Sticking to your plan is the single biggest factor determining successful investing.
In my 20 years’ experience as a financial advisor, I’ve learned that even if there were such a thing as the “perfect portfolio,” choosing the asset allocation that’s most likely to allow you to adhere to your financial plan is even more important than the allocation itself.
Because adhering to your plan should give you the greatest chance of achieving your financial goals, it’s critical that your plan not assume more risk than you have the ability, willingness or need to take. It’s equally critical you don’t invest in any strategy that contains risks you don’t understand. The reason for this warning is because any asset class or strategy can experience very long periods of underperformance.
If you don’t understand that risk, you’ll likely make the mistake of confusing strategy with outcome. That could lead you to abandon your plan when a long period of underperformance occurs.
A Real-World Example
The following example makes this point crystal clear. From 1969 through 2008, U.S. large-cap growth stocks (specifically, Fama-French large growth stocks ex-utilities) returned 7.8 percent a year. Long-term (20-year) Treasury bonds returned 8.9 percent a year over that same period, meaning large-cap growth stocks underperformed for 40 years.
The question is: Would you have abandoned your plan if you had invested in these stocks? If so, consider this: From 2009 through 2013, the returns were 23.1 percent a year for large growth stocks and just 1.9 percent a year for 20-year Treasurys. This difference was so great that for the full 45-year period, large-growth stocks now outperformed 20-year Treasurys: 9.4 percent versus 8.1 percent. Of course, the only way you earned that higher return was to patiently wait out the 40-year period of underperformance.
This point holds just as true for the low-beta/high-tilt portfolios my colleague Kevin Grogan and I recommend investors consider in our book, “Reducing the Risk of Black Swans.” What the New York Times called the “Larry Portfolio” basically limits the equity portion of the overall portfolio to small value stocks.