Financial Advisors Rank the Most Popular Investment Portfolios

Introduction – Beating Wall Street (0:00)

Brian: How to beat the Wall Street pros. By the way, it’s gonna be easier than you think.

Bo: And Brian, I am so excited to talk about this because we all want to know how can we be successful investors? How can we make our money work harder than we do? And in today’s show, we’re going to kind of walk you through how you should think about that and how you should analyze that.

Brian: But here’s a grounding fact. The typical investor is horrible at making and sticking to investment strategies.

Bo: And this isn’t based off you hear us talk all the time about, you know, the average person couldn’t come up with a $1,000 without going into debt. It’s not that we’re talking about even folks who make the decision to invest, make the decision to put their money to work, they just generally tend to be not very good at it. And don’t take our word for it. There’s actually a Dalbar study in 2023 that found that if you look at the 30 year annualized return of the S&P 500, it’s a little over 9 and a half percent, 9.65%. But the average investor over that 30 year time period, a good 30 years to be investing, only made about 6.8%.

Brian: And look, we were very generous by using the Dalbar study. We could have done JP Morgan. We could have used Morningstar. There’s actually a lot of research out there that shows, because this spread is only the delta here is 30% reduction, but I think that’s being generous because I’ve seen all the different ways that the typical investor blows up their investment portfolio. Just be careful and understand you might be your own worst enemy.

Bo: So then the question you ask, okay, well how significant is this? Okay, 9.65 to 6.8 doesn’t sound that significant, but again, that’s a 30% reduction in your return. And if that takes place over a 40 year working timeline, over a 40 year investing trajectory, it could nearly cut the amount in half. The person who just was invested in the S&P would have made $3.3 million, but the average fund investor has less than half that amount at $1.4 million. So, it can make a substantial and significant difference. So, the ultimate question becomes why, Brian, why is the average investor so bad at investing?

Why Investors Fail (2:24)

Brian: Well, it comes down to there’s two big things. And I’ll be generous with the first one, we’ll just say I don’t know any better. Lack of financial education. That’s what we’re here for. That’s why we do this show. And welcome to The Money Guy Show. But the real thing that I think is driving a lot of this is all of the emotional decision making. Tell me if this resembles things we’ve seen in our career. It’s the unhealthy relationship investors have with fear and greed. Meaning that markets are getting their teeth kicked in, people are looking for the exits and that’s typically peak opportunity to get a great deal. Other side of it is when things are overvalued, people get greedy and they typically are trying to load it up. There’s also chasing, talking about greed, chasing the hot dot, whatever is the most popular thing at the time right now that’s out there in social media, what’s out there in the nightly news. People are going out there and doing frequent trading on it. It’s not really driven by good fundamentals or anything else.

Bo: To drive this point home that the average investor is very bad at it, Fidelity actually did a study trying to determine, okay, what are our top performing accounts and all the trillions of dollars that we house? Which accounts are the top performing? And what you may be surprised to find is that it was not actively managed funds. It was not aggressive single stock investors that were picking the number one best high flying stock. Do you know what the number one top performing accounts Fidelity found were? Abandoned accounts. They were the accounts that people had completely forgotten about. Accounts that people didn’t even realize that they still had. And they even took it a step further and said that oftentimes some of their best performing accounts are estate settlement accounts where someone passes away and it might take 5, 10 years to find the beneficiaries or to settle the estate or work through the probate process. Those accounts, the accounts where nothing at all was happening were often the top performing accounts. Doing nothing was better than folks who actively try to do a lot of stuff inside their investment account.

Brian: This is almost because we, instead of having a good plan that works, you know, before, during, and after, it seems like everybody’s out there looking for their reaction they can do and they usually are working against themselves. This is to the point that if you think about great investors in American history, the late Charlie Munger, him and Warren Buffett built something incredible with Berkshire Hathaway. He has a saying, Bo, he’s turned a famous saying upside down. Can you expand on that?

Bo: Yeah, oftentimes people say, “Hey, don’t just stand there, do something.” We’ve all heard that expression. Well, Charlie said when it comes to investing, you want to do the exact opposite. He says, “Don’t just do something. Stand there. Don’t do anything. Don’t take action.” Because oftentimes, no action is better than taking action and making the wrong decision. We see emotional investors fall into that trap all the time.

Do Professional Investors Do Better? (5:19)

Brian: Okay, so we just detailed in great detail that the average investor is horrible at investing. But the good news is you can go hire somebody. I’m sure a professional money manager is going to be even better because they have all this education. So they’ve overcome that part of it. But they also they charge you fees. So they have to be getting something for this. So how about professional investors? How do they do?

