How To Arrive At A Sky-High Portfolio: Asset Allocation Daily

by: SA For FAs
Summary

Rob Marstrand: ​Consistency in a portfolio beats shooting for the moon.

Franklin Templeton Investments: Across the US population, 43% are projected to run short in retirement, leaving a $4 trillion deficit in what people need to have saved.

Thought For The Day: What is the mechanism by which compounding works its magic on your portfolio?

Small-Cap Growth

​"Small-cap growth, in effect, has lower exposure to the Value factor, and thus a lower expected return. But when we drilled down into the small-cap growth space, we discovered that the bulk of underperformance can be explained by the 'growthiest' of stocks within a growth index…" (Gerstein Fisher)

The Small-Cap Boom

"Small caps tend to underperform large caps in recessions as growth reverses and financing condition tighten, especially given higher debt leverage levels. While we don't see a recession on the horizon in the next few months, we do believe we are in the later stages of the expansion. As such, the days of the small-cap boom may be numbered." (BlackRock)

ETF Expense Ratios

​"It's no secret that expense ratios for ETFs are rock-bottom and heading lower. This is largely due to an ongoing and multi-year price war among ETF giants like Charles Schwab, Blackrock (iShares), State Street Global Advisors (SPDRs), and Vanguard. For example, Schwab's ETF lineup of broadly diversified equity funds carry annual expense ratios that hover between 0.03% [and] 0.07%." (ETFguide)

Volatility and Behavioral Finance

​"Volatility represents uncertainty, and behaviorally, people don't do well with not knowing what will happen. But the reality is you're not going to make much money when everything is predictable. The way financial markets work is more uncertainty means more rewards..." (Columbia Threadneedle Investments)

Why Do People Trade?

"Data suggests most traders fail miserably...In his fascinating blog post, [ Dr. Brett Steenbarger ] reviews data showing many people are so unhappy in their professional lives, that they may actually pursue trading on the glimmer of hope for a better lifestyle." (Jeff Miller's Stock Exchange)

Disrupted Retirement

"So it's really a "haves" versus "have-nots" kind of a scenario and we have a retirement security projection model at EBRI...and what we find is that across the US population, 43% are projected to run short in retirement, and that creates in excess of $4 trillion deficit in terms of what people need to have saved and have for retirement." (Franklin Templeton Investments)

Miracle of Compounding

"Compounding is all about making profits on your profits, by reinvesting your gains as you go along. It makes little difference at first. But, in the long run, even small differences to average annual returns can make a huge difference to the end result...Today I'm going to look at another aspect of compounding which is rarely understood. I'll explain why it's better to have returns spread fairly evenly across a portfolio of investments than it is to have them heavily skewed towards a small subset of the portfolio." (Rob Marstrand)

Thought For The Day

In the above-linked article, Rob Marstrand explains why, by virtue of the power of compounding, that seeking consistent returns is strategically superior to shooting for the moon. I believe he is correct, but before you consign yourself to the "boredom" of investing conservatively, I would like to assure you that, paradoxically, it is this dull sort of investing that enables you to reach for the moon.

Let's try a thought experiment. Sitting before you is a very thin piece of paper - the size of one of those fine silk-like pages found in a Bible, whose thickness is 0.001 centimeters. If you fold it in half, its thickness is now 0.002 centimeters; fold it three times and it's 0.004 centimeters. Fold it 10 times and the paper is now thicker than a centimeter, or precisely 1.024 centimeters.

Does this exercise seem tedious to you? A piece of paper that is barely bigger than a centimeter hardly seems exciting. And if I were talking about a paper folded over 1 million times, well that's outlandish - nobody's got that many folding opportunities. But no, I'm not talking about anything that outlandish. I ask you to consider how big our piece of paper would be if folded just 25 times. If you're really adventurous, figure out how big it would be at 45 folds. You can pause here, with your calculator, if you wish.

At 25 folds, that thin piece of paper is now just short of a quarter of a mile long - nearly as high as the Empire State Building. At 45 folds, that paper's thickness can reach the moon. Fold it just one more time and we're back home to our blue-green planet. The foregoing discussion summarizes a TED-Ed talk by Argentine journalist and mathematician Adrian Paenza.

Hopefully, this discussion gives you something of a sense as to why Einstein is said to have called compound interest the eighth wonder of the world. To be fair, this illustration is not a perfect metaphor for your saving and investing. We're not doubling our invested amount each year and markets take away some of what they give at times. But to me the key points of this illustration are that a) small efforts lead to large accomplishments if we persist in them, and b) small efforts still look small even at intermediate stages (e.g., after 10 folds). It's after we keep at it beyond an intermediate stage that we begin to see our efforts blessed.

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