perspective, these were the companies that occupied its top 5 slots in the year 2000: General Electric, Exxon Mobil, Pfizer, Citigroup and Cisco Systems.

Things change so diversify.

Second, S&P 500 is a large cap index. It owns the biggest 500 public-traded U.S. businesses. So when you own just this, you own only one flavor of the market.

Third, tech businesses have come to occupy too big of a share of the index lately. And many of the tech businesses trade at valuations far richer than the overall market, some justifiably so, many not so.

And the reason the market affords a much higher multiple to these growth-oriented names is because of the historically low interest rate environment we find ourselves in. And low interest rates means equally low discount rates.

But then they are also more sensitive to changes in interest rates so if and when rates rise, the value of these growth-aligned businesses will decline, oftentimes precipitously.

And if what you own in your portfolio is skewed towards these names, your portfolio will suffer. It will eventually recover but that recovery could take much longer than your patience can handle. The decade of the 2000 is a perfect example. If a portfolio of S&P 500 is all you owned, you had less money at the end of that decade than at the start. We often forget but then we have the data.

But enough with the ramble and on to some number crunching. We’ll run through some test portfolios that are exclusively invested in one type of stocks and compare that to the one that’s globally-diversified across size and value spectrum yet still 100 percent invested in stocks.

The first is an S&P 500 only portfolio. Of course, this is past performance and future performance can and will differ but one thing I can almost reliably say is that if you expect an S&P 500 only portfolio to do over the next decade what it did over the last, it’s not going to happen. It could if business profits suddenly explode to the upside due to some breakaway technological advancements but these things don’t happen that often and hence.

So this below is the best and worst-case rolling returns of an S&P 500 only portfolio over these past many decades.

And just to give you some perspective on all the things that transpired during this timeframe:

• The 1987 stock market crash.
• The Savings & Loans crisis of the late 1990s.
• Gulf War I.
• Real estate recession of the early to mid-1990s.
• The Asian financial crisis 1997-1998.
• Dot-com boom and then a bust 1995-2003.
• 9/11.
• Gulf War II.
• The housing market crash and the ensuing global financial crisis of 2008.
• The European debt crisis 2012.
• And of course the pandemic.

And embedded in between these major events are the many micro booms and bursts that happen from time to time. They will always happen because it’s systemic. It’s the nature of the markets.

This below by the way is the exact annualized performance of an S&P 500 only portfolio over these last two decades…

What stands out is how most of the gains are back-loaded. That’s because S&P 500 sucked wind the entire decade of the 2000s. All the gains are packed in the decade that just ended.

So the best time to have loaded up on large-cap U.S. stocks was in 2010, exactly the time of maximum despair for a large-cap only portfolio.

But then there are businesses that are not in the S&P 500 that are smaller in size that can be found in say the Russell 2000 index. Smaller businesses are usually risker, both in terms of price volatility and in terms of their ability to survive.

The best and worst-case rolling returns for a small-size companies only portfolio over these last many decades…

And the actual annualized return for these businesses going back 20 years…

The shocker is not that small companies earned more over time. That’s expected. Not guaranteed but expected.

The real shocker is that they made you more money with less risk than their large cap brethren (compare the 10 and 20-year rolling portfolio returns for the S&P 500 only portfolio vs. the Russell 2000).

Now spreading our wings a bit more and looking beyond our borders with international stocks with a great barometer for that being the EFA index, EFA as in the Europe, Far-East and Australasia.

The same rolling returns for an EFA-only portfolio of stocks…

And the exact annualized returns for that EFA-only portfolio over the past two decades…

So not that hot compared to say the S&P 500 or the Russell 2000 but that’s expected. International stocks have treaded water for quite some time but that’s the nature of the game. They will shine again at some point, no one knows when yet no big deal.

But now we’ll mix and match all these and bring in emerging markets, value stocks, mid-size companies etc. that exposes a portfolio to all available factors and possible outcomes. The exact portfolio is not as relevant because there are tilts and tweaks you can apply based on where you find a better bang for your buck at any given moment but assuming a portfolio that’s designed keeping first principles in mind, you won’t go wrong. And of course assuming a portfolio that you will stick with, come hell or high water.

The rolling returns first…

And the exact annualized return for that global all-stock portfolio over the last two decades…

A few condensed takeaways…

• First things first, this is diversification within a category of investments (stocks) so it’s not what a true diversified portfolio can and maybe should look like.
• Small-caps (Russell 2000) did better than their large-cap brethren (S&P 500) not only from the performance perspective but also from the perspective of delivering better risk-adjusted returns. That’s with comparing the 10 and 20-year rolling returns as well as the exact annualized performance over the last 20 years. Not what you would have expected considering the hype around S&P 500 this past many years but that’s expected considering how recency bias plays tricks on us. But then we got the data.
• International stocks sucked in this timeframe and that is and should be expected from any asset category from time to time. They say that you only know when you are truly diversified is when you always own one or two segments in a portfolio that are treading water at a given time. If everything does good or bad at the same time, you have a problem. That is to say that your portfolio should own a lot of uncorrelated investments though these days with correlation of literally everything with respect to everything else approaching one (perfectly correlated), it’s not that easy but that’s our world today.
• And when you sprinkle the ‘right’ type of investments in the ‘right’ proportion, though individually they might suck, the blended portfolio almost always overcomes that individual performance disadvantage over the very long-term. For the statistically inclined, that’s because when the variance of one investment is added to the variance of the other, the resulting combined variance of a portfolio is always lower. And hence that shows up in better portfolio outcomes, not only with what you make in returns over time but making those returns with a reduced portfolio volatility. So a win-win all around.

That’s all I have to say.

Thank you for reading.

Cover image credit – Chris F., Pexels

So first a snapshot of the many goals you might have to plan for…

And with life after work (retirement) being the most expensive amongst them, we will use that as a use case to lay out the construct since the same process can be replicated for other life goals.

But before anything, a thing or two about perpetuities. Back in the day in 1751, the British government issued something called Consolidated Annuities or Consols that paid a fixed 3% rate of return each year (cash flows) and had no maturity date (cash flows go on forever).

The modern day equivalent of a Consol is a perpetuity as in the cash flows continuing forever.

And quite elegantly…

The present value (the price today if you were to buy it) of a perpetuity = C/r

C is the cash flow you receive each year if you were to buy this perpetuity and r is the interest rate or the rate of return.

Most long duration assets are perpetuities. Stocks, especially of the growth kind, in theory are the ultimate perpetuities because the present value of the cash flows that they’ll generate that’ll flow to you in the form of dividends twenty, thirty, fifty years down the road is very close to zero. And hence their valuation today can be condensed to a very simple perpetuity type model shown above.

So that was some necessary sidetrack but not to dwell on it much, the most important takeaway is the estimation of the present value of a perpetuity.

Back to planning for retirement, this is what the accumulation and the distribution phases look like for that goal.

Though two different rates of returns are assumed for the two life phases, there is not and there should be not a clear demarcation between the two. Those rates of returns should change gradually, abruptly or none at all depending upon individual circumstances and market conditions but let’s assume these two distinct phases exist for you for now.

And we’ll start with the ‘in retirement’ phase first to help us quantify the $ value of the goal and then work backwards.

The first thing you’ll need to know are your income needs in retirement. I know it’s not easy to know that yet when you are like 25 but you should have some idea about the amount of money it takes to afford you a good life today. You then inflation adjust that to the year you retire and through retirement.

So during retirement, you’ll know the cash flow you’ll need and you have an estimate of the rate of return that the portfolio you’ll own is expected to deliver (r2 in this case).

Hence,

The $ value of the goal at retirement = The present value of a growing perpetuity that you buy right when you retire – The value of a growing perpetuity that you’ll buy at 100, discounted to the year you retire

Growing perpetuity is another flavor of a perpetuity where you assume growing cash flows (inflation-adjusted income need in retirement) instead of the constant cash flows we assumed in the original perpetuity equation.

So now that we know the $ value of the goal, we tackle the first phase of planning for retirement. And these are your accumulation years where you need to set aside a fixed amount of money each year to reach that goal.

We start with first discounting the $ value of the goal and bringing it to the present (at 25 in the plot above) using the assumed rate of return (portfolio growth rate = r1). Any savings (earmarked for retirement) that you already have now needs to be subtracted from the present value of the goal to calculate the gap you have to fill over the years to reach your goal.

That is…

The Gap = Present value of the goal – Savings you already have, earmarked for retirement

With this gap in savings required known, you can then reverse calculate the amount you need to set aside each year using the same perpetuity logic.

That is…

The Gap = The present value of a perpetuity you buy at 25 – The value of the perpetuity you buy at 65, discounted to the present (at 25)

You know the gap, you know the years to retirement and you know the portfolio growth rate during accumulation years and with that, you can back calculate the amount you need to save each year to fill that gap.

There is a lot that I skipped over to give a brief overview but for those interested in diving into the nitty-gritty of how this is done, a video tutorial is in the wings that I’ll release when ready.

Thank you for reading.