Bo: Yeah. When we think about professional folks who do this for a living, would you believe that according to Morningstar, only 42% of actively managed mutual funds beat their passive counterparts, just the index itself? Or what about this from S&P? 90% of actively managed US funds, nine out of 10, have underperformed compared to the S&P 500 over the last 15 years. And from the New York Times, fewer than 5% of active US stock fund managers have beat their benchmarks over the last 20 years. So even people who hold themselves out as being professionals, a very small fraction, a small percentage of them are even able to do better than their passive benchmark. So not even the professionals have figured this out.

Three Popular Investment Strategies (6:31)

Bo: So what are we as investors supposed to do? How are we supposed to tackle this? How do we figure out how we should be investing our dollars?

Brian: Well, I think it’s interesting because you can imagine if we just showed you the average investor is horrible at this, the average professional investor is horrible at this. You can see how quickly there’s some strategies that have shown up on social media. And that’s what we want to cover today. Three popular investment strategies that people get into. And one of them, the probably the most popular that I’ve seen on my feeds is VOO for life. That’s it. Just buy it and hold it forever. If you’re new to this whole concept and you’re like, what is VOO? VOO is the S&P 500. That’s Vanguard’s ETF. You could have said Fidelity’s S&P 500 index fund. You could have said Charles Schwab’s S&P 500. But VOO for life is just the popular one that you see out there. Probably because it rhymes with FOO. That’s got to be because it rhymes with FOO. But you know, so you see that this is basically just people saying we’ll buy this one holding, ride it all the way until we get to retirement. The other one is the three fund portfolio. Bo, this is interesting because it’s typically going to have, you know, a lot of probably the S&P 500 large cap. It’s going to have some international. It might even have some bonds. We’ll get into some of that. And then there’s even Dave Ramsey. A lot of you guys have found us and we appreciate you because you consider us kind of graduate level once you’ve kind of gotten out of debt. So Dave Ramsey has done a lot of good in the world of getting people out of debt that then it translates into a lot of people also following what does he do on investments. We want to go a little deeper and see what does that look like so you can figure out what do I need to be doing with my investment life.

Bo: So when we think about these three strategies, VOO for life, some sort of three fund portfolio or maybe following Dave Ramsey’s suggested portfolio, the question becomes, well, how do we decide which ones are good or how do we decide which ones we should use or what are the things we ought to know about each of these different investing strategies or investing portfolios? So we want to evaluate them. We want to kind of walk you through the metrics that we would use as we’re thinking about how to think about portfolios and how to think about putting our dollars to work. And so the evaluation metrics we’re going to use is we’re going to look at okay, how are these allocated? How do each of them spread the assets out across different asset class or different investments? How do each one of these portfolios attack risk? What would be the risk profile of these portfolios? And then ultimately we’re going to close out with performance. Okay. Well, if we just take away everything, which one of these portfolios has performed best? Which one has performed worst? And then how can I use that? What should I take away? What should I know about that? So, we’re just going to kind of walk you through how we would think about these. So, before you buy into any one of these strategies, it makes sense to understand, okay, what am I actually buying? What’s the allocation? How are these assets inside of these funds, inside these portfolios actually being invested?

Understanding VOO and the S&P 500 (9:21)

Brian: Well, Bo, he’s just call me Bo. Bo with the VOO. No, Bo, I just gave the insight that VOO for life is basically just buying the S&P 500. We have our audience, 40% of you are coming to us brand new all the time. We’re using a lot of terms here. Whether it’s the VOO for life, whether it’s the S&P 500. What is when we say the S&P 500, what even is that?

Bo: Yeah, it’s just literally the 500 largest publicly traded companies in the United States. So when you think about it’s names you’ve heard of. It’s the Home Depot, the Apples, the Alphabets, the Facebooks. It’s those kinds of companies that comprise the S&P 500. And so what these ETFs like VOO do is they just try to mirror, they try to mimic it. It’s a market capitalized weighted index. So the biggest companies have the highest percentage and then the next biggest, the next biggest all the way down to company number 500. That is what VOO invests in. So primarily large US companies, right? Maybe a little sliver of mid caps as they’re transitioning in their journey of growth from mid, but primarily this is a large cap holding index.

