When it comes to investing, we face a problem today that didn’t exist 40 years ago: there are too many options. Are you aware that there are over 5,600 companies on the U.S. exchange to invest in? On top of that, there are roughly 3,000 ETFs and 8,000 mutual funds to choose from. The question many people ask is, why are there so many investment funds?
The main reason, sadly, is marketing and investment companies looking for more ways to make money. If you’re like me, we need to narrow down our options to pick a path for an investment strategy. But before looking at the different investment strategies, let’s create a baseline for our discussion.
Setting the Baseline
Consider this: if you invested $1,000 in gold in 1980, it would be worth $2,430 today. That same $1,000 invested in the S&P 500 would be worth $110,000. But if you had invested $1,000 in Microsoft in 1986, it would be worth $3.27 million! Granted, if you invested that same amount in Blockbuster, you might have enough to buy yourself some popcorn at the movies.
Unless you’re Marty McFly, we can’t invest in the past. However, there are key takeaways that can help us with our future investments, which leads us to the main question: What is the perfect investment strategy for the perfect portfolio?
Exploring Common Investment Strategies
To answer that, we need to discuss some of the more common investment strategies available. I’m using the term “perfect” in a tongue-in-cheek way, but let’s explore the topic together.
Warren Buffett’s Approach: Buy and Hold & Value Investing
Let’s start by talking about Warren Buffett’s strategy, which combines two major themes: a Buy-and-Hold strategy and Value Investing.
Buy and Hold Strategy involves holding investments for years or possibly decades. If you’re willing to do that, then it needs to be with high-quality companies that can weather any form of storm and still be around for decades.
Value Investing involves searching for stocks that are undervalued by the market and buying them at a discount. The father of value investing is considered to be Benjamin Graham, who wrote the classic investment book The Intelligent Investor and mentored Warren Buffett. Graham taught that investors should focus on companies with a low price-to-earnings ratio, high dividend yields, and a strong balance sheet.
That sounds good in theory, but most investors like you and me don’t have time to research and understand if companies are undervalued or not. When we unpack the Buffett approach, most of us can follow the Buy-and-Hold aspect—that part’s easy. However, the Value Investing aspect is much more difficult because of the expertise required to fully understand a company’s value and whether or not it’s undervalued.
Buffett’s Advice for His Wife’s Inheritance
In a letter to Berkshire Hathaway shareholders, Warren Buffett directed that when he dies, the trustees are to invest his wife’s inheritance into 90% stock index and 10% short-term government bonds. Essentially, this is a two-fund portfolio that is heavily weighted in stocks. This goes against the common advice from financial advisors to take 100 and subtract your age, and that number is the percentage you should have invested in stocks.
For example, if you were 60 years old and you subtracted it from 100, you’d get 40. According to this philosophy, you’d have 60% in bonds and 40% in stocks—a very conservative approach. So why would Buffett break away from this common advice and have such a different strategy for his own wife?
Understanding Portfolio Failure Rates
To understand why, a Spanish finance professor ran a study where he looked at a baseline investment and broke it out into multiple points over 114 years to see which would do better during recessions and hard times, where only 4% was withdrawn each year. Then he reviewed the results of Buffett’s 90/10 split versus multiple different splits to see which had the highest rate of failure. In this case, failure means running out of money within 30 years.
As we can see, the highest failure rate was with 30% stock and 70% bonds, and the one with the lowest rate of failure was the 60/40 split. The potential gain from stocks far outperforms a heavy-handed bond mix, and Buffett’s 90/10 split for his wife had a very low rate of failure. Granted, she’ll have billions of dollars and not have anything to worry about. But for the rest of us, the main purpose of creating an investment strategy is to maximize growth while also having the diversity to minimize risk.
The Shift to Alternative Investments
As we all experienced in 2022, the impact of record inflation and increasing interest rates caused most investments to decline. In this situation, money managers began to change their asset allocation to include alternatives and physical assets that hold their value during market dips.
In a recent Bloomberg survey of money managers representing some of the richest families, their findings included a focus on diversity and safe havens, especially collectables with the greatest allocation to art. Case in point, contemporary art has doubled the S&P 500’s total return over the last 26 years, and in 2022, the art market had its strongest auction season of all time.
