Enrich Your Future 17: Take a Portfolio Approach to Your Investments

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 17: There is Only One Way to See Things Rightly.

LEARNING: Consider the overall impact of investments rather than focusing on individual metrics.

"There is only one right way to build a portfolio—by recognizing that the risk and return of any asset class by itself should be irrelevant."

Larry Swedroe

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.

Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 17: There is Only One Way to See Things Rightly.

Chapter 17: There is Only One Way to See Things Rightly

In this chapter, Larry enlightens us on the benefits of considering the overall impact of investments rather than focusing on individual metrics. This holistic approach empowers investors and advisors to make more informed decisions.

Don’t view an asset class’s returns and risk in isolation

A common mistake that investors and even professional advisors often make is viewing an asset class’s returns and risk in isolation. Larry emphasizes this point by giving the example of Vanguard’s popular index funds, the largest index funds in their respective categories, to make us all more cautious and aware of the potential pitfalls of this approach.

From 1998 through 2022, the Vanguard 500 Index Fund (VFINX) returned 7.53% per annum, outperforming Vanguard’s Emerging Markets Index Fund (VEIEX), which returned 6.14% per annum. VFINX also experienced lower volatility of 15.7% versus 22.6% for VEIEX. The result was that VFINX produced a much higher Sharpe ratio (risk-adjusted return measure) of 0.43 versus 0.30 for VEIEX.

Why more volatile emerging markets have a higher return

According to Larry, despite including an allocation to the lower returning and more volatile VEIEX, a portfolio of 90% VFINX/10% VEIEX, rebalanced annually, would have outperformed, returning 7.59%. And it did so while also producing the same Sharpe ratio of 0.43. Perhaps surprisingly, a 20% allocation to VEIEX would have done even better, returning 7.61% with a 0.43 Sharpe ratio.

Even a 30% allocation to VEIEX would have returned 7.59%, higher than the 7.53% return of VFINX (though the Sharpe ratio would have fallen slightly to 0.42 from 0.43). The portfolios that included an allocation to the lower-returning and more volatile emerging markets benefited from the imperfect correlation of returns (0.77) between the S&P 500 Index and the MSCI Emerging Markets Index.

The right way to build a portfolio

Larry says there is only one right way to build a portfolio—by recognizing that the risk and return of any asset class by itself should be irrelevant. The only thing that should matter is considering how adding an asset class impacts the risk and return of the entire portfolio.

Further, Larry stresses the importance of global diversification, a strategy that can reassure and instill confidence in investors and advisors. He points out that if markets are efficient, all risky assets should have very similar risk-adjusted returns. This argument for