The Three Fund Portfolio Explained (10:32)

Brian: All right. Now when we think about the three fund portfolio, it’s a little bit different. Oftentimes this is a mix of US equities, international equities and then some sort of bond funds or some sort of fixed income. And people will allocate according to their unique circumstances. So some people might go with like a 70/15/15 or some people might go with a 95/5. For our illustrative purposes, for like a balanced well rounded portfolio, we’re just going to assume for the three fund portfolio, we’re going to use three Vanguard ETFs, 70% in VTI, just the total stock market index, 15% in the international VXUS, and then 15% in Vanguard’s total bond, BND. So again, three ETFs across three different broad asset classes. And by the way, this could change for you based upon what you know, but we chose you know 70/15/15. The disclaimer I’ll say on this is your choice might be a little bit different on how much is risk on versus risk off.

Dave Ramsey’s Four Fund Portfolio (11:29)

Bo: And then if you listen to Dave Ramsey, if you’ve listened to any of his investing advice, he comes up with this idea. He says your portfolio should be split equally between four different categories. Growth and income, growth, aggressive growth, and international.

Brian: I’m surprised on international they didn’t put growth on it because it does feel like and look, everybody knows who’s followed our channel, we’re not Ramsey haters. We love Dave, but it is because like I said he is probably step number one if you’re trying to get out of debt, if you’ve had a discipline issue. You have landed on the Ramsey reservation. I mean there is no doubt about it. But it does concern me. I remember this is Bo. This isn’t like something that came up last week. This has been decades in the making. And it’s one of those things when I’m helping people manage money and I look at a portfolio, I pick on sometimes when I see a portfolio and I’m like, did you just choose anything and everything that had the word growth? That’s all you want to say. And I do feel like sometimes when I look at Dave’s portfolio because I don’t know if they’ve considered updating it, but it does look like it is an exercise in growth and income. Well, growth and income is probably going to be, you know, a balance of large cap, you know, both value and growth holdings. Growth just means it’s probably going to be on the aggressive side of the large cap holdings. Aggressive growth is probably going to be small cap or something like that. You know, get you a little bit more growth by juicing the risk. And then international, I mean, just by its nature, international has a lot of growth components to it. So, this thing seems like it is wild. It’s wild.

Bo: And so what we said is okay, Dave does not necessarily give specific fund recommendations, but we happen to know of some funds that would fall into these categories as Dave would qualify them. Well, think about it. He has endorsed local providers. We’ve seen enough of those portfolios come across that we know kind of the fund companies that a lot of those ELPs are using. And then it’s crazy if we don’t mention we live in the backyard of, so we know people who have actually Ramsey 401ks. So these choices of funds probably aren’t too far from what you’ve seen. If you are part of the Ramsey, you know, network or if you work with an endorsed local provider, you’re probably seeing some of these funds. So if you want to know what we’re using for 25% growth and income, we’re using the Columbia Large Cap Index, NEIAX. For the growth portion, we’re going to use the JP Morgan Mid Cap Growth Fund. For the aggressive growth, we’re going to use the Franklin Small Cap Growth Fund, FSGRX. And for international, we’re going to use the American Funds EuroPacific Growth Fund. That’s REREX. 25% in each of these.

Comparing Allocations (14:12)

Bo: So, when we think about VOO for Life and we think about the three fund portfolio, we think about Ramsey’s four fund portfolio. How do they compare from an allocation standpoint? Well, you can see we kind of have these pie charts or if you’re out there listening in podcast land, we’re kind of showing how are these assets, how are these portfolios spread across risk on assets, those are all the shades of blue and gold, and then risk off or risk reduced which would be fixed income. And what you can see is VOO for Life is pretty much all equities. It’s all S&P 500 as you would expect. Dave Ramsey’s portfolio also all equities, a very small sliver of fixed income in there with a three fund portfolio being the only one that really is allocated between risk off or risk reduced assets and risk on aggressive equity type assets.

Brian: Yeah, I mean this is one of those things where I think I mean a lot of these funds are doing a lot of the same work. I mean the big spread I see, VOO as we’ve talked about is just the largest US companies. I think that three fund is kind of that same thing but just with some diversifiers in there because you think about you’re adding some bonds, adding a little bit of international. And then Dave is probably, I mean I’ll be curious to see how this plays out from a performance standpoint, but it’s got a little bit of everything on the risk side of things, meaning risk on assets, because the only sliver of potential fixed income is in that growth and income holding. And look you could play around, I know we’ve done this analysis before, it probably is worth saying the disclaimer is that you could change some of this around, but I still think that if you’re looking at aggressive growth, growth and income, international, and then which, oh he just got growth, you know, these are probably pretty similar, but I will put the disclaimers that you could change funds around and maybe get a little different result, but I don’t think it changes the discussion at all.

