What is Portfolio Happiness?

Having been a financial consultant/adviser for the last thirty plus years, there is one question that haunts me everyday. When working with clients this is the question I like to start with, what is portfolio happiness? Unfortunately most everyone defines it in terms of performance. To me, that is a recipe for disaster. It is so easy to get caught up in the performance game we forget what we really want from our money. I understand the argument that performance is the way we keep score and see how managers did during specific market environments, etc. etc. But, The best money managers I know are focused on managing risk, first and foremost. I can only speak for myself, and my money, relative to what is portfolio happiness. That is simply safety of principle first and performance will follow. I have a quote on my desk and trading screens to remind me, “I can always make up for lost opportunities, but I can never make up for lost principle.”

I speak and correspond with investors everyday, and it does not surprise me in the least the number one question I am asked as an adviser is, “what is your performance?” Not, how do you manage the risk of a portfolio. Not, if my objective is an income of 4% per year, how do you manage the assets to provide the income while protecting my principle? No, we cut right to the chase and focus on performance. I get that you have been educated and trained to focus on those variables. Mutual fund companies do it, hedge funds do it, hell, half the spam email I get daily is telling me what the senders performance was last week trading straddles, spreads and condors on options. It is a habit and habits aren’t easy to break. However, when it come to managing your money it is vital to develop habits that get you to the goal, not living and dying by performance.

An example of this is a model we built many years ago that focuses on the ten sectors that make up the S&P 500 index. The strategy is break down the sectors and determine which offers the best opportunity relative risk/reward looking forward. For example, Financial Services is currently 16.1% of the S&P 500 index by weighting. If we conclude from our analysis that the sector has a high degree of risk, we can reduce the weighting by 50% to reduce the risk of the portfolio, or I can assign a 0% weighting to avoid the sector all together. If on the other hand we determine the risk is low relative to our analysis we can increase the weighting by 25% for more exposure to the sector. The goal is to control the weighting of the ten sectors relative to the risk that exist currently and looking forward. This allows me as the investor to manage my risk in accordance with my goals and objectives.

The next step of the process deals with performance or return on investment. We have assigned an objective of earning 1% per month to the above strategy, with the focus on not loosing principle. Note, that even though we are assigning an ROI objective to the strategy, our primary objective is preservation of principle. Therefore, we set out everyday to manage the money with the end objective in mind, but we are willing to forego the performance if the risk of obtaining it is too high. If the focus is to get the maximum performance relative to the objective, we loose sight of the risk taken to accomplish the performance. Some say that is semantics, but it isn’t when you see how money is managed by both individuals and professionals in practice. I was taught at a very young age, your first loss is your best loss, and that is why risk management of a portfolio take precedence over performance. If you manage risk performance will take care of itself over time.

So the next time you sit down and review your portfolio, ask yourself, does my portfolio provide me happiness and peace of mind? Or, do I stay awake at night worried about the losses or volatility of my money? Portfolio happiness is getting what you want and need from money without having to worry or take undue risk with your principle. Try this process and see if your happiness factor rises along with your peace of mind.

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