If you have followed investing over the past 10 years or so, you’ve probably heard about the Ivy League approach to portfolio management.
Truth be told, those high-end investment committees do some pretty tricky stuff. They own private equity and hedge funds and they even run their own strategies in-house. It’s very hard to copy.
Nevertheless, you can in fact replicate the majority of their investment style and enjoy very close to the same result. The fundamental idea is captured in the simple phrase “risk-adjusted return.”
What does that mean? It means making sure to own investments that perform as well as possible while keeping volatility in check, or at least within your expectations.
If you are young, say, in your 20s, you might be able to stand the idea of your investments rising and falling dramatically in value over a year. In fact, if you just got started saving and are focused on your career, you might not notice the ups and downs at all.
That kind of retirement investor can and should own a lot of stocks and a heavier complement of investments abroad.
On the contrary, a near-retiree in his or her late 60s is not likely to handle volatility well at all. What if that saver sees his or her account balance flying up and down over a period of a few months? The risk is an untimely panic.
The near-retiree is very likely to be looking at the balance more often than a younger worker. Second, even if the near-retiree thinks he or she is capable of taking the heat, they are also likely to bail out of a portfolio if things veer too low for comfort.
Risk-adjusted return portfolios seek to invest across a basket of investments that cancel out the worst of the volatility. When stocks fall, a slower-moving investment such as bonds might rise. When investors pull back from broadly held assets, alternatives such as real estate and commodities can prosper.
The trick the Ivy League investors have figured out is how to precisely measure those canceling-out effects and use them to build a solid, dependable annualized return.
They can get quite ornate, but for most retirement-oriented investors it’s enough to own a broad selection of index funds that approximate the university endowment thought process at a greatly reduced cost.
Fancy money managers cost money, while index ETFs are cheap. They might not bring all of the ability of a top-dollar investment braintrust, but they don’t track that far behind and do so at a dramatically lower price point.
Grabbing a bit of that academic brain power can be as easy as building a portfolio of six to eight asset classes, then deploying index funds to match in each class. Then it’s just rebalance and watch the returns pile up.