Bo: And so when we think about allocation comparisons between these three, while it may look like Dave’s has more colors there, we would argue based on risk off, risk on metrics, the three fund portfolio probably gets the gold medal here. It’s probably the one from an allocation, from a diversification standpoint is the most well diversified. Number two would be Dave’s portfolio and then number three would be VOO, S&P 500 index. So when I’m thinking about our power rankings, I’m going to say that gold medal or gold star goes to three fund portfolio when it comes to allocation.

Understanding Risk – Tolerance vs Capacity (16:32)

Bo: All right. So now let’s shift. We’ve talked about how they’re invested. Now let’s talk about risk a little bit because this is one we have to factor in. We have to think about this because risk is a certainty when it comes to investing.

Brian: You need to understand there is risk tolerance which is how you feel emotionally and handle that volatility. But Bo, I think one that really as we deal with more and more people as they approach retirement, the discussion that I get more fruit out of is also explaining this concept of risk capacity. What are we talking about when we mention that risk that’s kind of unsung or untalked about with most people?

Bo: Yeah. Risk tolerance is how much risk you can handle. Risk capacity is how much risk you should handle or how much risk your portfolio can handle. Far too often people will have a high risk tolerance. “Oh, nothing shakes me. I’m not afraid. I’m a cowboy.” But they might not have the timeline or they might not have the resources that they have the capacity to take on that much risk. So, when it comes to analyzing and assessing risk, you really have to measure both sides of that coin. What is my tolerance? But also based on my unique circumstances, what’s my risk capacity?

Brian: Well, let’s put some details on this. If you had a 72 year old gentleman who comes into the office and he says, “I am a cowboy. I literally am wearing chaps and I can do this and I have cowboy boots. I have everything to show you that you’re not gonna rock me with the market going up or down.” But if I showed this individual mathematically that yes, you seem like emotionally you’re going to be perfectly fine if your portfolio has variations in volatility of 30, 40%. But could you if it took years to recover? Do you have the time literally the clock, the minutes on the clock to let your money recover? And if you’re living off these assets, the answer is likely no. And that’s why we say be careful if you’re only measuring risk tolerance because there might be a math calculation going on that just because you can doesn’t mean you should.

The Role of Risk in Portfolio Growth (18:29)

Bo: But another thing that you need to recognize when it comes to what you ought to know about risk. It’s not just those two metrics. You also need to recognize that risk is a crucial part of any portfolio. If you want your portfolio to grow, if you want the dollars to increase in value, you have to take on some risk. And a common misconception is that maybe I can take on no risk and I won’t have any risk at all. But even that’s not true. Even if you were to put all of your dollars and all of your assets in very conservative, very safe, maybe even like government backed bonds and treasuries, there is a risk that exists that you might not keep up with inflation. You might not keep up with the cost of the rising prices of goods. So risk is a crucial part of any portfolio that’s going to grow. And if you misassess it or don’t assess it, you might have difficulty reaching your long term goals.

Brian: Yeah. You’ve heard me share the tale of two fathers and the fact that my father thought investing was CDs. So, he never really put his army of dollar bills to work. Meanwhile, my father in law was buying the Fidelity Magellan fund back when that thing was a rocket ship. And you quickly get an understanding of that, yes, taking risk, a calculated risk can actually be a very good thing for your portfolio. But Bo, I have to pick on, because I’ll pick on you a little bit because we see this with your first investment was buying some of these high flyers like satellite radio companies and other things because it just seemed like it was the coolest thing. Ladies and gentlemen, if risk is good, more risk has to be better. But what’s wrong with that?

Bo: No, that’s not the case. Risk is a necessity for meaningful growth, but it’s not a one to one relationship. Just because I take on more risk does not necessarily mean that I’m going to get more growth. I mean, we see this all the time. Penny stocks, for example, are more risky than the S&P 500. But just because you go put your money in a bunch of penny stocks does not mean that you’re going to outperform. More risk does not always equal more reward. More risk can equal more reward. So you need to understand it’s not a given. It’s not a one for one and it’s not a certain thing. That’s why it’s called risk.

Brian: And that’s why we like anybody who does a little bit of research on investing. You’re looking for an efficient portfolio, meaning one that’s that Goldilocks of maximizing the relationship between risk and reward to get you the best return without betting all of the farm that you get yourself in a pickle of a situation.

