The Joy Of Portfolio Boredom
By Roger Nusbaum, AdvisorShares ETF Strategist
Last week I stumbled across an article that favorably critiqued an alternative-strategy ETF for being boring which is its objective. “Boring” is not the stated objective in the prospectus but terms like market neutral, absolute return, low correlation to equities and some others really are about boredom. You can judge for yourself whether a given fund that is supposed to be boring is indeed boring as not every fund will deliver on its stated objective.
The word boring is worth exploring further as it is a very important building block of long term investment success. Ten years ago I wrote a post called Getting Rich Slowly and while I have no idea whether the phrase was a Random Roger original, I think it captures the path that most people want to take in terms of realistic participation in capital markets.
Getting rich slowly or maybe the more modest goal of getting financially comfortable slowly means some pretty plain vanilla portfolio construction. How you get to plain vanilla probably depends on the level of engagement you want to have in markets but from the top down it should start with blending together things like equities, fixed income and a small slice to alternatives (what for years I’ve been referring to as diversifiers) with relatively simply products and/or individual issues in such a way where all three sleeves avoid trading in lockstep but over a long period of time gives a chance for having enough money when you need it which presumably is at retirement.
As we have discussed many times before, one of the biggest impediments to long term financial success is succumbing to emotion at the worst possible times which can mean panic selling your portfolio at a low or repeatedly panic buying hot stocks at their highs at the height of excitement after a pundit just extrapolated past returns on stock market television.
I had the opportunity to moderate a panel that included Dr. Richard Thaler about behavioral economics/finance and one thing he talked about as a very common bias is loss aversion which basically means that pound for pound people feel losses far more than they feel gains. Take that out a little further and it explains why people often react to large declines like they’ve never happened before; the tendency to think this one is different.
The more exciting a portfolio is on the way up, the more “exciting’ it will be on the way down. Investors of course don’t mind excitement when it is resulting in gains but the longer it goes on, the more complacent they become in terms of forgetting the last decline or using hindsight bias to explain away the last decline. Investors don’t want boring until the market peaks out which of course is plenty guessable but not knowable.
If there is no way to know when the market will peak and losses trigger twice the emotion that gains do, then right there is the argument for boring all of the time.
Again the context for boring is not no equities but if you can buy into the idea that an adequate savings rate, proper asset allocation and not panicking are the most important determinants to long term portfolio success then the focus shifts more in line with the true long term objective. You are very unlikely to remember what your portfolio did in the 3rd quarter of 2013 or what the market did that quarter, without looking, because it doesn’t matter in the context of your long term financial plan. An exception would be if that was the quarter you retired. The only other way some random calendar quarter from your past is likely to matter is if you made some sort of catastrophic mistake like selling out in the first quarter of 2009.
The conclusion for me is a diversified portfolio of equities that at the very least offers decent upside participation, fixed income exposure that offers some ballast to normal equity volatility and a little exposure to diversifiers, as I said above, that hopefully allows for managing volatility and correlation such that the potential for panic is at least partially mitigated.