Cover image credit – Pixabay

This and the Capital Asset Pricing Model that Dr. Sharpe subsequently developed led to him winning the Nobel Prize in economics in 1990.

The Sharpe ratio…

In English, it is the excess return of a risky investment over and above the return that a safe investment yields per unit of risk (volatility) of that risky investment. This is another way of stating that what counts is not just returns but risk-adjusted returns.

The risk-free rate of course is not constant. Many use T-bills (Treasury bonds with a maturity of less than a year) as the benchmark for the risk-free rate but that’s not always right. Stocks as we know are long-duration assets (perpetuities in theory) so if you own an all-stock portfolio, you need to match that with a comparable duration asset like say a long-term bond with a 10-year or a 30-year maturity for instance.

And if you add shorter duration bonds to that all-stock portfolio, the duration of the risk-free asset and hence its return to calculate the Sharpe ratio needs to be adjusted accordingly to match duration for duration.

But in today’s never seen before interest rate world, the risk-free rate of return difference between long and short maturity bonds is not going to make or break things. In fact, you are free to ignore duration entirely and use a flat 1 percent rate of return in lieu for the risk-free rate.

So that was a bit of a technicality but what Sharpe ratio tells us is that you better get compensated for the risks you take in your portfolio. And the higher the Sharpe ratio for a portfolio, the better designed a portfolio you have. Within reasons.

Because you can play games using leverage etc. to prop up the Sharpe ratio of a portfolio but we know the thing with leverage. When things blow up, they blow up spectacularly.

But Sharpe ratio or anything to do with long-range portfolio construction and prediction does not work with individual stocks. Or individual bonds. Or a single piece of real-estate. Or your entire angel investment portfolio.

It only works with broad-based asset classes that you can derive meaningful statistics from to build a portfolio around which then forms the core part of your financial plan (more on that later).

So someone just starting out in his career could have owned an all-stock portfolio that is globally allocated, across size and value factors. Of course an all-stock portfolio means being exposed to the full brunt of the volatility of stocks but that’s expected.

And this is what you would have had to endure over the years. We are going to run through three different portfolios with this one being the one with a lower Sharpe ratio than the other two. A lower Sharpe ratio isn’t necessarily bad but if you are comparing two likewise portfolios, you’d want to the pick one with a higher Sharpe ratio as long as you understand what’s in that portfolio.

The exact mix of this all-stock portfolio is irrelevant because you can always implement your own tweaks based on which corner of the market you think offers a better value but this is what you should expect. Or at least this is what you did get going back in time.

Now these are rolling returns which means that say for the 3-year bar in the plot above, you’ll start out in 1987 and end in 1990, then move to 1988 and end in 1991, then to 1989 and end in 1992 and so on. That way, you are not picking and choosing timeframes.

So what stands out is there was a year when this portfolio declined in value by 41 percent but then there was also a year where the portfolio gained an equivalent amount. But there was never a 5-year period where this portfolio lost you money. So that’s the perk of remaining invested for the long-term.

And depending upon how lucky or unlucky you were, the difference in returns between different 20-year periods is huge. I mean there was a 20-year band in the same 1987-2020 time-period where you did almost 12x your money (+1072 percent) in one versus just 4x your money (+323 percent) in the other.

And that worst 20-year band most likely corresponds to the last 20 years that ended in 2020 as can be seen with the exact annualized returns that you were able to achieve with this all-stock portfolio.

But this 20-year band saw a lot. Starting out of the gate was the Dot-com crash followed by the housing market crash of 2008 and then of course the pandemic. Not saying that the next 20 years can’t be worse but just saying.

So if you endured through this, you should be able to endure through anything the market throws at you except for world-ending calamity. But then, your portfolio would be the least of your worries and hence.

Now someone mid-career who had amassed a reasonable amount of money towards retirement could start to temper down on the volatility by allocating say 20 percent towards bonds. Bonds are less volatile and don’t generally yield more than stocks but the lower volatility of bonds and their inclusion in a portfolio shows up in the increase in Sharpe ratio of that portfolio. Again, not necessarily good or bad but a metric you can use to compare across similarly constructed portfolios.

And the best and worst-case returns below.

The annualized returns for the same portfolio going back in time.

Not that much different from an all-stock portfolio but that was for the last 20-years where stocks were literally cut in half twice in one decade.

Now someone nearing retirement could have increased the allocation to bonds to say 40 percent. The Sharpe ratio for this portfolio as expected goes up so if you are comparing two portfolios with a similar stock/bond mix, you’d know which one’s more efficient.

And the best and worst case performance data below…

…as well as what this portfolio did going back 20 years.

Again, the anomaly with the last 20 years shows up with stocks not doing as well as they did historically and with bonds absolutely crushing it. This is unlikely to be repeated for a portfolio with 40 percent allocation to bonds over the next 20 years though.

So what kind of portfolio should you own? But before that, a bit on what I do with my (our family’s) money.

We use a core and explore approach to how we deploy our savings. The core is the can’t miss, can’t fail segment of our money that must be there when we need it and hence is invested accordingly. That makes up about 90 percent of all the money we have though that percent allocation is higher now for reasons I’ll elaborate on more below. And it’s invested in an all-stock portfolio like the one shown above for three reasons:

• 4 percent is what is typically used as a safe withdrawal rate from a portfolio to live on during retirement though that might need some adjustments considering the interest rate environment we find ourselves in. But a 4 percent withdrawal rate means your portfolio cannot afford a lot of volatility and hence bonds become an important component of that portfolio. But if say a 2 percent withdrawal rate is plenty to live on during retirement then there’s no need to add bonds as dividend income alone can fulfil your income needs and that is where we expect to find ourselves at.
• There is unlikely to be a repeat of bond market performance of the last 40 years over the next 40. So if you don’t need bonds, you should not need bonds. Yes, the right kind of bonds can and do make the ride smoother but if you don’t care about the ups and downs, you don’t need bonds either.
• And though an all-stock portfolio will have an inferior Sharpe ratio than a portfolio with a decent allocation to bonds, that in and off itself is not necessarily bad. Because there is no guarantee that adding bonds will enhance the volatility reduction benefits bonds provided in the past. So though Sharpe ratios are important to compare two similar portfolios, that is where that comparison stops. Just because a portfolio’s Sharpe ratio is lower does not automatically imply inferiority.

I also do a bit of exploring with our money and that’s where the tiny explore portion of our money is invested. We haven’t done much to this in the last many years due to the valuation environment we find ourselves in but we will at some point again when wonderful businesses could be had at reasonable valuations when this current cycle turns. And turn it will.

But of course there is no need to do the explore if you are not meeting your plan goals. And it also comes down to whether you enjoy doing all the work needed to explore because work it does take.

Plus since statistical calculations can’t be done with the explore segment of my portfolio, Sharpe ratios and things like that goes out the window. This is an attempt to eke out a bit more than what the core-only portfolio can deliver but of course there are no guarantees.

The explore portion of our money is currently invested in a bunch of businesses that are small, cash flow rich with predictable business models. At least, businesses that I can do some modeling and projections on. Businesses like Raven Industries that make precision agriculture products and engineered films. It’s been in the news lately as it is getting acquired in an all cash deal.

Other companies that were acquired since the time I first built this portfolio almost a decade back…

• Pall Corp., a maker of water filtration systems was acquired by Danaher Corp. August 28, 2015 was the last trading day for the stock.
• Mead Johnson Nutrition Co., maker of infant formula such as Enfamil brand, was acquired by Reckitt Benckiser Group. June 14, 2017 was the last trading day for the stock.
• Clarcor, a maker of filters for automotive and heavy industrial applications was acquired by Parker-Hannifin. February 27, 2017 was the last trading day for the stock.
• Kaydon Corp., a maker of industrial bearings and shock absorber systems was acquired by SKF. October 15, 2013 was the last trading day for the stock.
• Bio-Reference Labs, a provider of clinical laboratory testing services for the detection, diagnosis, evaluation, monitoring, and treatment of diseases in the United States was acquired by Opko Health. August 19, 2015 was the last trading day for the stock.
• Sigma-Aldrich, a company that develops, manufactures, purchases and distributes a range of biochemical and organic chemical products, kits and services that are used in scientific research was acquired by Merck. November 17, 2015 was the last trading day for the stock.

Then there are business like International Flavors and Fragrances. And W.W. Grainger. And Copart. And C.H. Robinson Worldwide and a few others that we’ll continue to own for a long time.

Hope this helps.

Thank you for reading.

Cover image credit – RF Studio, Pexels

Venture capital as a funding model didn’t exist back then. And back then is 1960s. You needed capital to start your business? You’d rely on the faith and generosity of friends and families or you’d go down to your local bank to pitch them on the promise that was your startup.

And banks were and still are in the business of lending. They lend instead of taking a stake in your business. So a completely different business model.

And conservativeness is the name of the game. Return of capital is more important to them than a return on capital. An excerpt from that book is indicative of those times.

“Here I’d built this dynamic company, from nothing, and by all measures it was a beast – sales doubling every year, like clockwork – and this was the thanks I got? Two bankers treating me like deadbeat?”

