Reading the financial headlines, you can gather more suggestions for how to organize a portfolio than any individual could ever hope to implement. Whether it’s “Ten Stocks to Buy Now” or “Protect Your Portfolio from the Next Crash,” the financial pundits have no shortage of advice for investors. It’s no wonder that many investors have a hard time committing to a long-term strategy, given the amount of often-conflicting and always urgent-sounding advice out there.
But there’s a better way to construct a portfolio than following the “guru du jour” or trying to time the markets based on the predictions of the pundits. In fact, years of financial research and scientific evaluation have revealed that certain aspects of financial assets—dimensions, if you will—can be expected to drive returns for investment assets over the long haul. Aligning your portfolio design and asset allocation with these dimensions will, over time, often provide superior returns without incurring excessive trading or management costs.
When considering stocks or stock mutual funds, there are three main dimensions to consider: size (large capitalization vs. small capitalization), value (stock price relative to book value), and profitability (operating income). The premiums derived from these dimensions has been consistently demonstrated in data going back 90 years and covering more than 40 countries. By aligning an equity portfolio to overweight stocks with higher expected returns along these three dimensions, an investor can generally expect to receive above-market returns over time.
As with equities, fixed-income (debt-based) securities exhibit dimensional characteristics, also. In this asset class, the dimensions align according to duration (time to maturity), quality (creditworthiness of the issuer), and currency (nation of issuer). Once again, by constructing a fixed-income portfolio in a way that overweights assets with superior expected returns, investors may achieve advantages in portfolio performance over time.
The Global Advantage
Additionally, research has shown that in any given year, one market or the other may provide superior returns. Though the United States represents about half of the global equity market capitalization, that leaves a significant amount of opportunity beyond the borders of the US. Because it is impossible to predict which global market will demonstrate the best growth in a given year, investors who incorporate international diversification in their portfolios may be expected to capture superior returns, over time, than those who focus solely on opportunities available domestically.
Of course, not all investors should hold equal amounts of all types of securities. For some investors, a portfolio weighted more heavily toward equities will be more appropriate for their goals and risk tolerance. For others, to whom preservation of capital and maintenance of current income are paramount, a higher allocation to fixed-income assets may be more appropriate. Because each investor is unique—including goals, tolerance for risk, and available resources—asset allocation must be dictated by the individual investor’s distinctive characteristics and priorities.
Allocating assets to an investor’s best advantage must also include attention to limiting expenses. Generally, portfolios constructed along the dimensional lines discussed above will not benefit from high-velocity, attempts to take advantage of short-term market trends—which are impossible to predict with any consistency, anyway. Thus, dimensionally oriented portfolios will generally experience much lower fee and management expense impact on portfolio value.
At Empyrion Wealth Management, we work with family stewards and others to design and implement asset allocations poised to capture the dimensions of return that can lead to superior long-term results. Most importantly, we are a fiduciary advisor, which means that every recommendation we make places the client’s interests foremost. To learn more about the value of evidence-based portfolio design and investment management for the financial future of your family, click here to read our white paper, “Family Stewards.”
Stay Diversified, Stay YOUR Course!