How to Build the Perfect Portfolio - Part 2 of 2

Your Money Guide on the Side

In this final part of a two-part series, Tyler Gardner explores how to build a resilient and effective investment portfolio by synthesizing insights from ten leading financial minds. Building on

Key takeaways

• The single greatest threat to investment returns is not market volatility but investor reaction to it—staying disciplined is key.
• A truly 'perfect' portfolio isn't mathematically optimal for everyone, but one tailored to your personal needs, risk tolerance, and long-term goals.

Main topics

• Building a diversified portfolio
• Behavioral finance and investor psychology

Notable quotes

The single most reliable destroyer of long-term investment returns is not market volatility. It is the investor's response to market volatility.

Conclusion

The ideal investment strategy, distilled from decades of research by top financial thinkers, is simple: build a

Transcript preview

Speaker 1 (0:00) The single most reliable destroyer of long-term investment returns is not market volatility. It is the investor's response to market volatility. People who did best in 08 were the ones who did nothing. The people who did best in 2020 were the ones who did nothing. The people who will do best in the next downturn, whenever it comes, whatever causes it, and I guarantee very little, but the people who will do best will be the ones who built a portfolio they understand, at a risk level they can tolerate, and then left it alone. 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 (0:58) Quick note before we start, September's pre-order bonus for my book Real Wealth is something I've wanted myself for years and never been able to find. So I created it. It's called the Real Wealth Money Calendar. 12 months, five action items per month, all on one page. Because most people I know already know what to do. They just don't necessarily know when and they don't have accountability. So this is your 2027 on one page. 60 moves in the month you actually need to make them. Pre-order Real Wealth at tylergardner.com slash book. Let me know you did, and your money calendar will be in your inbox in early October. Welcome back, my friends. If you're joining us for the first time, I would strongly encourage you to go back and listen to part one from last week before continuing. because what we're building on here is cumulative. And if you didn't catch last week's episode, that's okay. This is part two of how to build the perfect portfolio. And when I say perfect, I don't necessarily mean for you. I mean according to 10 of the world's greatest academic and finance minds ever to write and think about such a topic. The research for these two episodes was largely sourced from Professor Andrew Lowe and Professor Stephen Forrester's book, In Pursuit of the Perfect Portfolio. And as I mentioned last week, if you're a finance nerd like me, and you want to do a deep dive into some intro to finance, you can find Professor Lowe's intro to finance videos online completely for free as he's open sourced some of his introductory finance courses and he's one of the first people who got me truly excited to go into finance and portfolio management so if today's episode resonates i'd highly encourage you to check him out because i'm merely as always passing knowledge and research down the line now what's amazing about looking at 10 of these thinkers over two episodes is each thinker is going to add another layer to our thinking. And the goal, by the end of today's episode, is going to be to leave you with something genuinely useful. A framework built on the best thinking in the history of investing, translated, hopefully, into a language that doesn't require a PhD to understand. And for those of you who are with me in part one, welcome back. For those of you who are not, here's a quick recap. In part one, we covered five thinkers. Markowitz gave us the mathematical foundation of diversification. What matters, he said, is how assets move relative to each other, not just how risky they are individually. Sharpe told us to combine a riskless asset with the market portfolio and keep costs low. Fama said markets are efficient. and tilt towards small cap and value if you want, but never forget you can only get more return by taking on more risk. Bogle operationalized all of it with the index fund and reminded us that cost is the one variable we can actually control. And Scholz pushed back on all of them, not to say they're wrong, but to say Hey guys, have you thought carefully about what happens when everything goes wrong in an index fund at once? Today, we cover five more of the world's greatest financial minds. And then, and this is the part I have been looking forward to, we're going to pull all ten together into the five things they mostly agree on that you can take home and actually use starting today. Before we get into it, familiar ask, if you haven't left a review on Apple or Spotify, I would genuinely appreciate it. It helps new listeners find the show, and it tells me the microphone in the Vermont woods is pointed at something other than my dog, who's been asleep since roughly the second paragraph of episode one. Let's get in to part two of how to build the perfect portfolio. Thinker number six, Bob Merton. Bob Merton is, intellectually speaking, one of the most formidable people on this list. He shared the Nobel Prize in Economics with Myron Scholes in 1997 for his work on options pricing. He has spent decades at the intersection of financial theory and institutional practice. And he has thought more carefully than almost anyone about the question that actually matters to most people listening to this podcast right now. Not how do I maximize returns, but how do I make sure I don't run out of money before I run out of life? Like Markowitz, Merton believes you should try to maximize returns for a given level of risk. But Merton expands the definition of risk considerably. It's not just stock market volatility. There are many more risks than that. Inflation risk, your own longevity risk, the risk of a medical emergency, the risk of outliving your savings. And all of these can be reduced in different ways through diversification and careful planning. Here's the center of Merton's thinking, and I find it both beautiful and practical. Your perfect portfolio. in an ideal world is ultimately your own risk-free asset. Not the market. Not a diversified fund. Something specifically calibrated to meet your specific needs indefinitely with zero risk attached. Now, that's his optimal end state. And if you can accumulate enough savings so you could convert the entire thing into something like an annuity that covers your needs for the rest of your life, that would be awesome. It would be a guaranteed income stream that you cannot outlive, that covers your actual expenses, that renders the question of market volatility essentially irrelevant. At that point, you have won, says Merton. The game's over. You don't need to take any more risk. But, and I know you know this, this is where Merton gets practical, most of us are not going to get there entirely on our own. If it looks like your savings won't be sufficient to generate the income you need, that's when you need to invest some of those savings in riskier assets to try to close that gap. Not because risk is good, but because the risk of not having enough is worse than the risk of market volatility. Merton shares a car analogy with us that he loves, and I like it too. You want to get from point A to point B. That's the goal. You don't need to know what's under the hood. You don't need to understand the engineering. You just need to arrive in whatever vehicle gets you there without breaking down. So, for the purely practical-minded, Merton's actual product at Dimensional Fund Advisors consisted of a global stock index and two TIPS bond portfolios with intermediate and long durations, which, and I want you to notice this, is essentially identical to what Bill Sharp was recommending in part one. They used different intellectual frameworks to get there, but they arrived at the same practical destination. The one thing I'll say honestly, Merton spent years at Dimensional Fund Advisors, which is a professional investment management firm. So when he says that most people need professionals to manage this for them, and that the annuity is the ideal product, I'm not saying either of those statements is wrong, and I think he's genuinely right for some people, but I also think many people listening to this podcast can manage a two or three fund portfolio on their own without paying anyone to do it. The glide path and target date fund approaches that we've talked about in different episodes, and that he endorses, are excellent and Vanguard Fidelity Schwab offer these things at very low cost without requiring an advisor relationship. As always, Merton concludes, don't stress about whether your portfolio is 70-30 or 65-35. The only question that