Phil Knight in Shoe Dog

So imagine where we would be if we had to rely on capital from banks to fund our bleeding edge businesses of today.

But then we also have the landscape of today. Apoorva Dutt wrote a piece that is based off of excerpts from Dan Lyons book titled Lab Rats which talks about how Silicon Valley’s business model of moving fast and breaking things is making life miserable for the rest of us. This was in 2018 and things have just gotten crazier since then. Some choicest excerpts from her piece about Dan Lyon’s book…

“Silicon Valley has no fountain of youth. Unicorns do not possess any secret management wisdom. Most startups are terribly managed, half-assed outfits run by buffoons and bozos and frat boys, and funded by amoral investors who are only hoping to flip the company into the public markets and make a quick buck. They have no operations expertise, no special insight into organizational behavior. All they have is a not-very-innovative business model: they sell dollar bills for 75 cents and take credit for how fast they’re growing.”

Apoorva Dutt, Tech in Asia

“The vast majority of these new companies are losing money. Traditionally, to get rich in business you had to build a company that turned a profit, and then the profits were shared with investors. The new VCs have invented a form of alchemy in which they make a fortune for themselves while skipping the step about building a profitable company. I call it, Grow fast, lose money, go public, cash out. You pump millions (or billions) into a startup, so that it grows rapidly. You generate hype, flog the shares to mom-and-pop investors in an IPO, and scoot away with the loot. In 2017, I made a list of 60 tech companies that had gone public since 2011. Fifty of them had never made a profit. Some new companies lose incredible amounts of money.”

Apoorva Dutt, Tech in Asia

That’s harsh but there is also truth in that. And we can see some of that play out lately with many of the newly listed companies with their values down 50 percent and more. And they are still nowhere from being reasonably priced.

Venture capital as an ecosystem is not designed to work with a lot of capital. In fact you make things worse for startups who are doing things right and playing by the books on their plans to grow a business with profits as the end goal. And that must be the end goal for the system to flourish.

Because you can always throw junk in the public markets and the public might lap it up. To a point. It’s that same fool me once, shame on you, fool me twice, shame on me endgame.

And we don’t want that endgame.

Of course, few businesses start out of the gate being profitable. But there must be a point beyond which profitability becomes imperative. We cannot have billion dollar businesses perpetually losing money.

Mihir Desai, professor of finance at Harvard Business School and an author of one of my favorite books, The Wisdom of Finance, wrote a piece in New York Times right before Uber was about to go public and why you should root for that IPO to fail. That’s cruel but hear him out.

“This cycle – in which unsustainable start-ups make ever-larger promises to bloated venture capitalists, who promise more than they can deliver to flush sovereign wealth funds, who are too eager to believe them – distorts the allocation of capital and talent. The rush to invest, no matter the underlying economics, diverts entrepreneurial energy toward unviable business models.”

Mihir Desai, New York Times

Of course that’s nothing to do with Uber but that’s what we get when so much capital is chasing returns wherever it can find in this ultra-low interest rate environment with pension funds, endowments and even John Q public piling in.

Now that I’d depressed you enough, there’s still a decent justification for you to still participate in this ecosystem because not many avenues exist that can add sparkle to your portfolio with returns beyond what you already have access to. Plus all that thing about backing entrepreneurs and helping turn their dreams into a viable product or a service.

So how do you decide how much can you afford to invest in this space?

I’d start with my 10 percent rule. That’s your play money and venturing into venture capital is equivalent to that. Very high risk with a potential to knock it out of the park.

For those that are into statistics, traditional stock and bond investing have returns that are more normally distributed. Venture capital returns follow a power-law distribution.

And data shows that you’ll need a minimum of 50 investments to even have a shot at this.

So assuming you deploy $10,000 in each one of them, that’s $500,000 right there.

But you can’t just invest once and be done with it. You need to invest at the minimum in a follow-on round to make sure you don’t get diluted out of your initial stake.

So that’s another $10,000 for each of those 50 bets.

So you need to carve out a million dollars from your portfolio to play this game. And since this can’t exceed 10 percent of all the money you have means you can only afford to play this game if your net worth is in the 10 million dollar range.

So that’s the hard math.

The way around it is to invest in a pool with other like-minded investors. That way, you can get exposure to this asset class even with a lot less.

To me, investing in this sphere if opportunity presents itself is to be an enabler of this ecosystem. Not that it needs any of mine or yours help in the current environment.

But if there is a chance to strike it big, there is also a chance it all flames out. That’s the nature of this game and you must play the game to find out.

Thank you for reading.

Cover image credit – Startup Stock Photos, Pexels

Craig L. Israelsen, professor of all things financial planning at the Brigham Young University likens the art of portfolio construction to making salsa. I mean you can add your own flavor to a recipe but ultimately, the ingredients that constitute a wholesome salsa don’t differ much. And so shouldn’t the ingredients of your portfolio.

The recipe is your portfolio’s asset allocation. There are complex elements to it but inherently, not that complex.

Some of the elements that make up a salsa, say salt for example, may not be very exciting. And they are not supposed to be. They are neutralizers.

A well-designed portfolio should have its own set of neutralizers.

But then we’ve got a world where the only thing that matters is how you compare against the S&P 500 index. At least lately. Or God forbid, the Nasdaq. Talking about Nasdaq…

Comparisons against these indices didn’t happen as much during the decade of the 2000s when indices similar to these sucked wind but they happen now because we forget. We are too busy. We take mental shortcuts instead of thinking deeply about what we own and why.

And since when do we compare salsa to 500 ground-up tomatoes? We have created a misconception around what diversification is. The S&P 500 is a diversified set within an asset class. That’s not true diversification. That’s intra-diversification. It’s depth, not breadth.

And Nasdaq’s worse. Yes, yes, a lot of companies that make up that index will go on to change our world but it’s still mostly a narrow subset of the investible universe. And there are other means to own it.

So getting both breadth and depth is true diversification. A multi-asset portfolio that encompasses a need appropriate allocation is what you want.

A 60-year old’s portfolio should look different than that of a 30-year old.

A 60-year old’s portfolio with a solid pension should also look different than that of a 60-year old’s without a pension.

Back to the S&P 500, this is what you get when you own just it.

So the biggest 25 businesses take up almost 45% of your money. Even in a winner take all kind of an economy, that’s too much concentration in just a few businesses if this is all you’ll do with your money.

And large businesses don’t stay large forever. They become stodgy, bureaucratic and unmanageable and eventually get replaced by smaller, more nimble rivals. It is only a rare breed that can maintain their market power for decades on. A prime example of that process and there are many is General Electric which at one point was the largest market value business in the world but now is a shell of its former self.

The current bunch of the large cap universe could be an exception but history says otherwise. There is always something around the corner that would dislodge the hot ones of today. It might take longer but it’s going to happen.

Plus a portfolio invested only in the S&P 500 index leaves out stalwarts like these and 3,000+ others…

Not a collection that screams of deep value but it is a collection.

So what’s a flavor of depth and breadth? Maybe this…

That’s for domestic equities. The ingredients and the proportions can change based on where you are in life but seems even-keeled and at least pointing in the right direction. You do something similar for international equities. Then you bring in bonds and cash, real estate and alternatives. Now that’s salsa.

On bonds, the last 40 years have been the best 40 years in the history of the fixed-income world. That’s not going to be repeated so caution on what type and duration to own is warranted.

And the portfolio you design should be a function of how much you’ve saved, what you’ll continue to save plus growth in value. Expecting just your portfolio to do the heavy-lifting without a pitch from your savings is not going to cut it in this yield-starved world. Encounter anything that promises that, run.

And last, as Carl Richards, the author of The Behavior Gap says, you can have the best portfolio ever designed in the history of the world and you make one behavioral mistake a decade, you might as well have stuffed all that cash in a mattress.

So don’t.

Thank you for reading.

Until later.

Cover image credit – Karolina Grabowska, Pexels

So a very clean bell-shaped distribution.

But instead of say having access to 1 million data points, what if we had only 100 data points? The underlying population is still normally distributed but because of the smaller sample size, the distribution might not quite look bell-shaped which is what we were expecting.

It could look something like this…

So that’s the difference between dealing with sample data vs. population data. You could be dealt any hand possible based on the size of the sample you collect and the differences between sample to sample can sometimes be big. A given sample could precisely represent the population or could be a completely different distribution altogether even though the underlying population distribution is still normal.

So now that we got that straight, what does that have to do with our money? The plot below is the performance distribution of the two dominant asset classes that we have reliable data on over the past 90 years. Stocks here are represented by the S&P 500 index and bonds by the 10-year Treasury bonds. You could replace S&P 500 with a diversified global stock portfolio and you’d get more or less the same distribution but because global stock market data going that far back is not readily available, we use S&P 500 as a proxy.

