1. Equities Over Bonds
While equities do carry a higher risk than bonds, a manageable combination of the two in a portfolio can offer an attractive return with low volatility.
2. Small vs. Large Companies
The performance histories of U.S. companies (since 1926) and international companies (since 1970) show that small-capitalization companies have outperformed large-capitalization companies in both the U.S. and international markets.
3. Managing Your Expenses
How you invest your portfolio will have a direct impact on the cost of your investments and the bottom line investment return that goes into your pocket. The two primary methods to invest are through active management or passive management. Active management has significantly higher costs than passive. It is typical for the expense difference between active and passive management to be at least 1% per year.
4. Value vs. Growth Companies
Since index tracking has been available, value companies have outperformed growth companies in both the United States and international markets. Academic financial professionals that have studied both value and growth companies for decades have commonly referred to this as the “value effect.” A portfolio that tilts toward value companies above growth companies has historically provided higher investment returns.
Asset allocation and diversification is the process of adding multiple asset classes that are different in nature (U.S. small stocks, international stocks, REITs, commodities, global bonds) to a portfolio with an appropriate percentage allocation to each class. Since asset classes have different correlations with one another, an efficient mix can dramatically reduce the overall portfolio risk and improve the expected return. Commodities (such as wheat, oil, silver) are known to have a low correlation to stocks; thus, they can complement a portfolio by reducing the overall portfolio risk and improving expected returns
Over time, a portfolio will drift away from its original asset class percentages and should be put back in line with the targets. A 50/50 stock-to-bond mix could easily become a 60/40 stock to bond mix after a prosperous stock market rally. The act of adjusting the portfolio back to its original allocation is called rebalancing.
The Bottom Line
Despite how complicated portfolio investing has become over the last several decades, some simple tools have proved over time to improve investment results. Implementing tools such as the value and size effect along with superior asset allocation could add an expected return premium of up to 3 to 5% per year to an investor’s annual return. Investors should also keep a close eye on portfolio expenses, as reducing these costs adds more to their return instead of fattening the wallets of investment managers on Wall Street.