Measuring Portfolio Risk (20:53)

Bo: So then the question becomes, okay, well, how do we measure this? When we think about portfolios, we think about a VOO portfolio versus a three fund portfolio versus Dave Ramsey’s portfolio. How can we assess risk? Now, there are a number of different ways you can do this. We’re going to share with you some metrics that we look at as an investment committee here at our firm, but you might look at other metrics or you might take other things into consideration. This is by no means an exhaustive list, but here are some things that we like to look at. The first, especially when it comes to a portfolio is what is the beta of the portfolio. And beta simply measures how much volatility is present in an investment or in a portfolio relative to some stated benchmark, relative to some index. And so generally if beta is greater than one you would say it is more volatile than that benchmark. If it’s less than one you would say it’s less volatile. And if it was a negative beta, it means it moves opposite in different directions than that benchmark. So how volatile is it relative to a stated benchmark or a stated index that you’re trying to track? That’s the first metric.

Brian: Okay. And then so that one is going to tell me how much risk, how much riskier an investment is over just its benchmark. I’m expecting if it is riskier, man, oh man, I better get a better rate of return or you hope for at least anyway. Otherwise, it’s underperforming. But then talk to me about because what I get nervous about with investing is what if you, you mentioned penny stocks. It’s funny you mentioned that because what if you chose a penny stock that one year made 30% but then next year lost 5%, then next year it maybe made 1%. If you added all that together you’d be like oh my gosh this thing it looks like it annualized like 8%. But in reality the volatility of you know it made all of its money in one year. What type of stat can help us figure out what type of volatility I might be buying into?

Bo: What you’re describing is standard deviation. Standard deviation now measures the dispersion of returns around an investment or portfolio’s mean return. What it allows us to hone in on is how predictable are these returns. If the standard deviation is very very wide, then we’re going to have very low predictability of returns. If the standard deviation is very very narrow, we’re gonna have a higher predictability of return. So when it comes to risk, we want to know not only how much volatility is present relative to some given benchmark, but how much absolute volatility is present. So those are two volatility metrics that we look at. Now the third one is interesting because we don’t just want to think about risk, we have to also wrap in sort of this return component, right? We want to make sure that if we are taking more risk, we’re getting a better rate of return. And so there are some ratios that we can look at. And in the investing world, there are two that are most often quoted. There’s the Sharpe ratio and the Sortino ratio. I’m not going to explain the formula. I’m not going to, but I could because you know I studied that and I know. But here’s what they really say. How much return am I getting per unit of risk I’m taking. So if I’m taking on a lot of risk, I want to get more return. That’s what Sharpe ratio measures. The Sortino ratio measures the same thing, but it’s how much return am I getting if I only consider the downside. If I only look at the standard deviation of downside returns, how much more return am I getting for that volatility? So, this will tell you how efficient an investment or portfolio is at returning return for risk that you’re taking. I know that’s super super nerdy, but these are things that we look at when it comes to portfolio.

Risk Analysis Results (24:32)

Bo: So, what we said is okay, if we’re going to look at these three different metrics, how would we look at them across the VOO portfolio, across the three fund portfolio, across Ramsey? So, let’s look at the first one, beta. Remember, this is volatility relative to a benchmark. We picked the S&P 500 because that’s what most people often measure. Hey, how volatile is this compared to the S&P?

Brian: Well, and you can see VOO for life is basically one. I mean, it’s 0.9986. That’s probably just the cash, that difference between what they have to keep in cash to just manage these index funds. Yep. It’s a rounding error. So, VOO for life is the index itself. So as you can imagine from the definitions Bo shared, that’s a one for one on the risk you’re taking. Three fund because it does have 15% going into bonds in the example we use plus it’s got 15% going into a completely different asset class. But that’s a little more aggressive. You can see that probably that’s why it’s a little greater than 85% because if we had 15% going to bonds, you would think, well, this ought to be 85% of the beta. No, it’s 86% because we had aggressive, you know, international holdings in there. But you can see that diversifier did impact the beta.

Bo: And then when you look at Dave Ramsey’s portfolio, it actually has a beta greater that you would say that it experiences 105% of the volatility of the S&P 500 where the three fund portfolio experiences 86% of the volatility. So when we just think about beta and we think about relative volatility, I’m going to argue that the three fund portfolio kind of takes it on this one. But remember that’s only one volatility metric. Let’s look at the second metric, standard deviation. Okay, how much dispersion exists around the mean return for these individual investments. Remember big standard deviation, low predictability, small standard deviation, high predictability. What you can see is once again VOO, 15.8% standard deviation around the mean return. So that means you could expect returns if the mean return for VOO over this time period was 15%. Over the given time period returns range or at least the bulk of returns range from 0% to 30%. Make sense?