Stocks are more volatile than bonds. We know that and we can see that from the comparison of the spread between stocks and bonds. And I don’t know about you but neither of these distributions look bell-shaped to me. That’s because though we have data on 90-years of performance for these two asset classes, they still represent a small subset of the population of all the returns that have happened before and all the returns that will materialize in the future. So the underlying distribution of the stock and bond market returns could still be normal and if we assume that, here’s what the distribution of returns could look like for the two asset classes over a span of say 1,000 years .

Almost bell-shaped. So the underlying distribution can be assumed to be normal even though the 90-year sample does not look anywhere close to normal. And unfortunately, we have to make that assumption to assess the impact of these statistics on our portfolios. And our lives.

So now that we got that straight, say you are a young whippersnapper with a 40-year investment time horizon. Your time horizon in reality is much longer than that but let’s just stay with this for now. You have some cash that you’ve saved up and you want to plunk that down in a portfolio of stocks that yields on average say 7% during that 40-year time frame. Why stocks? Because you are young and you can afford any level of volatility (these words could come back to haunt you) the market throws at you. And 7% for an all-stock portfolio is lower than what the markets have yielded historically but we know the valuation and the interest rate drill and hence 7% sounds about right as an assumption.

So what would you have in 40 years if a single $1,000 were left to compound at 7%. $14,974 or rounding that off to say $15,000. So that’s 15x your money.

What’s missing? That 15x assumes a constant 7% return each and every year. That of course is not real. Markets don’t move in averages. They can fall a few years in a row, then be up a few years and so on. That’s volatility and the difference with different levels of volatility on the final accumulated wealth can be yuge.

To prove that, we simulate by drawing 10,000 samples of 40-year interval from a population of portfolio returns that is normally distributed but with varying levels of volatility.

And here are the results starting from the worst-case (losing your shirt) to the best-case (making a killing).

So with a 50% volatility, 85% of the portfolios lose money over this 40-year time frame. This is akin to a more venture type of investing and you might want to do that with some portion of your portfolio but not with your entire portfolio.

Or this could also be an outcome of a very concentrated portfolio of stocks.

Historically, the standard deviation (volatility) associated with a broadly diversified stock portfolio is around 20%. With bonds, it’s about 6%. You mix the two and you really have to try hard to push the volatility beyond 15%. So in theory, you almost never lose money with that portfolio. Or at least you didn’t historically.

But avoiding capital loss is not your only goal. You are doing all this to also make some money because you can be a wage-slave for only so long.

So some more data on just how much are you able to grow your wealth by with different levels of volatility but with the same average return.

One thing is clear. Off the chart volatility kills as is evident by the 50% volatility mark in all the plots. You lose most of the time. Plus the probability of you making a killing are so infinitesimally small that you’d rather not try. But then this is where a collection of most small businesses and start-ups lie so not trying is also not good for you and me and the economy. It is these risk takers and investors willing to fund these ideas and businesses that creates this quality of life we take for granted. So we take those chances and we should but with a small portion of our portfolios.

And you don’t have to take crazy risks to do well over time. A portfolio with 5% volatility takes you quite far almost all the time. Yes, you are less likely to make a killing as shown by the ‘no bar’ in the ‘more than 50x plot’ above but you are likely to always match and exceed inflation.

And sometimes that’s all you need, especially during retirement.

Plus any portfolio with volatility less than 15% always made you money and at most times, a lot of money.

And if you are dollar-cost averaging through this 40-year investment timeframe, even an all stock portfolio works, especially during the early phase of your accumulation cycle.

But what you haven’t asked and what you should be asking is, who would go for portfolios with crazy volatility yet only earn 7% returns on average? We know the risk-return trade-off. The more risk you take, the more in terms of a return you should expect.

So then we analyze situations where returns are different – lower returns for a less volatile portfolio and higher returns for the more volatile one. That is, you are getting compensated for taking those crazy risks.

But do you really get compensated for taking those risks in the long run? Back to the data again…

The situation improves a bit for the crazy volatile portfolio but you still end up losing your invested capital 60% of the time.

So the probability of you making a killing with a highly volatile portfolio improved but not by much. In fact, a vast majority of portfolios that return 5% with 10% volatility do better that the portfolios that return 15% but with 50% volatility.

So the moral of the story is to shoot for decent returns that will allow you to meet your goals but ignore volatility at your own peril. And in fact, if given a choice between a higher return but a more volatile portfolio compared to a lower return, less volatile portfolio, choose the latter. Not only will you sleep easy but you’ll sleep easy while getting rich.

Until later.

Cover image credit – Paulo Valdivieso, Flickr

How do I know? Let’s run through some of the events the world has persevered through and yet capitalism marched on. The plot below is the growth of a dollar invested towards the end of 1914 in a basket of U.S. stocks and left there untouched since.

That story likely repeats for global stocks as well but because of limited data going that far back, we’ll use the data we have as a proxy.

And all these markers are events, mostly bad where if we were in the midst of them, we had every reason to bail. But had we not and remained invested, we did well.

Also, the y-axis above is log scale so those bumps that appear to be baby bumps are in fact deep craters that almost looked like it was the end of the world. But we are still here. You are still here.

A cursory look at the market returns we would have to endure through to get here.

These are annualized returns that measures the value of a dollar invested from the start of each year to the end of that year. This does not capture the intra-year (within that year) volatility which many a times is massive. What I mean by that is that we might end a year with say a 7% portfolio return but we would have endured a 30% intra-year drawdown first to eventually recover enough and avail of that 7% return.

And that has happened and will continue to happen. Persevering through that and sticking to our well-crafted investment plans is the only choice we have. And that is the right choice.

It’s one thing to look at the annualized returns and think, no biggie. I can handle that.

But a year is a long, long time watching the value of our portfolios decline day after day, month after month. Only when passing through that phase do we really realize how excruciatingly painful it is. We are likely experiencing that now. But endure through that we must. That is part of the deal.

If one year decline is rough, multi-year declines like the period post the Dot-com crash or the 70’s bear market or during what we had to endure through during the Great Depression is 10x worse. Things eventually recover but we have to continue investing through that by sticking to our plans no matter what. That is the only choice. And that is the right choice.

But who has a 100-plus year timeframe to invest? Okay, so let’s break this timeline into smaller chunks.

1915-1950

Why the quote unquote around only? Let’s chronicle the events that transpired during this time span to find out. And a 35 year timeframe matches a typical career span so even better.

1914 Austrian Prince Archduke Francis Ferdinand travels to Sarajevo to inspect the imperial armed forces in Bosnia and Herzegovina, annexed by Austria-Hungary in 1908. The annexation had angered Serbian nationalists who believed the territories should be part of Serbia. A group of young nationalists hatch a plot to kill the Archduke during his visit to Sarajevo. After some missteps, 19-year-old Gavrilo Princip was able to shoot the royal couple at point-blank range while they traveled in their official procession, killing both almost instantly. The assassination sets off a rapid chain of events as Austria-Hungary immediately blames the Serbian government for the attack. As the large and powerful Russia supported Serbia, Austria asks for assurances that Germany would step in on its side against Russia and its allies that include France and Great Britain. On July 28, Austria-Hungary declares war on Serbia and the fragile peace between Europe’s great powers collapses, beginning the devastating conflict now known as the World War I.

1914 The outbreak of war forces NYSE to shut its doors on July 31, 1914 after large numbers of foreign investors start selling their holdings in hopes of raising money for the war effort. All of the world’s major financial markets follow suit and close their doors by August 1. It would be about 4 months the markets remain closed. Imagine that happening today.

1915 One millionth Ford automobile rolls off the assembly line. Concerns around the fact that the demand for oil will outstrip supply and that the world will run out of oil soon. And then what? The Peak Oil theory will remain a concern like forever and here we are today with the likes of Tesla relegating the fact that the world will ever run out of oil as a non-issue. Stocks gain 81% that year.

1915 The Armenian genocide. Between 600,000 to a million dead.

1917 U.S enters the war. Stock market declines by 22% that year.

1918 Worldwide influenza pandemic strikes (Spanish Flu). It continues till December of 1920 infecting around 500 million people, a quarter of the world’s population. Estimated death toll ~ between 17 million to 50 million and possibly as high as 100 million, making it one of the deadliest pandemics in human history. An estimated 675,000 Americans die. Stocks gain 11% that year.

1918 Germany signs the Armistice at Compiègne ending World War I. 20 million dead worldwide with 21 million wounded.

1918 Russian revolutionaries execute the former czar and his family leading to a Russian Civil War between Reds (Bolsheviks) and Whites (anti-Bolsheviks). Reds win in 1920 and hence the onset of worldwide communism.

1927 German economy collapses. Stocks gain 37% that year.

1929 The stock market crash on Oct. 29 marks the start of the Great Depression and sparks America’s and likely the world’s most famous bear market. The S&P 500 falls 86 percent in less than three years and does not regain its previous peak until 1954 (in price). Stocks decline 8% that year.

1930 Unemployment soars, trade suffers from Smoot-Hawley tariffs. U.S. imports from and exports to Europe fall by some two-thirds between 1929 and 1932 while overall global trade declines by similar levels in the four years that the legislation is in effect. Stocks decline another 25% that year.

