Think about Your Portfolio

May 09, 2024

Most professions bear their own unique social burdens—people looking for advice in casual social settings. CPAs often get random questions about taxes. Attorneys are pumped for free advice on legal matters. My son-in-law is a dermatologist and Mohs surgeon. You can probably imagine the cringe-worthy moments he endures as people seek his opinion about moles or skin conditions at social events.

As a financial advisor, my social burden is relatively light. When people find out what I do for a living, they often want to talk to me about where the market is going, or a stock they recently purchased. These conversations are usually pleasant, and I enjoy them quite a bit. But for some, their interest dies when I ask about their investment portfolio. What do they like about it? How is it working for them? It’s not a sales pitch; I’m genuinely interested.

I’ve discovered that many people don’t spend much time thinking about their portfolio. To them, a portfolio is like a giant bucket, a mishmash of all the random stock tips they garner over the years. They give little thought to how much should be invested in a given stock, or how much should be allocated to an asset class. They don’t really consider the risks involved. Instead, their portfolio strategy is to ride winning positions until they start losing, and then keep riding them, hoping they eventually win again. This haphazard, emotional approach has very little chance of long-term success. No wonder numerous studies show individual investors consistently perform well-below market benchmarks.

If you want to be a successful investor, you simply have to think about your portfolio.

Large financial institutions have developed strategies for managing large portfolios. Some of the largest portfolios on the planet are managed by insurance companies and public pension funds,. Every portfolio under their management has a clear purpose. They hire armies of actuaries to help them understand the liabilities their portfolios are intended to fund. Once that purpose is understood, portfolio managers design portfolio strategies suited to that purpose. Understanding the portfolio’s core purpose helps managers make disciplined decisions.

Much like insurance companies or public pensions, you need to clearly define the purpose of your portfolio. Financial planning can help you bring all the pieces of your financial life together into a unified framework, showing exactly how your investments fit into your financial life and what you need your portfolio to do. It will also show you how long your portfolio needs to last, and what kind of return it needs to generate. This projection helps you understand the kinds of risk you should take, or how much risk is appropriate.

Risk is a fact of life for every investor, but most investors have a limited understanding of it. More than anything, risk is the likelihood of losing multiplied by the magnitude of a potential loss. In other words, risk estimation is all about probability and degree.

Some risks are obvious. If someone pays you a million dollars to play a round of Russian roulette, the downside and probabilities are clear. But other risks may be harder to see. What if someone offers you an investment with consistently high returns, no matter what the overall market is doing? What if they have a successful track record stretching back nearly twenty years? What if they have testimonials from hundreds of satisfied clients? Would you trust your life savings to such a scheme? The victims of Bernie Madoff did just that, completely blind to the risks they were taking.

Inflation represents another subtle risk. Even very low levels of inflation can do tremendous damage to an unprotected portfolio over long periods of time.

Efficient market theory says an investment’s price reflects the market’s judgments about risks and opportunities inherent to that particular investment. Likewise, modern portfolio theory says portfolio return and risk are tightly linked. You can design a portfolio with the maximum expected return for a given level of risk. Conversely, you can build a portfolio that minimizes risk for a given level of expected return.

Thinking about your portfolio means carefully weighing the risks and returns of your investments, given your portfolio’s purpose.

 Please see important disclosure information here.

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to