Show Notes
Welcome back to The Long Term Investor.
Today’s episode is a little different. I’m sharing a conversation that originally aired on The Plancorp Perspective, a podcast we produce for Plancorp clients. My colleague Ranie Verby, Plancorp’s Director of Practice Management, put me in the guest chair to talk about my new book, The Perfect Portfolio.
Despite the title, this isn’t a conversation about the exact funds or stocks you should own. It’s about something more important: how to build a portfolio around what your money is actually for—and how to make sure it’s one you can stick with when another investment is getting all the attention.
Ranie and I discuss why smart people still make bad investment decisions, why process matters more than outcomes, the four questions I use to evaluate any new investment idea, when complexity is worth it, and what benchmarks should actually tell you.
Get your copy of The Perfect Portfolio here.
What a “perfect” portfolio actually means
Ranie begins by challenging the promise embedded in the title of my new book, The Perfect Portfolio. If there is no investment that is best for everyone, how can any portfolio be called perfect?
I explain that “perfect” describes fit rather than superiority. Two people can have similar goals and similar tastes yet react very differently to the same portfolio. Their circumstances, time horizons, tax situations, willingness to tolerate risk, and emotional responses will never be identical.
That is why portfolio construction should not begin with “What is the best investment?” It should begin with “What is this money for?” Until you understand the life the portfolio is meant to support, you cannot determine which tradeoffs make sense.
The objective is not to assemble the most impressive collection of investments. It is to build an evidence-based portfolio that serves its purpose and that its owner can hold for as long as possible.
Why smart people can be unusually vulnerable to investment mistakes
Ranie identifies one of the book’s recurring themes: smart people still make bad investment decisions—and intelligence can sometimes make the problem worse.
Successful people are accustomed to solving difficult problems through effort, information, and attention to detail. Investing is different. Markets are complex adaptive systems with millions of interconnected parts, and more information does not always produce a better answer.
I discuss research suggesting that greater cognitive ability can make people better at constructing persuasive explanations for decisions they already want to make. I also describe a study of professional horse-racing handicappers in which additional information increased the participants’ confidence without meaningfully improving their accuracy.
The lesson is not that investors should remain uninformed. It is that confidence and competence do not always rise together. Sometimes the simple solution is not evidence of shallow thinking; it is the conclusion reached after doing the deeper work.
Why process matters more than a good outcome
I argue that the most damaging investment mistake is not choosing the wrong stock or missing a market forecast. It is making decisions without a clearly defined process established before the decision arises.
Investors often judge a decision by what happened next. But a sound decision can produce a disappointing result, just as a reckless decision can get lucky. Putting nearly everything into one stock that subsequently rises 1,000% may create a wonderful outcome without making the original decision prudent.
Doing nothing is also a decision and should be evaluated through the same process. Otherwise, investors can create a convincing explanation after the fact for nearly any choice they make.
Ranie takes the framework back one additional step by asking, “What problem are we trying to solve?” If an investment is not solving a clearly identified problem, it may be adding activity without adding value.
The four questions every new investment should survive
We walk through the Probabilistic Decision Protocol, a four-question filter for evaluating whether an investment deserves a place in the portfolio:
- Why do you expect positive returns?
- Does it meaningfully improve your portfolio?
- Does it introduce unnecessary complexity?
- Are you ignoring base rates or extrapolating recent success?
The framework begins with my preference for avoiding bad ideas rather than worrying about capturing every good one. Much like the drug-approval process must weigh the cost of approving something harmful against the cost of rejecting something beneficial, an investor must consider the risks of both action and inaction.
An investment should have a defensible source of expected return. It should also improve the entire portfolio by meaningfully increasing expected returns or improving diversification—not merely provide another line item.
Finally, the decision should account for base rates. A company such as Nvidia may have produced extraordinary returns, but recent success alone does not tell us what investors should reasonably expect next. The bar for admission should be high; a portfolio needs a bouncer, not a greeter.
When complexity earns its place in a portfolio
The important word in “unnecessary complexity” is unnecessary. Complexity is not automatically bad when it solves a real problem and provides benefits that outweigh its costs.
Separately managed accounts are one example. An SMA may add hundreds or thousands of individual positions to a report, but that complexity can be worthwhile when the account systematically realizes capital losses that can offset gains elsewhere.
Private investments can also serve a legitimate purpose for certain investors. They may offer additional sources of expected return or diversification, particularly for someone with substantial assets, ample liquidity, and the capacity to accept long holding periods.