1932 Six million die in Soviet famine. Stocks continue their decline (another 9%) after a horrific 44% decline the year before from the already depressed levels.

1933 Germany and Japan withdraw from League of Nations. Stocks soar 50%.

1934 Dust Bowl problem continues. The worst drought in 300 years plagues 75% of the country. Stocks remain almost flat for the year.

1935 Nazis repudiate Treaty of Versailles. Stocks gain 47%.

1937 Beijing falls to the invading Japanese forces. Stocks decline 35%.

1938 Hitler annexes Austria. A 29% stock market gain.

1939 Germany invades Poland. Stocks close flat for the year.

1940 France falls under Nazi occupation. Stocks decline 11%.

1941 Pearl Harbor attack. US enters World War II. Stocks decline another 13%.

1944 The Battle of the Bulge called “the Greatest American battle of the war” by Winston Churchill. Fought in the Ardennes region of Belgium, this was Adolf Hitler’s last major offensive in the war against the Western Front. Hitler’s aim was to split the Allies in their drive toward Germany. The German troops failure to divide Britain, France and America with the Ardennes offensive paved the way to victory for the allies. Lasting six brutal weeks, from December 16, 1944, to January 25, 1945, the assault, also called the Battle of the Ardennes, took place during frigid weather conditions with some 30 German divisions attacking battle-fatigued American troops across 85 miles of the densely wooded Ardennes Forest. As the Germans drove into the Ardennes, the Allied line took on the appearance of a large bulge, giving rise to the battle’s name. The battle proved to be the costliest ever fought by the U.S. Army (about 100,000 casualties). Stocks gain 19%.

1945 Hiroshima and Nagasaki nuclear bombings. 200,000 dead. Stocks gain 36%.

1946 Worst work stoppages since 1919. Less than a year after the end of World War II, stock prices peak and begin a long slide. As the postwar surge in demand tapers off and Americans pour their money into savings, the economy tips into a sharp “inventory recession”. Stocks decline 8%.

1950 North Korean communists invade South Korea. Stock market gains 31%.

So this 35-year timeline that includes the Great Depression, two World Wars, pandemics and every unimaginably bad thing that could have ever happened to this world and we still came out okay being invested in capitalism.

And if there was ever such a thing as financial planning in those days and you panicked and deviated from the plan you had in place and sold at any point in time, well that would have been a sin. Not the greatest of sins but a sin. Why?

The financial underpinnings of the world were still in the early formative stages. The Federal Reserve bank that acts like a stabilizing force during times of economic upheaval today didn’t even exist up until 1913. And even when it did, there was not a lot of data and expertise on how to navigate around pandemics and wars and recessions. Everybody was learning. The system was learning with the world waffling back and forth between two distinct economic systems.

So you were forgiven if you had committed that ultimate sin but had you not and dollar cost averaged into the markets during those 35 years by investing a dollar each year, this is what you’d have.

So instead of $15, you end up with an amount 13x more. That’s hail to the power of an ironclad gut, a long-term mindset and dollar cost averaging. And notice that reduction in volatility because of your consistency in adding to your portfolio no matter what.

Let’s finish off this timeline thingy by recounting the major events that happened 1951 hence and the journey of that dollar that you (or your prescient ancestors) started in 1914.

1951-2020

1951 Seoul falls to Communist forces. Stocks gain 24%.

1953 The Korean War ends with the signing of the Korean Armistice Agreement. The agreement creates the Korean Demilitarized Zone (DMZ) to separate North and South Korea and allows the return of prisoners. However, no peace treaty is signed and the two Koreas are technically still at war, engaged in a frozen conflict. The Korean War is relatively short but exceptionally bloody. Nearly 5 million people die with more than half of them, civilians. Almost 40,000 Americans die in action in Korea with more than 100,000 wounded. Stocks remain flat for the year.

1957 Asian Flu Pandemic (a Chinese origin H2N2 avian influenza) claims 2 million lives. Stocks decline 10% that year.

1958 The Great Chinese famine kills 30 million. Stocks gain 44%.

1959 The Cuban Revolution – communism at America’s doorstep. Stocks gain 12%.

1961 The Bay of Pigs invasion – a failed attempt at ousting Fidel Castro from power. Stocks gain 27%.

1962 Cuban missile crisis sparks Cold War jitters. President Kennedy is assassinated. Stocks decline 9%.

1964 U.S. involvement in the Vietnam War accelerates post the Gulf of Tonkin incident. U.S. also conducts large-scale strategic bombing campaigns against North Vietnam and Laos. Stocks gain 16%.

1968 The Tet Offensive. American public’s resistance to the Vietnam War grows. Despite heavy casualties, North Vietnam achieves a strategic victory with the Tet Offensive as the attacks mark a turning point in the Vietnam War and the beginning of a slow and painful American withdrawal from the region. Stocks gain 11%.

1973 Israel’s Yom Kippur War and the subsequent Arab oil embargo sends energy prices soaring. A lengthy recession ensues. Inflation rate tops 10%. Nixon resigns post the Watergate scandal. Stocks drop 14%.

1975 Vietnam War ends with about 1.4 million Vietnamese and 58,000 Americans dead. Stocks gain 37%.

1979 Iran hostage crisis. Stocks gain 19%.

1980 After nearly a decade of sustained inflation, the Federal Reserve raises interest rates to nearly 20 percent, pushing the economy into a recession. The combination of high inflation and slow growth (stagflation) was a big factor behind Ronald Reagan’s victory over President Carter. Stocks gain 31%.

1983 Terrorist explosion kills 237 U.S. Marines in Beirut. Stocks gain 22%.

1987 Black Monday. Dow falls 22.6% in a single day, the worst in one day since the Panic of 1914. Yet, while the days after the crash were frightening, by early December, the markets bottom out and a new bull run commences. Stocks go on to not only make back all the losses but end the year +6%.

1990 Iraqi troops invade Kuwait. Stocks decline 3%.

1991 The Persian Gulf War. Stocks deliver a 30% return.

1997 The Asian currency crisis. The crisis starts in Thailand on July 2nd with the collapse of the Thai baht after the Thai government is forced to free-float the baht due to lack of foreign currency reserves that previously supported its peg to the U.S. dollar. Capital flight ensues almost immediately beginning an international chain reaction. At the time, Thailand had borrowed heavily that made the country effectively bankrupt even before the collapse of its currency. As the crisis spreads, most of Southeast Asia and Japan see slumping currencies, devalued stock markets, depressed real assets and a precipitous rise in private debt. Stocks earn 33% that year.

1998 The Russian financial crisis. Long Term Capital Management blows up on excessive leverage. Stock market gains 28%.

2000 The bursting of the Dot-com bubble. Stocks decline 9%.

2001 September 11 terrorist attacks. Stocks decline another 12%.

2003 The 2nd Iraq War begins. Stocks gain 28%.

2005 Insurgency spreads. Stocks gain 5%.

2007 A long-feared bursting of the housing bubble becomes a reality and the rising mortgage delinquency rate quickly spills over into the credit markets. By 2008, Wall Street giants like Bear Stearns and Lehman Brothers start toppling and a financial crisis erupts into a full-fledged panic. By February of 2008, the market falls to its lowest levels since 1997. Stocks earn 5% that year.

2008 Lehman Brothers files for bankruptcy. The global financial system is on the verge of collapse. Stocks end the year down 37%.

2016 Donald Trump elected President. Stocks gain 12%.

2018 End of the year stock market decline approaches 20%. Stocks end the year down 4%.

2020 The ongoing Coronavirus pandemic. A 26% decline so far.

I understand any amount of chronicling of history is not enough in light of the mayhem we have seen in the markets and in our portfolios lately. And these are also the times that remind us of the role bonds and cash play in our portfolios if drawing income to live on is a necessity. For the rest of us, we did right by sticking with the portfolios we own.

But these are also the type of events that separate us from folks who commit the ultimate investing sin if there was ever and that is to panic sell. There is no reason to and there is no need to. Granted, there will be some restructuring in the global economic landscape in light of this pandemic. Weaker companies will fail and the stronger ones will come out even stronger than before. And you don’t want to be there picking winners and losers because you are statistically much more likely to own losers than winners. You want the market to sort this out and it will over time.

This world of ours has endured far worse and we see that. We would come out of this just fine. I bet we would be looking back in a decade on this entire episode and say that was nothing. The world has seen far worse. 

And if you are in your twenties or thirties or even in your forties and you are new to this market volatility, I say this: you will have many such episodes in your life when your portfolio massively declines in value, sometimes for a reason and other times, without any. But you have to remain invested because that is part and parcel of this whole process of getting from point A to point B and beyond.

And for the finance nerds out there, when we invest in stocks, we are in fact buying perpetuities that promise to deliver a stream of cash flows this year, next year and many years beyond that, discounted at an appropriate discount rate to the present day. This episode we are living through will impair a few years’ worth of those cash flows but the longer term cash flows will eventually come through. They have to.

Markets tend to overextend on the way up and on the way down. That’s natural. But remember, things are never as bad as they seem when all hell is breaking loose and you are in the midst of that. At the same time, things are never as good as they seem when everything is going great.

