Cooking up a great investment portfolio is easier than you think – just so long as you don't pay too much for the privilege.
That's the conclusion of Mebane Faber, co-founder of Cambria Investment Management in El Segundo, Calif. He recently published Global Asset Allocation, a fascinating test of portfolio strategies proposed by billionaire Warren Buffett and hedge-fund giant Ray Dalio, among many other financial geniuses.
Mr. Faber's conclusion? It's relatively simple to construct a diversified portfolio that should produce decent results over the long haul. In fact, investors spend too much time fretting about whether they have exactly the right mix of assets because most intelligent combinations tend to produce similar results over the long haul.
Most of us would be better off looking for ways to cut our investing costs. "We find that the best performing strategy underperforms the worst strategy when we tack on fees," writes Mr. Faber. "Ultimately, smart investing requires that we not only monitor asset allocation, but of equal weight, we focus on the advisory fees associated with the investment strategy."
Anyone who is thinking of managing their own money or wonders if they're spending too much for professional management should read Mr. Faber's book. It's a lucid guide to what a do-it-yourself investor can expect from any one of several strategies proposed by great investors. While he's a U.S. author writing for a U.S. audience, his findings can be easily applied by Canadian investors as well.
His goal is to demonstrate how we can reduce risk by mixing different assets together in our portfolios. Any single class of investment can suddenly turn sour (remember stocks during the financial crisis?), but a diversified blend of bonds, stocks, commodities and real estate is a reliable recipe for good results over the long haul.
Of course, all of this will come as no surprise to anyone who has slumbered through Finance 101, but the vexing question has always been exactly how to stir together assets into the most profitable casserole. On that point, Mr. Faber does something novel – he stages a bake-off among the main contenders.
The contestants include the classic 60-40 mix of 60 per cent domestic stocks and 40 per cent domestic bonds, as well as a global equivalent. There's also the All Seasons portfolio inspired by Mr. Dalio, the hedge-fund star, which goes heavy on bonds with a generous dash of gold and commodities.
In proof that the 1970s will never die, libertarian Harry Browne's once famous Permanent Portfolio (equal amounts of stocks, bonds, cash and gold) makes the list, as do much newer strategies from contemporary investment thinkers such as Rob Arnott, Marc Faber and David Swensen, as well as Mr. Buffett.
The winner, when tested on how it would have performed during the four decades from 1973 to 2003, was a portfolio suggested by Mohamed El-Erian, a former co-chief investment officer at bond giant PIMCO. In a 2008 book, he suggested a mix of 18 per cent U.S. large-cap stocks, 18 per cent foreign developed stocks, 15 per cent emerging-market stocks, 6 per cent 30-year bonds, 11 per cent 10-year bonds, 6 per cent inflation-protected bonds, 13 per cent commodities and 13 per cent real estate investment trusts.
So is this the last world in smart investing? Um, maybe, maybe not. As Mr. Faber notes, the truly surprising thing is that the spread in real (that is, after-inflation) returns among the eight strategies he tested was a mere 1.84 per cent. The worst strategy, the Permanent Portfolio, produced a 4.12 per cent real-average annual return between 1973 and 2013. The best, Mr. El-Erian's portfolio, ticked in at 5.67 per cent. (The spread is even closer if you drop the Permanent Portfolio from the mix. Then the other seven strategies all finished within a percentage point of one another.)
Mr. Faber's results suggest that worrying about asset allocation doesn't gain you much, if anything, once you get past a certain basic level of diversification. Yes, it pays to make sure your portfolio includes stocks, bonds and real assets (such as real estate and commodities). But once you have reasonable exposure to all three broad classes of assets, further fine tuning can't be counted on to produce further gains. The winner among the eight strategies varied from decade to decade, as did the actual returns.
What will reliably put money into your pocket is cutting your costs. Investing in these asset classes through low-cost exchange-traded funds will let more of the gains trickle through to you. You can also get a boost from rebalancing once a year – selling your winners and investing the proceeds in your losers to get back to the proportions in your original blend.
But spending too much on advice can quickly turn even a high-performing strategy into an also-ran. "The single biggest take-away from this book is to not ruin your allocation by paying too much in fees," Mr. Faber writes.
Ian McGugan