Historically, the art market used to be hard to enter, but with Masterworks, you can diversify your portfolio with multi-million dollar paintings from legends like Picasso, Banksy, and Monet for just a fraction of their total value. Masterworks has built an impressive track record for its exits, all of which are profitable. With those results, Masterworks has seen over 700,000 investors try to gain access. There is a waitlist, but I’ve reached out to them to give you all priority access to their latest offerings—just click the link in the description below.
Index Investing Strategy
The next area to cover is the Index Investing Strategy, which involves investing in a broad market index such as the S&P 500 rather than individual stocks. This strategy became popular by John Bogle, who happens to be the founder of the Vanguard Group. He believed that most investors would be better off investing in low-cost index funds rather than actively managed mutual funds.
These index funds seek to match the performance of an underlying index and they have much lower fees than actively managed funds. There are a lot of studies that suggest that index funds perform as well, if not better, than actively managed funds. But for some reason, actively managed funds are far more popular. I believe it’s because, psychologically, many of us believe that an actively managed fund is going to have experts who can find better deals and uncover more opportunities, even though the results for the index funds prove that completely wrong.
The Bogleheads’ Philosophy
With regards to Bogle, his followers are referred to as Bogleheads—and that’s not to be confused with bobbleheads. Some follow more of an 80/20 split, where they have 50% in domestic index funds, 30% in international indexes, and 20% in bonds, making it a three-fund portfolio. There’s another sect of Bogleheads that has more of a two-fund portfolio with a 60/40 split.
Most investment strategies have nearly the same themes:
- Buy and Hold: Minimize your turnover by investing for the medium and long term.
- Diversify Assets: Reduce your risk by having domestic and international stocks along with bonds.
- Don’t Try to Beat the Market: Invest in index funds to keep up with the market, not beat it.
- Adjust Over Time: Change your portfolio mix as you get older to minimize your risk.
Other Notable Strategies
Within these strategies, I’ve talked about the Bogleheads and Buffett, where they may have had a two-fund or a three-fund portfolio, but there are a lot of different strategies.
The Coffeehouse Portfolio
The Coffeehouse Portfolio, created by Bill Schultheis, is discussed in his book The Coffeehouse Investor. The intent is to create a strategy that is so simple that you could do it while sitting down and having a coffee. The strategy is a 60/40 split but emphasizes a diversified asset allocation, including REITs.
The Swensen Portfolio
Next is the Swensen Portfolio from David Swensen, who happened to be the chief investment officer at Yale University’s endowment. His strategy is a 50/30/20 split, where 50% is stock, 30% is bonds, and 20% is real estate in the form of REITs. One of the major drawbacks of this strategy was that during the 2007 recession, this portfolio had about a 40% drop due to the heavy investment in real estate.
The Permanent Portfolio
There’s another strategy called the Permanent Portfolio, whose sole purpose is to provide steady returns with very low volatility over the long term. An investment analyst named Harry Browne came up with this strategy in the early 1980s. It consists of:
- 25% stocks
- 25% bonds
- 25% cash (in the form of treasury bills)
- 25% gold
It’s a very stable strategy but doesn’t grow as much as the more common 60/40 split.
Comparing Strategies: Which One Is Best?
If you’re anything like me, your head is spinning with all these different strategy options. When it comes down to it, which one is best? Let’s compare them all at once.
- Permanent Portfolio Strategy: Average return of 7.4% since 1990.
- Swensen Portfolio: Average annual return of 8.5% since 1990.
- Coffeehouse Strategy: Comes in at 8.5% since 1990.
- S&P 500: Average annual return of 9.9% during the same period.
- Microsoft: Average return of 19.4% during that same time.
Now, I am not trying to condone investing in a single stock like Microsoft—that’s more like gambling than investing. Investing in a single stock can be risky; for example, if you had only invested in Blockbuster, you’d be broke. What I am saying is that investing can be as complicated or as simple as you want it to be.
Yes, all of those strategies underperform the S&P 500 on average and they require a lot more work, but due to the diversification, they weather hard times much better than the S&P 500.