So plan for things to go bad when things are going well. And when things look miserable, keep in mind that things will eventually get better.

So don’t go crazy not having any safety buffer to tide you through in situations where your income gets disrupted temporarily. At the same time, don’t panic.

And if you are a market participant (you have to be, you have no other choice), you’ve got to own stocks. There is no plan you can theoretically design in today’s interest rate environment where you can avoid that asset class completely. But when you do own stocks, you’ve got to be prepared for declines every now and then because as Charlie Munger says…

“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder, and you deserve the mediocre result you’re going to get compared to the people who do have the temperament and who can be more philosophical about these market fluctuations.”

Not sure about being philosophical…okay, I can be a bit philosophical but if it makes you feel any better, this is a small collection of businesses amongst the thousands you own if you own a global market portfolio. And they are selling at a discount. So buy if you can.

Some companies will burn and die but capitalism will survive. It has to because… Pascal’s Wager?

The only folks who get absolutely demolished in bad times are the ones who take on excessive leverage. The only leverage that you should very reluctantly sign up for in your own personal life is your home mortgage. And very, very reluctantly at that.

And leverage, especially with stocks, never. Because I am with The Oracle on this…

“It’s insane to risk what you have and need for something you don’t really need. You will not be way happier if you double your net worth.”

And Black Swan events like these is when we see the folks flirting with leverage get completely wiped out. Those 10 AirBnB rentals that you thought you could lever up and make a killing? Not happening. That’s the nature of blind risk and capitalism has a way to cleanse the system every once in a while. That’s ultimately healthy but you don’t want to be a part of that process.

But never in my wildest imagination did I predict these unfolding of events not only with the markets but with our lives. I have been hoping and praying that there would be a correction to clean out the excesses because I feared that the longer the good times rolled, the more remote a chance of a decline will seem, the more overconfident investors will feel and the more risk they’ll take. Which means that that eventual fall, which is a near certainty, would be far more deep and wide.

But what about all those folks who got out just in time before the markets crashed and will likely get back in before they recover?

Yes, of course. And I have a bronze colored bridge I’d like to part with at the right price.

You might get lucky timing the getting out part once or maybe twice in your life but you also have to get the getting in part right. And markets don’t usually recover when you think they’ll recover. They make big and sudden moves which will catch you off-guard and you then miss the boat. Plus these moves tend to happen at the bleakest of times when all hope is lost.

And say you got out in time before the crash and you got back in at the bottom. So you got lucky twice. What’s the lesson you learnt? That the moment you have that inkling of a disaster on the horizon in the future, you’ll get out. And that disaster never happens. Or it happens but it’s not as severe and the markets zoom past the point you sold. What happens then? You wait? Wait for a decade?

Because that is precisely what many investors did this past decade and hence missed out on all those gains before these recent spate of events.

So don’t mess around. Remain invested.

Good investing is a lot about psychology and behavior combined with a decent dose of history with a sprinkle of math and finance. Any one of them missing from the mix and it’s going to be real hard to meet your goals.

And getting sucked into a fad here and a fad there and assembling investments with no particular rhyme or reason beyond hoping that you buy low and you will get to sell higher is not what it’s all about. I have seen folks talk about this airline stock or that cruise stock. Fine. A few of them will work out but what’s the definition of working out? A double or a triple? Pre-tax?

And you for sure didn’t stake the kind of money that’ll change your life. So if you didn’t, don’t bother. Stick to your plan.

I am not saying you have to but maybe you’ve got to have someone who knows these things watch over your financial life. Because as Phil Demuth, author of several excellent books and the founder of Conservative Wealth Management opines…

“If you manage your own money, you are potentially vulnerable to every crackpot investing idea that comes along. It only takes one.”

Only one. Maybe you will but most don’t get many shots at this. So act wisely.

And what I am truly worried about is the long-term health of our retirement system because when I see stats like an average retiree nearing retirement has only $50,000 saved, I say holy s#*@. We are screwed. Because as William Bernstein says…

“I’ve flown airplanes, and as a doctor, I’ve taken care of kids who can’t walk. Investing for retirement is probably harder than either of those two activities, yet we expect people to be able to do it on their own.”

And that’s why we all yearn for those pension systems of the past where we had someone other than us pool assets together with our fellow savers and design a plan with enough safeguards to make sure that the money lasts longer than any of us individually.

That don’t exist and we’ll have to live with that. In the meantime, a few tips to navigate around this and future market turbulences.

• Always, always keep emergency reserves that cover at the minimum 6 months of living expenses. And depending upon the type of work you do, maybe you need more but 6 months is the ideal minimum. Granted, it is a tall order for many folks who cannot afford to set aside literally anything because they can’t. But I know you can. How? Because you got this far reading this.
• Never panic. You will encounter many a market crashes and recessions through your investing life. You just have to acknowledge that fact and design a plan that lets you survive those events. You need to realize your own volatility to heartburn ratio and this is the time to take notes. The higher that ratio, the more equity risk you can handle and the higher the returns you can expect. A lower ratio means that you’ll sleep alright but then you have to be prepared to save ungodly sums of money to maintain the same standard of living as before through a likely long retirement.
• It’s obvious but try to avoid taking on too much debt of any kind, especially of the lifestyle kind. Screw that big home with an albatross as a mortgage if it bogs you down. It’s unfortunate that we as a country through our tax policies and incentives have turned shelter into an asset class. And a retirement plan. That’s stupid and real bad in the long run, not only for you as a home owner but also for future economic growth. And environmental costs aside, it locks people in place, decreases social mobility and increases risks in the system and in our lives. Let others participate in this game but you remain mindful of the debt you take on.
• Never borrow and invest, ever. We’ll see the repercussions of that soon as a lot of over-leveraged real estate ventures and businesses go belly up. I mean all these folks were running their ’empires’ in a way that they could not sustain a couple months of income disruption? Come on.
• And stay far, far away with that mindset of Keeping Up with the Joneses. Design your life around being happy with as small an overhead as possible. The freedom and the peace of mind that comes with that will be priceless. You’ll sleep better, play better and work better. All good.

So that’s all I have to say for now. Thank you for reading.

Until later.

Cover image credit: Josie Stephens, Pexels

When outcome is essential and matters more than relationship, use trust, but verify. When relationship matters more than any single outcome, don’t use it. 

So true that. But since there are no relationships to care for when it comes to being a good steward of our money, we should trust little and verify a lot. And that task becomes a lot easier with a bit of intuition and access to data.

So there is this thing called rebalancing and it means exactly as it sounds. Say we start with a 60/40 stock-bond portfolio and over time as the markets evolve, that allocation drifts to say 65/35. If the intent is to maintain a constant allocation, we’d sell the stock component of the portfolio, taking out the excess and buy into the bond portion to bring the allocation back to 60/40. That’s rebalancing.

And it sounds like a great idea. We sell something that has gone up and buy the other that has gone down – a classic buy low, sell high approach. So that’s great. But then I read something along the lines that rebalancing between stocks and bonds works but rebalancing within a category is not ideal or does not work as effectively.

Take stocks as a category for example. You’ll likely own some large company stocks, mid-size company stocks and some small ones. And then you’ll own developed market international stocks and emerging market stocks and so on. Not all of them will move in the same direction all the time. Some will zig while others zag. Or some will zig some while others will zig more and so on. So if you rebalance within a category, you would be theoretically doing the same thing that you ideally would want to do – buy low and sell high.

But now there’s this doubt and we need to get to the bottom of it to make sure all’s okay. So as we would do and as we should do, we test both approaches at once to validate that what we’ve done all along was not inferior to what we should have done.

So we go back to data and test whether an invest & forget approach works better than say rebalancing annually. Ideally we would and should rebalance as often as there is an opportunity to rebalance but let’s just assume we do it once each year. We’ll use data on annual returns for four asset classes to test the two approaches.

• Large company U.S. stocks
• Small company U.S. stocks
• International stocks
• U.S. bonds

We invest $100 in a portfolio comprised of these four asset classes at the start of the entire time period in varying proportions of 10% increments and assess whether rebalancing does what it is supposed to do. A snapshot of different portfolio combinations is shown below.

Each row is one portfolio and with 10% incremental allocation spread across four asset classes means 258 different portfolio combinations we get to try this on.

Starting with year 1, in year 2 in case of the rebalancing approach, we sell whatever has deviated to the upside from the original allocation and buy what has declined to bring the allocation back in line. For the invest & forget approach, we split and invest the original $100 into the allocation we started out with and let the money ride till the end of the period. The end of the period by the way is 2018 and the dataset contains 49 years of data starting in 1970. So we are comparing the ending values of each portfolio at the end of 2018 to test the rebalancing vs. invest & forget approach.

The first thing we should do to get a good feel is to look at how the ending values are distributed between the two options.

