With the domestic stock market seemingly immune to the COVID-19 pandemic and our national deficit growing beyond the imaginable just months ago, it seems appropriate to share a few words on the concept of risk. Despite decades of wealth managers harping on the need to diversify client portfolios, too many are set up to implode when the financial markets shift.
Investment Management 101
Diversification across all asset classes is a critical risk management tool. If done properly, your portfolio should consist of an asset mix specifically suited to your age + associated risk management plan. The goal is to reduce risk, measured by volatility, while improving stability and total return.
So, how risky is your portfolio today? That depends on how many asset classes can be found. Is your portfolio limited to large/small/domestic/international stocks? You might want to rethink that!
Ideally, you’re following the Yale Model, sometimes referred to as the Endowment Model, developed by David Swensen and described in his book, Pioneering Portfolio Management. The general idea is to divide one’s portfolio into five or six roughly equal parts and invest each in a different asset class. Central in the Yale Model is broad diversification and relatively heavy exposure to asset classes such as private equity and real estate compared to more traditional portfolios. Swenson’s method was particularly revolutionary at the time, as it warned readers against “liquidity,” explaining that it comes at a heavy price in the shape of lower returns. Think public vs. private investment vehicles here.
So, what is an advisor or CIO to do? Seek out investment options that can help bring greater diversity to your portfolios. The very best advisors never stop learning and are always seeking ways to improve investment results. The time is now.