Careful What You Wish For

We talk frequently about smoothing out a portfolio's ride. A smoother ride hopefully reduces the odds of panicking when the market goes down a lot with the idea being that a portfolio constructed to have less volatility than the broad market will probably be down a lot less during years like 2008 or 2022. There is  tradeoff to being down less which is being up less in years like 2009 and 2023. 

The other day I said that I think it is valid to take a much smoother ride to the same destination keeping in mind the years where that type of portfolio might lag by a lot. Below is a great example of what I mean that takes in seven years.

Portfolio 2 is 100% VBAIX which is a proxy for a 60/40 portfolio. We'll keep names out of it for Portfolio 1 other than to say only 35% is in plain vanilla equities with the Vanguard S&P 500 ETF (VOO). The two have almost identical long term returns but Portfolio 1 has far less volatility. Looked at from the end of the time studied, who wouldn't want that outcome, but what is it like, year to year?

Portfolio 1 has lagged in 5 out of 7 years. By the end of 2021, would you have been able to stick with it? If you stop the study at year end 2021, Portfolio 1 is lagging by 400 basis points per year. You've lagged four out of five years going in 2022 with no idea what markets would do in that year.

It would be difficult to stick with if you're an individual investor because it would be natural to have doubt. It would be difficult to stick with if you're an advisor because of the doubt and the possibility that some portion of your client base would become impatient. 

I mentioned 35% is in VOO, the other 65% is in several alternatives that I would say are all very different from each other and there is no plain vanilla fixed income exposure. If Portfolio 1 works it works because of the attributes of the alternatives. Having that much in alternatives would be trying at times and so maybe not optimal for the reasons outlined above but introducing the attributes of well vetted alternatives in smaller slices can help smooth out the ride some, not as much as in today's post because again that may not be ideal, but some and that can get the job done. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.