Ken Fisher Explains How to Build a Well Diversified Portfolio

Transcript

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sometimes people ask me
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how do you build a
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diversified portfolio correctly
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and
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the answer
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presumes that already
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you've concluded you want to build a
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diversified portfolio
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it steps over the issue of why a
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diversified portfolio is important
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versus not
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so some people will tell you that it's
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not and
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right now i'm not going to get into that
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argument
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when you want to build a diversified
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portfolio
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you
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step back to the core concept of modern
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portfolio theory as created originally
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by harry markowitz in 1951
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that looks at the notion
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of what's called mean variance
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optimization which is a jargony term
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that really means
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to have things that have similar
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long-term return expectations
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but where those components
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zig and zag against each other
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so the total portfolio has lower
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volatility
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relative to that long-term return
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that's
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the construct
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the construct is to blend together items
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that have short-term negative
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correlations but similar long-term
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returns
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so that you've got things that are
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zigging and zagging against each other
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this month
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providing greater portfolio stability
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but that over the long term tend to get
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you to the same place
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as opposed to let's say having
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all tech stocks which you know is not
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diversification
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that tend to have okay returns in the
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long term but tend to have wild
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volatility in the short term or all
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railroad stocks or all commodities or
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all anything
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which gives you more short-term
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volatility even though it might get you
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to the long-term return the purpose of
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the diversified portfolio is to have it
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be more stable toward that long-term
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goal so what does that mean that means
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broader what does broader mean it means
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you don't just have one sector
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you don't just have one industry you
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don't just have one stock
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you move off to the broadest indexes
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most people traditionally have thought
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about that as what's the broad accepted
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in america u.s index which would be of
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course the s p 500 for most people's
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thinking
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you could even go a little farther than
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that to some broader cap weighted
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indexes
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for the united states but even further
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in my thinking you say to yourself in
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the very long term
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and this is central to
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thinking about equities correctly
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no major category
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can have superior returns to any other
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major category because eventually as
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there's a perception that that category
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has a superior long-term return
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companies and investment bankers will
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create enough new supply
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of that category to overwhelm
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that perception of superior demand
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and that supply will meet the demand to
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bring the pricing back into line with
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other categories so if you look at very
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long-term returns like 30-year returns
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categories tend to neutralize within a
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very very tight bandwidth very tight
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between countries
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i don't mean some little third world
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country that might do this but i mean
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between the broad u.s versus foreign
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uh u.s versus europe
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broad categories returns tend over the
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long term to neutralize
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between sectors
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tend to neutralize not about a single
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stock
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not even necessarily a simple subset
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industry within a sector like buggy
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whips
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but the broad sectors
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in that
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the broadest is to just think about the
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whole world and own the world index
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it gives you the most things that zig
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when something else zags that keep you
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going toward that same 30-year return
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so if you're building a diversified
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equity portfolio
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the world index becomes the thing you
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build against and you match to it
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then you may choose to overweight and
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underweight certain sectors based on you
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thinking they will do better
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and that's fine you may even choose ones
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that you think have more zig
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and zag to them than some of the others
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but the central point is
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to build that zig and zag in and yet
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with an index whether it's in america
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only with the s p 500 or whether it's
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with the broader world as a whole
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the concepts not to try to get a higher
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return it's to get more things that are
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seeking and zagging against each other
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against a very long term return goal
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in that
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you then get to the simple point that
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you say well if i'm going to increase
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these parts to decrease those parts
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what's the basis for that
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why would i increase these parts and
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decrease those parts versus the index
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and the answer is you think somehow some
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way you know something
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that isn't already priced into the stock
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market
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now that in itself is a fairly
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close to arrogant argument
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because for the most part
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when i ask myself what do i know today
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that
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everybody else doesn't know
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most of the time the answer is nothing
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and if you don't know anything that
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other people don't know
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the
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theoretical argument for passivity is
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almost perfect you just buy the index
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sit on it you've got the diversified
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portfolio it's easy
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it's easy and you will get the index
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return
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you have to stop and ask yourself do i
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know something other people don't know
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and the basis in portfolio theory for
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making an active bet
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is always and everywhere
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only that you do believe somehow some
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way you know something other people
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don't know it and therefore this bet
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will pay off
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because if everybody else knows that
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they've already pre-priced it and
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therefore it won't pay off
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so
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to build
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the diversified portfolio where you
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don't actually believe you know
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something other people don't know
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passivity is the rule get the whole
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world do it passively it's cheap
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it's easy
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done
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the rest of the time to try to improve
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on that and get a higher return relative
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to risk relative to the benchmark of the
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world
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or in america if you're doing america
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only the s p 500 you have to go back and
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say what do i know other people don't
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know and you better be modest about
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answering that question because
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otherwise you get yourself into trouble
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because in capital markets
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overconfidence is the biggest killer as
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the great humiliator is always waiting
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to try to humiliate you me and everyone
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else for as much money as possible over
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as much time as possible
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because that's what the market does
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so your final question becomes and i
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reiterate
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what do you know other people don't know
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otherwise passivity with a broad index
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is the easiest way to build diversified
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portfolio
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[Music]
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