Brian: Yeah. A lot of volatility the higher the numbers are. And that’s why when you see the three fund, you see that diversifier actually helped because it’s got a little bit more predictability than VOO or even the Ramsey. And Ramsey, I mean, because and I pick on the fact that it’s just got growth in every one of these funds. You can see swinging for the fences. It’s got a very high standard deviation.

Bo: All right. So, when I think about these, I again, I would say the three fund portfolio has a lower standard deviation. So, it’s going to have a higher predictability of returns. I’m going to say that three fund portfolio kind of wins out when it comes to standard deviation. But remember that’s only one part of the equation. We also want to factor in return. We want to think about that component as well. So when we look at our Sharpe and Sortino ratios, how much return are we getting for the risk that we’re taking? And all you really need to know here is the higher the number the better. The higher the number is, the more return I’m getting per unit of risk. So you can see when it comes to Sharpe ratio, VOO has one of about 0.67. The three fund is about 0.54 and the Ramsey portfolio is about 0.36. So VOO would obviously win in Sharpe and then even when you think about the Sortino ratio, how much additional return do I get when I just consider the downside, again VOO is at almost 0.76, three fund at 0.61 and the Ramsey portfolio 0.44. So just from the ratio standpoint, it looks like VOO would be the top performer and that kind of would be expected because of what’s happened in the S&P over the last decade.

Brian: I would caution people, remember past performance does not necessarily mean future performance is in that. If you looked at, if we chose a different time period. I don’t know that VOO would have dominated as well as it has for the last 10 years specifically. It has been really good. If we had brought in and I’ll mention a term that we’ll spend a little more time on the last decade, that would be a completely different kind of analysis here. So you have to look at the window of time that you’re using. But it is once again it’s powerful to see that three fund portfolio even though the lion’s share of that holding is probably more similar to VOO that diversifier definitely kind of kept it where it was respectable you know. And then Ramsey’s kind of surprised me because now this is once again given a little bit of a disclaimer. We chose the funds that we’ve heard through the grapevine and we’ve seen in prospects that come through. But it is one of those things where I was real disappointed with how low that number is when you risk adjust it because you would think swinging for the fences you’d be getting more when it actually just means more risk.

Bo: So when we think about these three different risk metrics, beta, standard deviation, the Sharpe and Sortino ratios, I’m going to argue that three fund was the winner on beta, it was the winner on standard deviation and then VOO was the winner for Sharpe and Sortino. I’m gonna say that if I had to do power rankings here, I’m still gonna give my three fund the gold medal, but VOO was right there. It was close. It’s a silver medal. I mean, they were kind of neck and neck, photo finish and then Dave would be the bronze medal when we’re just thinking about risk metrics. But again, we’re only talking about one facet. The other thing we have to think about, and this is what 95% of people actually look at and 95% of people actually care about when it comes to investing is performance.

Performance Comparison (29:54)

Bo: Yeah, this is where it matters. How do these portfolios actually compare when we look at them? Now, you hear us talk about this all the time. We love long term performance, right? So, we’re not going to look at this over the last month or over the last quarter or over the last six months. We actually want to look at it over a number of different time periods. And so what we said is how do these different portfolios hold up if we look at it over the last one year, the last three years, the last 5 years and the last 10 years? And when we do that it creates an interesting narrative.

Brian: I mean it is kind of a stomping in the fact that, it’s not completely surprising but you can see that VOO for life which is the S&P 500 has dominated really. I mean you look at the one year, the three year, the 5 year, 10 year, not a period there that the S&P 500 didn’t dominate. So that’s one of those things that man from historically that if you’ve been in the S&P you’ve been greatly rewarded. That’s why also you see it in this three fund portfolio because it’s not uncommon that the lion’s share holding out of that three fund is probably going to be something like a total market index or an S&P 500 where they’re going to have a lot of overlap in those funds. And then you can see because we’ve now added in diversifiers like small cap international and things that are separated from the S&P. You can see Dave’s portfolios probably have the most variation when you look at the annual difference between one year, three year, 5 year and 10 year performance.

