We cannot give personal investment advice without knowing your personal risk tolerance, but this video may help in developing expectations about how a portfolio generates retirement income and builds enduring family wealth. Thinking through what you expect from you portfolio may help in permanently maintaining a long-term strategic outlook. To start, let’s clarify that we’re talking about performance of a diversified portfolio. Investors commonly expect a 10% annual return on their investments. That’s the return statistic referred most often in the financial media. To be clear, the Standard & Poor’s 500 stock market index has averaged a 10% return for decades. But a diversified portfolio is not 100% in stocks.
This table shows the annualized risk and returns of seven distinct assets for the 50 years ended December 31, 2022. The seven assets were selected because, as a group, they comprise a diversified portfolio, and they have been indexed publicly since 1970. That’s according to Professor Craig Israelsen, who designed this asset allocation model to explain portfolio design to students at Utah Valley University. Using risk and return statistics spanning 50 years is a constructive way to plan for the decades ahead because it covers a lot of American financial history, and history often rhymes and repeats the past periodically.
Of the seven assets, U.S. small-company stocks offered the best return. However, they also experienced the greatest risk, as measured by standard deviation. Think of standard deviation as a measure of the potential aggravation you might experience from an investment. The price volatility of high-risk investments tend to make their historically-higher-returns harder to achieve but hold the potential to give you more aggravation. Depending on your risk tolerance, investors may not be able to stand the aggravation of watching their nest egg decline by 40, 50% or more, and they sell when their losses swell and the outlook is grim. Selling when prices are low is, of course, the opposite of the strategy long-term investors want to implement.
What’s the prudent long-term strategy to be gleaned from the past half-century? The asset class with the best risk/reward tradeoff was large-company stocks, as measured by the S&P 500 stock index. The seven-asset portfolio was much more efficient, offering 90% of the return of the S&P 500 but with 40% less volatility. Aligning your expectations with data in this table may help as the bear market approaches its one-year anniversary on June 13, 2023
Please contact us with any questions or to set up a meeting, and don't hesitate to share this video with people who might benefit from my work.