Great Investors Don’t “Rubber Stamp”

By |2018-12-20T16:24:33-04:00April 18th, 2018|Blog, Great Investors Series|

“We don’t make investors more successful by giving them portfolios that pander to their fears. We don’t change the portfolio, we change the person – if he will permit us to do so. We do that by leading him to better temperamental values, chief among which are 1. Tolerance for ambiguity and 2. Resilience.”
-Nick Murray

In last month’s article, I shared some wisdom from the greatest investor of all time. This month, I discuss a new way to think about “asset allocation.”

To start, let me share that I am proud to announce the publication of my new book, “Clarity: How Popular Culture is Misleading You About Successful Wealth Planning and What to Do About It.”

While I was writing my book, I surveyed a group of clients and friends about some of the key wealth planning issues that were causing them confusion so that I could address them in my book. There was one response that I found particularly interesting: this “rubber-stamped” approach of being more conservative with assets as you age stops making sense if you have more than you will ever spend.

Conventional Wisdom: The Rubber Stamp Approach

The traditional approach to asset allocation advice is largely rooted in the desire among the financial media, financial advisors, and the firms they represent to pander to the fears of the investing public. Chief among these fears is the irrational fear of equity ownership.

If you open an issue of your favorite personal finance periodical, turn on CNBC, or walk into the office of your neighborhood brokerage firm, the odds are that you will be advised to fill out a “Risk Tolerance Questionnaire” as the first step in the process of designing your investment policy. You will have to answer a list of questions about your tolerance for the loss of your investment principal. These questions are generally asked before any discussion of your overall situation, your goals, liquidity needs, or your current asset base. Next, you will be “rubber stamped” with an Investor Type and provided with a set of rules for how your portfolio should be allocated between stocks and bonds:

  • You are a “Growth and Income” investor. You should allocate 60% to stocks and 40% to bonds.
  • You are an “Aggressive Growth” investor. You should allocate 80% to stocks and 20% to bonds.
  • You are a “Conservative” Investor. You should allocate 40% to stocks and 60% to bonds.
  • Or, God forbid, you should take 100 minus your age to determine your optimal allocation to equities.

The goal of this process is to help you match your portfolio allocation policy to your tolerance for risk and to help you to formulate a plan to maximize your “risk-adjusted return.” This approach tends to focus on the investor’s tolerance for risk, as if the reduction of risk is the only goal of the investing process and the job of a financial advisor is to deliver his client the portfolio that produces the highest return possible with a level of risk the client can stomach.

What if the “reduction of risk” is not really the most important goal of the investing process? What if the real goal of investing is to maximize return over the investor’s time horizon so that they might accumulate the wealth necessary to achieve their most important lifetime goals?

Asset Allocation Strategy: The “Time-Based” Approach

Most asset allocation “rubber stamp formulas” are based on an attempt to produce “risk-adjusted returns” for clients. Many advisors are seeking to dampen volatility (thereby eroding return) so that investors won’t panic and sell their equities during volatile times.

However, Great Investors don’t seek to “dampen volatility” by limiting equity exposure so that they can sleep better at night. Instead, they accept that volatility and return are forever linked, and they work to develop the temperament and emotional resilience to sleep at night, despite any volatility.

At Concentus, we have developed a simple approach to asset allocation that focuses on the goal of maximizing returns over time, while providing realistic protection against the “risk of loss,” which we believe can happen primarily as a function of investor behavior.