So clearly rebalancing works as is evident from a slight right shift of its distribution as compared to invest & forget. The spread is a bit wider though with rebalancing which is not desired but a bigger question is, are we comparing the same portfolios when comparing outcomes between the two? What we should ideally compare is the ending value of portfolio 1 in the invest & forget case with the ending value of portfolio 1 in the rebalanced case, the ending value of portfolio 2 in the invest & forget case with the ending value of portfolio 2 in the rebalanced case and so on.

So that’s what we have done next and this is what we find when we do a portfolio by portfolio comparison of the ending values…

• Out of 258 portfolios, each with a different asset allocation, the ending values of 243 portfolios that were annually rebalanced equaled or outperformed those of the invest & forget ones. So a 94% outperformance rate if the portfolios were rebalanced as compared to invest & forget.
• 79 portfolios out of 258 that were annually rebalanced outperformed invest & forget ones by more than 10%.
• And the ending values of three out of 258 portfolios outperformed invest & forget by more than 25%.

So rebalancing works or at least worked almost all the time. But what if the bond allocation was held constant at say 40%? The original thesis was that rebalancing is more effective between categories (stocks vs. bonds) versus within categories (within stocks or within bonds). So trying that out…

Apparently the same story here with the shift in distribution for the rebalanced case more to the right than for the invest & forget approach. Oh and by the way, because the bond allocation is held constant with only the remaining three asset classes in the stock category allowed to vary, only 60 portfolio combinations are possible.

A portfolio by portfolio comparison of the ending values yields the following results…

• Out of 60 possible portfolios, each with a different asset allocation and a fixed bond allocation, the ending values of 59 portfolios that were annually rebalanced equaled or outperformed those of the invest & forget ones. So a 98% hit rate making the case even stronger for the rebalancing approach.
• 25 portfolios out of 60 that were annually rebalanced outperformed invest & forget ones by more than 10%.
• And one outperformed invest & forget by more than 25%.

So if you had to wager, rebalancing still wins.

What if you owned an all-stock portfolio? Would rebalancing still outperform invest & forget?

Appears to be a yes. And again as before, only 60 portfolio combinations are possible so a portfolio by portfolio comparison yields the following…

• Out of 60 possible all-stock portfolios, the ending values with the rebalanced approach equaled or outperformed invest & forget each and every time. So a 100% hit rate in favor of rebalancing.
• But none of them outperformed by more than 10% so not a big thumping vote for one over the other.

But what if the returns of the past do not repeat in the same sequence? Could the outcomes be different with a different sequence of returns?

To assess that, we sample returns for each asset class randomly and recreate the asset class returns dataset each time and compare the ending portfolio values between the two approaches. And just to make sure that we have at least attempted to try every which way to convincingly make one approach fail over the other, we do this 500 times. The results…

With portfolios constructed out of a combination of the four asset classes (large company U.S. stocks, small company U.S. stocks, international stocks and U.S. bonds)…

So a very strong vote in favor of rebalancing even with randomized returns sequences.

With a 40% constant allocation to U.S. bonds and the allocation to stocks allowed to vary…

Rebalancing wins here as well.

And for the stocks only portfolios (large company U.S. stocks, small company U.S. stocks & international stocks)…

So you’d be crazy to not rebalance your portfolios from time to time.

But here’s a thing. This whole thing is fundamentally based on the fact that mean reversion will always happen. That is, if an investment has deviated from its normal course either on the upside or the downside, it will always revert back to its mean course over the long term.

But what is long term? Ten years, twenty-five years, hundred years? We can only know this in hindsight maybe long after we are dead so that’s one thing to consider.

And what if an investment ceases to exist? Individual companies we know live and die all the time so to guard against that risk, we’d diversify into a sector. Could an entire sector vanish or never, ever revert back to its mean trajectory of growth? Of course.

What about countries? That’s easy, Japan.

The post-war rebuilding which eventually culminated into a real estate led economic boom of the 1980’s Japan was so big and went on for so long that just the fact that it all eventually came crashing down does not quite do enough justice to the sheer scale of that bubble. Edward Chancellor in his book, Devil Take The Hindmost chronicles the reasons for the boom and what led to its eventual implosion.

One of the key drivers for the boom…

Between 1956 and 1986, land prices increased 5,000 percent, while consumer prices merely doubled. During this period, in only one year (1974) did land prices decline. Acting on the belief that land prices would never fall again, Japanese banks provided loans against the collateral of land rather than cash flows.

Land prices will never fall again, wonder where we have heard that before? So the banks lent money just because the value of the land rose. And the more it rose, the more they lent, creating that self-fulfilling feedback loop of ever increasing prices, leveraged to the hilt. Things got so crazy that by 1989,

The grounds of the Imperial Palace in Tokyo were estimated to be worth more than the entire real estate value of California (or Canada, if you preferred).

And the post-crash recovery didn’t quite materialize or hasn’t yet materialized due to structural reasons that are unique to Japan, though there are signs that things might be finally on the mend. But then they have a long way to go.

Back to the rebalancing or not rebalancing question at hand, so if a portfolio design is done not considering the fact that there might not ever be a mean reversion, we are doomed.

And I might have insinuated before that I am strongly in one camp or the other but I am not completely sold on either. So I employ a mix of both. And that’s because I don’t know the future. No one knows the future but try one must with as much supporting research and evidence. And a bit of intuition.

Thank you for reading and persevering through.

Until later.

Cover image credit – Matthew T Rader, Pexels

So what’s the paper about? Designing diversified portfolios through the use of uncorrelated asset classes as a way to invest optimally with a goal to earn the highest rate of return for a given level of risk. Yes, it’s a mouthful but this simple yet intuitive approach to portfolio management didn’t exist until 1952. At least no one attempted to formalize it and present it in a way he did.

And the ‘right’ amount of diversification is all about correlation or to be more precise, uncorrelation between different investments in a portfolio. Owning stakes in 10 different technology companies is not diversification. Or spreading your bets between say a portfolio that invests in the Dow vs. the S&P 500 index is not diversification. How do we know? Because again, correlation but before we jump into that, a bit about the different types of investments or asset classes you could consider to design your portfolio.

So we know an investment. Buying that stock in the hope that it appreciates in value while it pays dividends (or not) is an investment. Buying that bond that pays interest until it matures is an investment. Or that piece of real estate that provides rental income is an investment. But what’s an asset class? I got my hands on returns data published in the Feb 2019 issue of the Financial Planning magazine by the Steele Mutual Fund Expert for 7 major asset classes going back to 1970. We’ll use this and probably some other data series to do whatever we need to do here.

Those asset classes are Large U.S. Equity, Small U.S. Equity, Non U.S. Equity, Bonds, Cash, REITs and Commodities.

Large U.S. Equity comprises of all large publicly traded companies in these United States. What constitutes large could be different based on the organization assembling that asset class but in general, it means all companies with market capitalization of $10 billion or more. Then there’s an asset class that owns small companies. There’s one that owns non-U.S. companies, there’s one that owns bonds, real estate etc.

Real estate here is not the home you own. Owning that is akin to owning a single company stock or a bond. Real estate here is the entire real estate sector represented by REITs or Real Estate Investment Trusts. What’s a REIT? It’s a publicly traded entity that owns or finances income producing real estate spanning a variety of sectors. For example, that mall you just visited, that could be owned by a REIT. Or that apartment complex where you rent your home? That’s more than likely owned by a REIT. So is that office park or that hospital etc. So a REIT might specialize in one type of real estate but REITs as an asset class gives you broad exposure to every type of real estate. That’s diversification but diversification within a segment of an economy.

And commodities is exactly what it means, owning commodities like gold, silver, copper, oil, wheat, corn etc. You don’t own them physically but you own a stake in a collection of them and someone holds and keeps them safe for you. Yes, you have questions and I’ve got to explain more but for now, just assume that you bought a collection of stuff and held it till 2018 (the last year for which we have data for).

But why not do all this portfolio optimization with individual stocks? Or say bonds? The math is the same so it is doable but what we have here is 49 years of data. And we know a lot can change in 49 years. How much? Take the Dow Jones Industrial Average (DJIA) index for example and compare its constituents in 1970 to the present day constituents.

Only 4 companies that existed in 1970 still remain in the Dow. What happened to the rest? Some got acquired or merged with other companies but most flamed out. And yet the DJIA continued to march on higher from around 800 points in 1970 to 26,000 points today. And that’s not factoring in any dividends. So if you’d done this math in 1970 with the companies of that time and built a portfolio around them, your situation is likely not looking that hot now. And building statistics-based portfolio models requires that the asset class does not vanish which it does in many cases when you build a portfolio around just individual stocks and bonds.

Okay, so we have returns data on these seven asset classes. How can we get a sense of how they have performed over these many decades? We start with the distributions. What do they look like? Are they narrow or wide? Is there any bimodality in the data? All this with this one plot below.

