Larry Swedroe, principal and Director of Research at BAM Alliance, joins the Validea team on their Excess Returns podcast to talk about his portfolio.
Here is the breakdown in timeline:
- 02:54 – Larry’s biggest long-term goals with his portfolio
- 06:31 – The relationship between wealth and happiness
- 08:00 – How Larry views retirement
- 10:39 – Larry’s framework for constructing his portfolio
- 19:43 – How Larry’s market exposure has changed over time
- 24:39 – How Larry thinks about incorporating illiquid assets
- 28:30 – How Larry approaches fixed income
- 31:28 – How Larry approaches his equity exposure
- 36:56 – Larry’s thoughts on market timing
- 40:09 – How Larry thinks about international diversification
- 42:41 – Larry’s approach to private investing
- 48:56 – Overcoming investor’s behavioral problems
- 53:22 – Investments that generate happiness instead of returns
- 57:21 – The one lesson Larry would teach the average investor
If you are deep in the wealth management space, you will come across Swedroe’s commentary of style factor, passive, systematic investing or whether specific types of investing are backed by evidence.
I will not list out everything, but my main takeaway is:
How you set up your portfolio dramatically depends on the financial objective you wish to achieve.
Larry basically explained that he had made his money (as early as 30 years ago). He also explain the evolution of his portfolio.
When he started investing, due to his time horizon and risk tolerance, he invested 100% in equities. When he sold his first business thirty years ago, he moved to a 60% equity and 40% bond portfolio because… why do you need to take so much risk if you won the game?
When his firm sold their second business to Focus Financial, he moved his equity allocation lower to 30% (Which sounds like 100% Small Cap Value in Dimensional, Avantis and BridgeWay). Eight years ago, when a sort of interval fund structure make it possible to gain liquidity for relatively illiquid private investments, Larry shifted his portfolio to 50% alternative investments.
He has also given his children his money so they have enough. In financial planning terms, he has fulfilled all his financial goals.
His portfolio will interest more for those in the capital preservation mode, or those thinking of leaving a legacy.
At no point did he says that he is targeting X% a year in return.
For sure, he takes into consideration getting returns but also minimizing risks.
Knowing what he knows, he prefers to be diversified over a portfolio of different risks to earn the premium from those risks.
Here is how he puts it:
If we believe markets are efficient, and I think they’re, all risk assets should have similar risk-adjusted returns. The evidence says that.
There is only one logical conclusion to build the portfolio.
- You should own many unique sources of risks. What are these unique sources of risks? They should fit the follow criteria that he shared in one of his books:
- There is an evidence of a premium above Tbills.
- That evidence is persistent over very long periods of time and economic regimes.
- It should be pervasive, like it should work worldwide, and not like a lucky outcome in the US.
- It should be appropriate, and robust to various definitions. Value should work regardless if its price-to-book. How do you know that isn’t luck? It should work for price-to-cash flow or EBITDA-to-Enterprise Value. Momentum should work whether you use long term or short term signals.
- It should have evidence that it survives transaction costs.
- There should be logical risk-based or behavorial-based reasons for you to believe the premiums will persist.
- The more uncorrelated assets you add, the less safe fixed income you need in your portfolio. You are dampening the risk of the portfolio more efficiently, dramatically cutting the tail risks (which Larry wrote about in his book Reducing the Risk of Black swans)
I think when it comes to capital preservation, do you consider the returns you get so much? I think returns is essential, but we should frame it as “we want every chance to get good returns and the only way is through taking risks that we can be compensated (basically premiums)”.
But what is big enough is for the portfolio not to die.
But how to prevent the portfolio from dying?
- Rely on evidence of how different risks behave.
- Be diversified over different risks.
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