Building and designing a successful investment portfolio is subjective, as each investor has a different definition of achieving success. Because success is articulated differently for investors, it’s plausible to see how the portfolio building process can be part “art” and part “science”. Of course, if it were only science it would be much easier because we would know definitively the inputs to consider in our equation, meaning we could precisely anticipate the output. Two atoms of hydrogen and one atom of oxygen, and voila, you predictably get water! But, the reality of stock, bond, real estate, and other financial markets is that they fluctuate in a way that reflect the instincts and proclivities of, in the words of economist John Meynard Keynes, “animal spirits”.
You may have noticed in the last quarter of 2018 that stock market values for indices including the DOW, S&P 500, and NASDAQ all dropped significantly from their October the 3rd highs. Yet, everyone from the informed public to policy makers knew the same current and relevant information to make educated and informed investment decisions. Despite that shared knowledge, many had different financial outcomes.
The “science” part of portfolio building is important. Having an understanding of which direction interest rates are headed, the unemployment rate, other economic trends, as well as what government stimulus or spending is likely to occur is a solid foundation to building a successful portfolio.
But, the “art” of building the portfolio is an unparalleled and equally critical component to developing the balance that will maximize your investing experience. The “art” of it begins with a real understanding and introspection of what risk and willingness for loss you are willing to accept without deviating or altering your investment course.
Literature and pundits will tell you to “stay for the long term” and “weather the storm,” or to “ride it out”. But, I know you. You are like Keynes described when he said, “emotions ostensibly influence and guide human behavior,” meaning, you’ll “stay the course” as long as you can stand it, but when the markets really decline you’ll effectively say “mercy, I’ve had enough” and likely choose to sell. Selling at the nadir of a market decline is really the moment when you should be buying. But too often, emotion dictates, and “fear” and “greed” drive ultimate decision-making.
While everything is clearer in hindsight, if you allocate the portfolio in a way that has less risk to begin with, then you can handle the decline in stock market values because you won’t feel the same pain when you open your month-end statement. That is the “art,” to know just what you can handle and not to accept more risk, no matter how tempting the returns are in the stock market or how much money your next door neighbor professes to have made in the stock he or she told you about.
It’s not black and white; it really is part art and part science. And, the sooner you’re ready to blend the two together, you’ll find an allocation of investments that are just right for you. Not too hot, not too cold, but just right. The “Goldilocks” economy is one where it’s not so hot that it causes inflation, and not too cold to lead to recession, but still operating with full employment and economic stability. We were in that environment for years, but that is a story told better by the artist who wrote it.
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