Stacking the plots makes comparisons easy and here’s what we can conclude…

• That faint line in the middle of each plot is the median. Half the returns are below that line and half above. From what I see, small U.S. equity seems to have the highest median returns followed by real estate and then large U.S. equity. I say median returns for large U.S. equity and real estate are almost identical. Median returns for commodities and non-U.S. equity are comparable which are then followed by bonds and then cash. So we should know which one would have generated the most amount of wealth, right? Small U.S. equity for now but we’ll see.
• As long as the returns are randomly distributed, you’d want more of them to be on the right of the 0% line than to the left which happens to be the case with each asset class above.
• Cash and bonds have lower spreads (risk) and lower median returns than other asset classes. That’s expected if you believe that there should exist a risk premium as you take on more volatility with your investments.
• The spread (standard deviation to be more precise) for commodities appears to be the widest but quite a big chunk of the returns happens to be on the left of the zero line when compared to other asset classes. That has implications and we’ll see.

So what made the most amount of money?

Real estate or REITs to be more precise and by a wide margin. And look at the difference in value between that and say small U.S. equity. Almost a double in REITs vs. small U.S. equity even though the median return for small U.S. equity is in fact higher than that for REITs. So why this apparent discrepancy?

You would have sensed it by looking at the spreads but variance or the volatility in returns is what makes that big of a difference. Not that REITs didn’t have years where the returns were negative but they were not as many as small U.S. equity. And look at commodities. You would have made more money being an investor in supposedly safe bonds than in commodities even though there were more years with higher returns in commodities than they were for bonds.

Before we move on, a bit about the median and the mean (average). Median is the half way point when you sort a data series in ascending or descending order. Say you have a data series with 5 data points; 3, 2, 5, 9, 7. The sorted series then is 2, 3, 5, 7, 9. The median hence is the number 5. We know the average or the mean and that is (3 + 2 + 5 + 9 + 7) / 5 = 5.2. Had to get this out of the way because up until now, we have been making statements using the median values but we need to come back to the mean because that is what this is all about.

The summary then for the average or mean returns and volatility for the 7 asset classes under consideration is as shown below.

REITs actually earned just a hair bit higher annual returns on average than small U.S. equities but with 3% lower standard deviation. And an investment in commodities sucked even after earning 9.5% returns on average and thank the volatility number associated with that asset class for that.

So just returns are not enough. Risk adjusted returns is what counts. A 50% drop in the value of your portfolio does not take a 50% return back to break-even. You need a 100% return to get back to what you started out with. So minimizing that drop in the first place means that it would be a lot less harder to come back to where you were in case your portfolio experiences bouts of volatility. Which it will from time to time.

But even investing in the ‘best’ of asset classes did not come without its own issues. Compare for example bonds to large U.S. equities and REITs.

Bonds of course didn’t make you as much money but they allowed you to sleep like a baby as is evident from the drops in value above from time to time for large U.S. equity and REITs as compared to bonds. Another way to calculate the frequency of heart burns you’d have to endure is to compare drawdowns between the three asset classes.

So quite a few times, you experienced gut-wrenching drops in the value of your portfolio in REITs and in large U.S. equity even though in the end, you came out way ahead. And there’s no guarantee of anything. That 50% drop could have turned into a 60% or a 70% drop. That’s the price you paid to make all that money by persevering and hanging on through that for dear life. And that’s if you did but not many do.

If you cannot handle this extent of volatility, you add bonds and cash because as you can see, there’s hardly any volatility associated with either of them. You didn’t make a killing but as stated before, you slept well. But there’s a caveat especially with bonds which we’ll get to later.

So how big of a slice should bonds and cash occupy your portfolio? Or better yet, how can you create a portfolio that lets you choose the amount of heart burn you are willing to endure? And what’s the ideal portfolio mix that gets you the best return with the least amount of risk? We use mean-variance optimization (or as Fredo would say, “I’m smart.”) to attempt to answer such questions.

Say you mix and match different investments in varying proportions and you get portfolios with risk-return scenarios like below.

Risk here of course means volatility (standard deviation). One of those portfolios is marked in red and the other in green. Both delivered the same return but with starkly different risk levels. And of course you’d pick the lower risk portfolio for the same given return.

Or how about the two portfolios below in red and green?

You’d not pick a portfolio that’s red over say green. Why would you.

Or say you are 22, just out of college and in your first job trying to decide what investments to populate your 401(k) with. You could and should decide to go all out on the risk-return spectrum by choosing a portfolio shown in green on the far right below. You don’t quite yet have as much financial capital to worry about volatility but you sure do have plenty of human capital ahead of you that you’d slowly and eventually convert to financial capital. And because you are adding to your savings with each paycheck, a bit of volatility might actually help than hurt as you get more opportunities to accumulate assets at depressed prices.

Or you could be in retirement where you have pretty much exhausted your human capital and are sitting on a boatload of financial capital that you would slowly extract to live on. You’d rather then own the portfolio in green shown on the lower left.

You would have sort of noticed a theoretical upper bound across the risk spectrum in terms of the returns you can expect from combining investments in varying proportions as shown below.

That’s what’s called the Efficient Frontier. Portfolios on that frontier are considered optimal, offering the highest expected return for a given risk. Portfolios that lie below that frontier are considered sub-optimal and do not generally compensate for the portfolio risk you bear.

So now that we’ve got that straight, we’ll use the data we have on those asset classes and assign them weights in 10% increment and create portfolios (7,658 of them in total) to see which ones lie where on this risk-return spectrum.

We’ll pick 5 different portfolios to dig a bit deeper into their contents and to extract any insights if any.

Portfolio_7658 is the highest risk portfolio that’s allocated to and you guessed that right, 100% into commodities. And it’s not an optimal portfolio because it’s nowhere close to the Efficient Frontier.

Portfolio_920 is the lowest risk one that owns 10% bonds and 90% cash. No surprise there.

Portfolio_2823 delivered the highest average return and it’s comprised entirely of REITs. Again, expected as we saw before.

Portfolio_4575 lies on the Efficient Frontier with 10% volatility. It’s allocated to 20% large U.S. equity, 30% to bonds, 40% to REITs and 10% to commodities. A bit decent but not ideal and will explain why (I am not done yet ).

Portfolio_4755 lies on the Efficient Frontier as well but with 15% volatility. It’s allocated to 20% large U.S. equity, 70% to REITs and 10% to commodities. Again not ideal.

So now you start to see issues with formulaic approach to portfolio construction. Some don’t make sense, some are too heavy into a few asset classes and some are overly lop-sided. But just for the fun of it, we’ll see what each of these portfolios did if you’d picked one of them at the start of the period and rebalanced annually to the same allocation you started out with.

As expected, Portfolio_2823 did the best as it was entirely comprised of REITs. Portfolio_4755 did about the same and was more diversified. I would have picked that over Portfolio_2823 any day though that still was REITs heavy.

But the entire premise of all this is that it relies on historical data. You can do all the math you want but we know that thing we hear everywhere we look. And that is, past performance is not a predictor of future results. How would you have known to pick only REITs when you created that portfolio 50 years ago? That’s your entire adult life. You’ve got this one shot to get from point A to point B so taking that chance requires a level of obliviousness that borders on well, obliviousness. Or even if you did pick it ‘right’, what are the chances that you hung on through all the ups and downs that a heavily concentrated portfolio would have exposed you to.

Plus what happened in the past is unlikely to be repeated again, at least not in the same way and that’s all due to what interest rates have done over these last many decades. Take bonds for example.

We know the deal with bonds. As interest rates go down, bond prices go up. And up they have with the relentless bull market in bonds since the early eighties when interest rates were double digits to where they are now. Can the bond bull market continue? Not a chance and hence building portfolios based on historical returns data on bonds will of course not turn out great.

That interest rate tailwind is there for stocks as well.

Why? Say you need to make a capital investment to increase production of whatever stuff you are in the business of making. So you go to a bank for a loan for say a duration of 10 years. The prevailing interest rate at the time is say 10%. Now you make those interest payments on time for the first year and record whatever profits your business generated which of course is net of interest expense. But say the rate declined to 8%. What would you do as a steward of that business? You’d run to the bank to refinance at the now lower rate. You suddenly don’t have as much interest expense and hence your net profit rises. And so does the value of your business or the stock price, all else remaining constant.

And it’s even truer with real estate than with stocks.

Real estate is packaged commodities. It just sits there. It does provide a service and that is shelter but beyond that, not much. It’s not going to create a cure for cancer or reinvent the way how we live or travel or communicate. It’s also an extremely interest rate sensitive asset and likely more so. We see evidence of that with the obvious negative correlation above between rates and an investment in REITs. Can the REIT out-performance continue? Very unlikely.

But it’s not that you completely ignore this theory. You use a bit of it and a bit of your understanding of history, business and the economy and create a portfolio that is just right for you. I’ve shared some of my thoughts on how to go about doing that here and will do more from time to time. But in the end, you are the one who will have to persevere and endure all the ups and downs associated with your choices in the coming decades. Because as Morgan Housel quotes,

Something stupid you can stick with will probably outperform something smart that you’ll burn out on.

So your ability to stick with what you own in your portfolio provided you have justifiable (to you for sure) and quantifiable reasons to own what you own is what will ultimately count.

So long and long.

Until later.

Cover image credit – Quang Nguyen Vinh, Pexels