Bo: Now here’s the temptation. I think folks are going to look at this and be all right top performer VOO for life. That’s what I want. That’s me. Sign me up for that. But it’s interesting because we know just because one asset class and when we think about VOO, we’re really talking about US large cap S&P 500 holdings. Just because it was the top performer over the last year, over the last 5 years, even over the last 10 years, does not necessarily mean that it’s going to be the top performer moving forward. That’s why we have to assess risk in conjunction with performance. Because if we think about the last 20 years, we’ve shown you guys this illustration before. This is just a Callan period periodic table of returns. It shows the return of different asset classes in any given year. And what you can see is that some years the top performing asset class might be the bottom performing in the subsequent year. You can look at, pick any color. You pick real estate, the red color. You can see that some years it’s the best performer and some years it’s the worst performer. You could do the same thing with emerging markets. Some year it’s the best performer and some years it’s the worst performer. So when we think about portfolio allocation, we’re not suggesting that you have to pick which color is your color and which color you love. That’s why we like diversified portfolios. And we can do probabilistic allocations where we assign a higher allocation to the holdings that we have a higher confidence level in and a lower allocation to the ones we have a lower confidence in. But again, I think the natural bent, the natural tendency for an investor might be, okay, I’m going to look at the one that’s near the top the most and I’m just going to go all in on that. And over the last decade, that would have been VOO that would have been the S&P.

The Danger of Recency Bias (32:56)

Brian: Well, I think there’s also we have to be careful of the season or the recency bias that we’re all living in. I think about like Dave’s portfolio. Dave came up with this back in the 90s when his book first came out mid 90s. And I look at even on this Callan periodic table if you go look at 2005, 2006, 2007, Dave’s portfolio would have crushed it in this because look at what the top performing asset classes were. It was emerging markets, so a lot of those international and then the third one is developed excluding the US so you can see his portfolio would have absolutely crushed in those years because you don’t see the S&P 500 was much further down. But then you go look at this Callan periodic table and you look at how often the large cap holdings is in the upper third of performance and it’s almost every year. I mean it is there is definitely a recency bias towards S&P 500 over performance and that’s something we should be very aware of so that everybody watches this show doesn’t just say VOO for life. You know I’ve always heard there’s a reason it’s on social media is because Bo there’s a little thing that whispers in my ear because I’ve been managing money since the 90s and we just chose the S&P. You could have done the QQQs. If you think about the technology sector and I think about all the clients or prospects that I dealt with in the 90s where I had 50 year olds who were choosing those info and tech funds and other things because they were like man the high flyers, you buy the technology stocks and you really go into that sector and then the lost period of time after the great dot com bubble that kind of popped you would have sat in the desert for years waiting for the train of opportunity to come back around. We’ve actually experienced that with the S&P 500. You hear about it called the lost decade. Can you describe what we’re talking about when we talk about the lost decade?

Bo: Yeah. If you look at the return of the S&P 500 from January of 2000, dot com bubble all the way to December of 2009, right there towards the end of the Great Recession, total return for the S&P over that time was about negative 9%. It was almost flat over that 9 year period, almost 10 year period. And so if you were someone who would have been investing everything and would have had everything in the S&P 500, I begin to ask the question, man, what if this lost decade was the decade that I started my retirement? What if in the years that I needed to pull off my portfolio? I had a year like 2008 where intra year, it was actually down 50% intra year. Could I still stay the course? Could I still have the resolve to stay in that portfolio if all of my eggs are in that basket? If I’m betting on this one asset class and this is a decade where that asset class is not exactly doing exciting things.

The Math of Portfolio Losses (35:44)

Brian: Well, and that’s why I’m glad you brought up that, you know, a period where because to have a lost decade, you had to have an extended period of underperformance or something so steep that it skewed the data. And here’s what I think is interesting. And a lot of people, this is why risk capacity is a real thing. As I think about my brand new retiree who is, you know, because especially after you have like a year where the market does really well and makes double digits, everybody’s like, “I want more of that. Load me up.” And I always have to remind them. I was like, well, let’s talk about the math of this because remember risk tolerance, just because you think you can handle it, could you actually survive this when we’re living off of these assets? Because there’s this weird math dynamic that occurs with returns. If you lose 20% in your portfolio to make back your money, you have to have an offset gain of 25%. It’s not just 20 for 20. Yeah, it’s not 20 for 20. You have to actually get a little bit more to make it back. It’s a weird thing about mathematics. Same thing. Let’s just go ahead and amplify this up to 50%. If you lose 50%, you don’t make 50% to get back. You have to make 100% to get back. Same thing. And this, by the way, gets steeper. You lose 60%, you got to make 150%. You can see how vicious this cycle is. And you can imagine what this does to you emotionally while you’re trying to live off of this money. But then even you think about the time component. If we know that markets you count on a planning and you’re hoping you make 8, 9% out of your investments and you know that you have to make 67 to 100% to make back what you lost, that might be 7 to 10 years worth of good growth just to get you back to break even. You might not have the amount of time on the clock to make that work. So make sure you’re not sleeping on this concept of risk capacity.