Understanding Market Corrections
An important point to consider is that the market has a correction of about -10% on average every 1.2 years. Since World War II, we’ve had a recession on average about every five years, and it takes the stock market roughly 27 months to recover from those losses.
This is a crucial point because wherever you’re at with your investments, you need to ask yourself if you can afford to lose 27 months of your investments to a recession.
Crafting My Investment Strategy
Next, I’m going to walk through how I’m approaching my investment strategy over time. For the most part, I’m taking Buffett’s stance with 90% stock and 10% in fixed-income assets—not necessarily just in bonds but in items like treasuries, bonds, CDs, etc.
For my portion of stocks, I’ll have them across several index funds and a few individual companies that are domestic. In addition to that, I’m going to have a small percentage in international stock indexes. The line between domestic and international is completely different today than it was 30 years ago when most of these strategies came about. Some could argue that stocks like Apple and Microsoft aren’t simply domestic since they generate so much of their value overseas. But with some dedicated investments internationally, the intent is that if the U.S. is in a recession, then the foreign markets hopefully aren’t.
For context, since World War II, we’ve had five global recessions, but in that same time frame, we’ve had twelve recessions within the U.S., which is roughly a 42% chance of an overlap. That’s the power of having dedicated international stock within your portfolio.
Rebalancing and Tax Considerations
A point that I didn’t cover earlier is there’s an underlying issue with locking yourself into a dedicated split of, let’s say, 60% stock, 20% real estate, and 20% bonds. Following that structure to a T means you need to rebalance your portfolio once a year to keep those balances. If you happen to rebalance within a tax-advantaged account like an IRA, then it’s really no big deal. But if it’s not in an IRA, then you’ll be paying capital gains tax on rebalancing, and you’re going to be losing some of your investment.
Instead, I’m keeping with the approach of investing on the front end with a mix of 90/10, but I’m only going to rebalance it in my tax-advantaged account as needed.
Planning for Market Downturns
At Amazon, they teach you the concept of always working backwards to solve a problem. For me, the problem to solve is: How do my investments survive a recession where it takes an average of 27 months for the market to recover?
In simple terms, I want my fixed-income assets to give me enough of a buffer to provide funds if I need them for three years. I’m rounding the 27 months up to three years just for simplicity. Making it through 27 months to minimize your risk is less important in your 30s, 40s, and early 50s. When I’m about 5 to 10 years out from retirement—of actually pulling out funds—then I want to ensure that I have enough in my fixed income assets to weather a three-year storm.
If I review my expenses and know that I need $35,000 a year, then over three years, that’s going to be $105,000 that I would want in my fixed income assets for potential liquidity. If I have $500,000 in my total portfolio, having $105,000 in bonds or fixed-income assets would be 21% bonds and 79% stocks.
That’s if I had the intention of selling my fixed-income assets as needed. If you invest in bond ETFs, they often pay a monthly dividend that you can use to subsidize your living expenses. However, those dividends are around 3%, and if I had $105,000 invested there, it would give me roughly $262 a month in dividends. But that wouldn’t be enough to cover all my expenses during a bear market.
Overall, I would plan to sell some of my fixed-income assets over the three-year period as needed, and once the market corrects itself, I would then begin to rebalance my portfolio to have the right fixed-income asset mix just as before. This happens to be my approach for how I’m planning my portfolio, but yours may be completely different.
Final Thoughts: Is There a Perfect Investment Strategy?
Some of you out there are extremely savvy with your investments, and I know that many of you would also take the approach where you may leverage dividend stocks to give you added cash flow to make up for your fixed-income assets—and that would be a fantastic approach as well.
In going back to the original question of what is the perfect investment strategy and portfolio, I think we’ve probably all come to the same conclusion: There is none. But if you take the time to create an investment strategy—any strategy—then you’ll probably do just fine.
Each person needs to take into account their situation, their risk appetite, what they have for time the horizon to retirement, and how much they have invested versus their total expenses. The worst thing you could do is not have any strategy at all because having no strategy will meet low expectations every time.
The Secret Money Rules That Changed My Financial Life
Thank you for reading.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Always consult with a financial advisor before making investment decisions.