The 92% that matters most
I entered my internship at Landaas & Company eager to observe and learn from the investment professionals. As I sat in on meetings with clients, I noticed clients were asking a lot of questions about daily news reports and how those events affected their portfolios.
I watched advisors as they listened to the clients and addressed their concerns. The discussions always included a review of asset allocation and why the client’s portfolio had the particular holdings it contained.
One of the advisors I sat in with used this analogy with investors while they sat in his office, overlooking Lake Michigan: “I am here to give you the best boat, that being a personalized balanced portfolio.”
He reminded clients about the strategy of diversifying assets to take care of their long-term financial needs.
His approach is in line with economist Harry Markowitz’s Modern Portfolio Theory, which advocates investing in various asset classes to balance risks and rewards to optimize long-term performance.
Other research has shown that strategic asset allocation accounts for approximately 92% of a portfolio’s variable performance over time. The remaining 8% has to do with such issues as market timing and individual investment selection, fine-tuning one’s portfolio in response to short-term market volatility.
The daily volatility that I heard many investors ask about may be because they are more likely exposed to it every day in the news.
The paradigm of how people get news has been shifting. The Pew Research Center reports that 23% of Americans got their news from a newspaper in 2012, that’s less than half the rate of 47% in 2000. Even viewers of cable news have been on the decline, with other news outlets, such as social media sites, emerging.
But the newer news sources tend to rely on shorter messages that lack depth and analysis. Art Rothschild, vice president at Landaas & Company, sees this shift heightening his responsibilities to help investors filter the “noise” they hear, to keep it from distracting from the purpose of their custom portfolios – the strategic asset allocation that researchers say accounts for 92% of performance.
Trying to time the markets and pick the right stocks and other shorter-term strategies can increase the emotions of fear and greed in investors. That 8% portion of performance can motivate investors to do things that make them feel better for the moment but mislead them to make impulsive decisions that could adversely affect their long-term financial goals, says Brian Kilb, executive vice president and chief operating officer at Landaas & Company.
“My job is to make clients do the thing they might not want to do but that they need to do in order to have what they want in the long run,” Brian says.
One advisor keeps data handy to show investors the power of portfolio diversification. According to the data, compiled by J.P.Morgan, a diversified investment portfolio (55% U.S. stock, 15% foreign stock and 30% bonds) generated an annualized return of 7.4% since 1994. Yet the average investor received annualized returns of only 2.3% over roughly the same period.
Investors can sabotage the long-term results of investments if they become too caught up in trying to execute the actions that make up that 8% of portfolio performance. By moving money around too often, they tend not to give their portfolios the time needed to fully reap the rewards.
The uncontrollable and unpredictable nature of that 8% portion of a portfolio’s performance can be overwhelming at times, the advisor says. He acknowledges that when he shares with clients his analogy of their personalized balanced portfolios as “the best boat” he can provide.
“Even the best boat in the world won’t get you across the lake without wind,” he says. “And I can’t control the wind.”
The sailing may not always be smooth, but by focusing on what they can control – carefully maintaining their customized balanced portfolios – advisors can give clients their best chance of getting to the other side of the lake. Investors benefit from paying attention to the 92% of portfolio performance that really matters instead of dwelling on the other 8%.
“As is true of the sailor,” Paul says, “investors too must have patience and keep focused on the long-term destination.”
Lauren Seubert was a summer finance intern at Landaas & Company. She is a junior at the University of Notre Dame, where she is majoring in economics and applied mathematics.
(initially posted Aug. 30, 2013)