How to Build the Perfect Portfolio - Part 1 of 2
Your Money Guide on the Side
In this first part of a two-episode series, Tyler Gardner explores the concept of building the 'perfect portfolio' by examining the foundational ideas of ten leading financial
Key takeaways
- Diversification reduces risk without sacrificing return when assets don't move in perfect correlation.
- The most important factor in portfolio success is not picking winning stocks, but structuring a diversified mix of uncorrelated assets.
Main topics
- Modern Portfolio Theory
- Diversification and Correlation
Notable quotes
"Every dollar in fees is a dollar that doesn't compound."
"The perfect portfolio is not just about investing, it is about all of your decision making."
Conclusion
Building the perfect portfolio isn't about finding a single ideal formula, but rather applying timeless
Transcript preview
Speaker 1 (0:00) Every dollar in fees is a dollar that doesn't compound. And over 30 years, the difference between a 1 % expense ratio or management fee and a 0.3 % expense ratio and lack of management fee is not trivial. It is, in most cases, the difference between a comfortable retirement and a stressful one. Speaker 1 (0:24) Hello, friends. This is Tyler Gardner welcoming you to another episode of your Money Guide on the Side, where it is my job to simplify what seems complex, add nuance to what seems simple, and learn from and alongside some of the brightest minds in money, finance, and investing. So let's get started and get you one step closer to where you need to be. Speaker 1 (0:49) Quick note before we dive in, August's pre-order incentive for my book Real Wealth is now live, and this one is my favorite so far. Pre-order this month, tell me you did at tylergardner.com book, and I will send you a draft chapter of a new book that I'm already working on. And no, not even my editor at Norton has seen this writing yet. This sneak peek is yours to keep. delivered to your inbox in early September. Pre-order today and you're locked in for every monthly incentive through December 1st. TylerGardner.com slash book. Now let's get into it. Welcome back, my friends. I am more excited than I probably should be about the next two episodes in a wonderfully, unabashedly, financially nerdy kind of way, and I'm not going to apologize for it. Many of you know I started this whole endeavor a few years back simply by walking through the woods and making short videos about investing, saving, spending, and the psychology behind all of it. But predating that by about two decades, I had been kind of obsessed with a question I think all of us are asking in some form. How do I build the perfect portfolio for me? Does it even exist? Is it universal? Is it something you set up once and then walk away from? Good news and bad news. The answer to all of the above is yes and no, and it depends on who you are, and it ultimately depends on who you ask. Over the next two episodes, I'm going to try my best to step back from my own views, which at this point should be fairly clear to anyone who has spent more than 15 minutes with this show, and let 10 of the greatest financial minds ever to think seriously about this question take center stage. And here's what I promise, this is not a pitch. There will be no proprietary products, no funds, no advisor relationships, no subscriptions. What I'm going to do is take the actual academic research, the work of 10 people who spent their careers trying to solve this perfect portfolio problem rigorously, and translate it into language that you can absorb on a Monday morning. before you finished your first cup of coffee and have absolutely no interest in hearing the words beta, price-to-book ratio, or sector rotation. Now, the research behind these two episodes comes from a book called In Pursuit of the Perfect Portfolio by Professor Andrew Lowe of MIT and Professor Stephen Forrester of Ivy Business School at Western University. I want to give them full credit up front because this work is outstanding. and it deserves to be known. And I want to say something about Andrew Lo specifically, because he's one of the reasons I fell in love with finance as a discipline in the first place. He's put some of his introductory finance lectures online for free, genuinely free, from MIT. And if you're curious about finance as an academic subject, rather than just a practical one, he is an extraordinary teacher, and I would encourage you to find them The book itself, fair warning, is not exactly a beginner text. It reads like what it is, serious academic work by serious academic people. So if you're not familiar with the language and math of finance, it's going to be a little bit of a workout. But if you are up for that challenge, it is one of the best books on investing I've ever encountered, and it offers a ton of great takeaways. So you can read it, or you can trust that I'm here as always to offer you some takeaways. from some dense texts so you don't have to read them. But I encourage you to read it and support that type of work. What I am going to do in these two episodes is I'm going to take the key ideas from 10 of the thinkers that Lowe and Forrester profile, explain what each one believed about building the perfect portfolio, and then, and this is the part that I care most about, try to bring it... all together at the end of episode two into something you can actually use starting right now. I don't ever want to create something that is purely theoretical, and I always want to provide some simple and actionable takeaways. And here's what I find remarkable about the project of creating the perfect portfolio. These are 10 of the most rigorous, most credentialed, most intellectually serious people who have ever thought about this problem. And surprise, none of them are trying to sell you their services for $2.20. So if nothing else, you can trust that these thinkers wanted, by and large, what was best for you, the retail investor. Before we get into it, familiar ask if you found the show useful in any way. If you've shared it with a friend who needs to hear the message of low-cost investing, a review on Apple or Spotify genuinely helps. It helps new listeners find the show, and it lets me know I am not just talking into a microphone in the woods of Vermont with nobody listening but a sleeping bloodhound. It takes 30 seconds. I would be, and already am, grateful. All right, let's build the perfect portfolio. Speaker 1 (6:02) Thinker number one, Harry Markowitz. If this were a movie, and honestly it should be, so someone call Scorsese, Harry Markowitz would be the origin story. Markowitz is the father of modern portfolio theory, which he developed in 1952 in a paper so foundational that it's difficult to overstate its importance. Before Markowitz, investing was largely intuitive. You found good companies, you bought their stock, and then you hoped. Markowitz came along and said, that's not wrong exactly, but you're missing something fundamental about how risk actually works. Here's the key insight, and I want you to hold on to this because everything else in these two episodes builds on it. What matters for a portfolio of stocks is not just how risky each individual stock is. What matters is how they move relative to each other. This is called, as we've gone over together in a few episodes, correlation. If you own two stocks and they both go up and down at exactly the same time in exactly the same proportion, you have not diversified anything. you have just bought the same risk twice. But if you own two stocks that tend to move differently, one goes up when the other goes down, or at least they don't move in perfect lockstep, then the combined portfolio is actually less risky than either stock alone without necessarily sacrificing return. This is the magic trick of diversification, and Markowitz formalized it mathematically. he showed that risk can be reduced without sacrificing expected return simply by holding a portfolio of assets that aren't perfectly correlated. Now, what does that mean practically? It means you don't need to spend enormous amounts of time obsessing over individual stocks. You need to be, and I love this framing, just close to getting it right. The exact composition of your portfolio matters less than the basic structure of it. Are you diversified across assets that don't move