But they also introduce additional fees, tax reporting, illiquidity, manager-selection risk, and uncertainty about when and how returns will arrive. The relevant question is not whether an investment appears sophisticated. It is whether the specific benefits justify the financial, administrative, and behavioral burdens for that particular investor.
Private markets, simple portfolios, and the human on the other side
Ranie asks why investors often interpret a more complicated portfolio as a more sophisticated one.
I explain that a single fund can hold thousands of securities and rely on highly sophisticated trading systems, even though it appears as one line on an account statement. The simplicity experienced by the investor can conceal enormous complexity underneath the surface.
Exclusivity creates another temptation. Investors may assume that something is better because not everyone can access it. But many of the world’s wealthiest people became rich by building a concentrated business—not by following a repeatable portfolio strategy available to ordinary investors. Investing is better understood as an enhanced form of saving. If it is constantly exciting, something may be wrong.
We apply that idea to private equity in retirement plans, where wide differences among managers, leverage, limited liquidity, and infrequent valuations create additional challenges. Even when an investment makes sense in a spreadsheet, it can fail if expectations and reality are too far apart.
Treasury Inflation-Protected Securities offer a simpler version of the same lesson. An investment can behave exactly as designed and still feel broken because the S&P 500, a friend’s portfolio, or whatever is dominating the headlines happens to be winning. A theoretically optimal portfolio is not optimal if the person on the other side cannot hold it.
What benchmarks are actually designed to do
We turn to the role of benchmarks and the tendency to treat them as scoreboards.
The original purpose of a benchmark is to explain performance. Comparing a U.S. stock allocation with the broad U.S. market or an international allocation with the international market can help an investor understand what happened and ask better questions.
That does not mean every component must beat the overall market. A diversified portfolio contains different ingredients that are meant to behave differently. Judging every holding against the S&P 500 can make useful diversification appear defective whenever U.S. large-cap stocks are leading.
The more important benchmark is often goals-based: Are you still on track to fund the life your plan was built to support? Financial plans should already account for recurring downturns and extended periods when parts of a portfolio disappoint.
Portfolio returns are only one input. Saving, spending, working years, longevity, and the willingness to use money for meaningful experiences also matter. Investors can become so focused on making the number grow that they postpone the very life the portfolio was supposed to make possible.
Why advisors still matter when investing looks easy
Low-cost funds and investment information have never been more accessible, which raises an obvious question: Why should anyone still need an advisor?
I describe advisors as the oldest form of automation. A good advisor creates a repeatable process, applies it systematically, and helps prevent emotions from controlling decisions. Not every advisor does this equally well, which makes the process and philosophy behind the advice important.
Even though I oversee investment strategy for more than $10 billion in client assets, I use an advisor and hold my own portfolio in a single fund. Knowledge does not eliminate bias, and having more control does not necessarily improve personal decisions.
Advisor value also tends to arrive unevenly. It may become most visible during a market decline, tax decision, family disagreement, health event, career change, or other moment when the consequences are unusually large. An advisor can also create continuity between spouses and across generations as financial responsibilities change.
Systematic rebalancing, tax-loss harvesting, asset location, planning, and portfolio customization can create measurable value. But the less measurable benefit may be just as important: the ability to spend less time worrying about money and more time concentrating on the people and experiences that matter.
The question to ask before touching your portfolio
Ranie closes by asking what someone should consider before changing a portfolio that no longer feels perfect.
My answer is: “What would make me change my mind?”
That question is useful when you are considering a change, but it may be even more revealing when everything feels great. What circumstances, evidence, or outcome would cause you to reconsider your current confidence?
Thinking through those scenarios in advance can function like exposure therapy. It forces you to imagine what could go wrong before a market move, headline, or emotion places pressure on the decision.
A perfect portfolio is not one that never becomes uncomfortable. It is one built through a sound process, aligned with a meaningful purpose, and durable enough to survive the periods when something else inevitably looks better.
Resources
- The Perfect Portfolio
- Ranie Verby
- The Plancorp Perspective
- The original Plancorp Perspective episode
- The Four Questions to Ask Before Adding Anything to Your Portfolio
- Plancorp’s Fee and Value Calculator
- Frances Oldham Kelsey and the FDA’s review of thalidomide
The Long Term Investor audio is edited by the team at The Podcast Consultant.
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