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11 Signs You Own the Right Portfolio – The Annotated Version

This post by Jonathan Clements was so good that I thought it deserved some more detail:

1. You’re so well diversified that you always own at least one disappointing investment.

CR: Being well diversified means hating some part of your portfolio. This is the key building block and lesson from Modern Portfolio Theory. In essence, we want to have lots of uncorrelated assets that, by having different degrees of variance, actually reduce the overall portfolio variance when combined. This means that you should always have parts of your portfolio that you hate because you know that those parts are likely to reduce the overall variance at future times when they perform well and other components perform poorly.  If you’re constantly searching for a portfolio comprised of nothing but positive performing instruments then you’re likely incurring costs and risks that are inappropriate.  See, The Appropriate Portfolio vs the Optimal Portfolio.  

2. Your livelihood isn’t riding on both your paycheck and your employer’s stock.

CR: You have to build a comprehensively allocated portfolio. I call this the Total Portfolio approach. That is, you should think of your entire financial life as one big portfolio with your savings portfolio (what most people call their investment portfolio) acting as a buffer to meet future (un)certain spending needs and your investment portfolio acting as the driving source of future income. The best investment you’ll ever make will be in yourself as you generate skills, goods and services that can be sold to other people. The residual income of that output will drive the amount you can ultimately contribute to your savings portfolio over time. Diversify your skills, your assets and your time!

3. If the stock market’s performance over the next five years was miserable, you wouldn’t be.

CR: Nothing plagues investor performance like the problem of short-termism. This is why I love thinking of the stock market like a bond. Too many people think of the stock market on a daily, monthly or annual basis. In reality, the stock market is like a 25 year high yield bond. If you’re well diversified you should be able to construct a portfolio that has an appropriate duration for your specific risk profile. Odds are, if you’re viewing all of this on anything less than a 5 year time horizon, you’re not judging the instruments correctly as a 25 year instrument literally cannot satisfy the short-term needs of someone who views it within daily, monthly or annual increments.  See, How to Avoid the Problem of Short-Termism.  

4. You can remember the last time you rebalanced.

CR: We don’t rebalance because we want to generate market beating returns. We rebalance a portfolio to maintain a specific risk profile. William Bernstein has referred to this as the Rebalancing Bonus.  I’d argue that rebalancing is a bonus not because it will generate better future returns, but because it will help an asset allocator stick with an appropriate plan.  After all, by not rebalancing you risk letting your portfolio become riskier than you want it to be and when that occurs you risk making changes at inopportune times in the future.  You should remember the last time you rebalanced so you know your portfolio is in-line with your risk profile.

5. You have no clue how your investments will perform, but a great handle on how much they’ll cost you.

CR: We can’t guarantee future performance, but we can guarantee future costs. The arithmetic of investing shows us that the average portfolio with higher costs must, by definition, underperform the average portfolio with lower costs.  Costs matter.  See, The Cost Matters Hypothesis by John Bogle.

6. You don’t have any hot stocks to boast about.

CR: If you know the individual stocks in your portfolio well enough that you brag about them then you probably aren’t diversified very well. The well diversified asset allocator doesn’t brag about their individual positions. They brag about owning so many positions that they can’t even begin to name them all.

7. For every dollar you’ve salted away, you have an eventual use in mind—and the dollars are invested accordingly.

CR: The only good investment plan is one that you stick with and consistently contribute to.

8. Jim Cramer? Who’s that?

CR: I love Jim Cramer, but “Mad Money” has nothing to do with building a prudent savings portfolio. If anything, your portfolio should be treated nothing like mad money.  It should be more like “incredibly boring money”.

9. A year from now, you plan to own the same investments.

CR: If your portfolio is changing substantially on a year to year basis then you’re likely incurring the biggest cost of all – the Uncle Sam cost. Taxes are the biggest impediment to long-term performance. You should always seek to enhance your future returns by maintaining a minimum of a 366 day time horizon so you can reduce your tax bill and let more of your money work for you.

10. You never say to yourself, “Wow, I didn’t expect that.”

CR: As Mark Sellers once said, if you take care of the downside then the upside takes care of itself. A good portfolio is built to hope for the best, but expecting the worst. Too many people reach for return without realizing that they’re often reaching for risk. If your portfolio acts in ways that surprise you then you don’t have an allocation in-line with your risk profile. Change it now before the market forces you to change it! There’s nothing more degrading of future returns than having an asset allocation that you can’t stick with over time.

11. You take tax losses when they’re available—but they aren’t available very often.

CR: Every incremental dollar helps. I’ve argued in the past that tax loss harvesting is probably overrated, but that doesn’t mean it shouldn’t be done on occasion. A few thousand dollars here and there could add up to lots of thousands of dollars in the long-term.