June 25, 2020

The Perfect Portfolio

All my life, I’ve been in search of the perfect portfolio.

What is the perfect portfolio?

It is one that grows a little bit every day, with almost no drawdowns and no volatility, providing a healthy return over risk-free US Treasuries.

Is it attainable?

Not really, though this is the goal of active money management. The big multi-strategy hedge funds try to achieve this with portfolio managers in different “pods” pursuing different strategies, balancing out the gains and losses.

But this is the holy grail. And this is what happens to most people pursuing the holy grail:

Indiana Jones and the Last Crusade; Source: stephenthelawyer.com

The actual grail is supposed to bring you eternal life. The fake grail takes it away from you. Kind of like your investment returns.

Behavioral Aspects

The goal is not to pick the portfolio that returns the most. Those are the fancy, gold, jewel-encrusted cups from Indiana Jones and the Last Crusade... where the true grail was a plain, sturdy cup.

These days, people focus on returns to the exclusion of all else. They want the portfolio stuffed with aggressive growth mutual funds that return 12%. They don’t think for a moment about risk.

You have to consider risk, in addition to return.

This gets into the behavioral aspects of investing. I like to say that with any trade you make, at some point, you will be tested. You will experience losses and question your motives for the trade. You will be frightened. You will despair.

The goal in building a portfolio is to not be frightened—to “set it and forget it,” checking in on it once a year or so.

If you only invest for returns without considering risk, there is a pretty good chance you will experience a drawdown severe enough that you will contemplate dumping the position—perhaps at the worst possible time.

Volatility leads to stupid decisions. And your decisions will get worse the more volatile your portfolio is. People don’t do this with money market funds.

There is a fine line between investing and gambling, and a lot of what is going on right now is gambling. There’s a place for rank speculation, but not with your retirement savings, and not with your core portfolio. You can set aside 10% of your assets for “play” money, if you want.

It may seem obvious, but you shouldn’t gamble with money you can’t afford to lose.

One thing I have always been good at—and I don’t know why—is building a portfolio that minimizes volatility. This is the core of absolute return investing—taking a number of individual trades that on their own, should have alpha, but when combined, actually improve the risk characteristics of the portfolio.

Personally, I have a portfolio with a number of highly risky positions, but the portfolio itself is not all that risky.

Of course, during times of extreme stress, correlations go to one, and all hell breaks loose, but this is why you have a hedge.

The Solution

I’ve spent a lot of time thinking about the perfect long-term portfolio for everyone.

It’s not 100% stocks, for obvious reasons.

It’s not 80% stocks/20% bonds—still too high on stocks.

Even the old 60% stocks/40% bonds portfolio gives you too much risk.

We spent some time last year talking about the 35/65 portfolio, which is the combination of stocks and bonds with the highest Sharpe ratio along the efficient frontier. There are reasons why 35/65 doesn’t work as well anymore, including ultra-low interest rates.

So you have to think about bringing other asset classes into your portfolio. Because stocks and bonds only represent a small part of the investable universe.

In particular, you want to build a portfolio that gives you some positive exposure to inflation, which the 35/65 portfolio does not.

The inflation/deflation argument is all over the place right now. But I can tell you, the government and the Fed have been doing things for the last few months that are not encouraging if you’re worried about inflation.

You want to build a portfolio with a high Sharpe ratio—this gives you a favorable relationship between risk and reward. A portfolio with a high Sharpe ratio will use risk more efficiently. Portfolios with high allocations to stocks use risk very inefficiently.

And most importantly, you want to build a portfolio with a very low max drawdown—this is the maximum loss that the portfolio might sustain over any given year. This is where people are tested—an 80/20 portfolio will incur breathtaking losses in periods of market stress.

So I created something called The Awesome Portfolio that does all of these things for you, and more. It’s hard to oversell how revolutionary this is—it has the potential to change your life.

There’s far too much to cover here. So I wrapped up all the details for you in a new special report—The Awesome Portfolio.

Inside you’ll find easy-to-follow steps you can take right now to minimize the volatility in your portfolio, minimize your risk, and boost your long-term profits... along with 5 investments to quick start your personal Awesome Portfolio today.

As a special thank you for reading The 10th Man, I’m offering you one of the first copies of The Awesome Portfolio at over 50% off the retail price. Click here to access your copy.

Jared Dillian

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