The Verdict on These Three Strategies (37:28)

Bo: All right. So when we think about the performance of these three different funds, obviously VOO has to take the gold star over the last decade, has been the top performer. I would say three fund gets the silver medal and then Ramsey obviously takes a bronze. So when you see this, it’s kind of mixed. And when you think about this, it’s not like there is a clear winner of which portfolio is absolutely best and what portfolio makes the most sense. So how do you decide when it comes to how you invest your dollars? What do you need to think through?

Brian: I think this comes back to in personal finance, your specific answer is going to be very personal. And that’s why when we have prospects come in the door, these are the things we try to do. First of all, we want to have a meeting where we figure out how do you process money. What’s your money psychology? Then we want to do some exercises just like all the other financial institutions where we actually test and get a kind of a snapshot of what your risk tolerance is. But then we’re going to take that extra step. We’re going to say, hey, just because you can doesn’t mean you should. We’re actually going to start measuring your risk capacity. How does that intersect with your goals, your desires, your assets that you have? And then after we’ve gotten all that data gathering and we’ve brought in all that information, it’s the culmination of then creating a plan that will be good before, during and after and it incorporates all your goals, all your desires and your timelines, your age. All of that is going to be accounted into our plan of how we manage your money. And I would encourage you to do the exact same thing with your finances. Don’t let somebody sell you something on social media that’s going to be the end all. That’s not an actual personalized decision.

Focus on What You Can Control (39:04)

Bo: That’s exactly right. You can do this very thing for yourself. So, when it comes to designing your portfolio, focus on the things that you control. We often say that your actions are way more important than your allocation. Don’t spin all of your wheels trying to figure out, do I put 1% here, 1% there, 1% here. Focus more on the things that you can control. How am I being tax efficient? How am I spreading out my assets to match my risk tolerance and risk capacity, not how am I out there trying to beat the market? When you’re doing this, don’t overthink it. Don’t over complicate it. Don’t make it harder than it has to be. And when you do that, it allows you to actually focus on the things that move the needle, like what is my savings rate? How am I putting my money to work? And the beautiful part is when you do this, when you keep it simple, it doesn’t have to get complicated. It doesn’t require a finance degree to be able to do this for most investors. Most investors can apply this methodology to their portfolio. What’s beautiful, Brian, is the financial world has actually made this even easier than ever.

Our Recommendation – Index Target Retirement Funds (40:08)

Brian: So, you may be asking, what did we choose out of the three of these? Which one of the three was the best? And If you saw two of the three things we looked at measuring, the three fund did pretty good. Now, even the performance, yes, VOO for Life dominated that, but if you think about the way the three fund was set up is that it’s still getting a lot of that performance. But here’s where we’re going to flip the script on you guys. We didn’t choose any one of these three specific holdings. We think that there’s actually something you ought to consider that’s more dynamic because you’re going to change. Your financial life will change as you get older. Your risk profile changes, your desires, your goals, all these things. You need something that’s not just static and sits there like a VOO for life or like a three fund. You need something that actually changes with you. And that’s why what we love is for somebody starting out and you just don’t know what to do with your money. What’s wrong with considering an index target retirement fund?

Bo: Yeah, I love index target retirement funds because they check all the boxes. It allows you to not worry about all the allocation because it’s done for you. You can focus on the actions you can take which are how much can I save and what year do I want to retire. It forces you into the place where you’re not overthinking and you get to focus on the things that actually matter like your savings rate. You’re not over complicating it. You are keeping it simple. So it literally goes down the list of all the things that we said that you as an investor can do. So for people that are just starting out in their financial journey, for people that are just beginning to build and for people that haven’t reached that level where it makes sense to have a custom curated portfolio, I think target retirement index funds are great because it takes a lot of the great things about the three fund portfolio and about VOO and about other options out there and it kind of pushes them all together.

Brian: Well, it’s more dynamic because I mean it has what’s called a glide path, meaning that when you’re young and you have 40 years from retirement, this thing’s going to be pretty aggressive, too. It’s going to load you up. But as you approach retirement or as your life changes over time, this will change and adjust dynamically just like you would probably want a good asset allocation to do. Now look, everything has limitations. What I like about index target retirement funds is that they’ve tried to take target retirement funds but make them that much better because it’s using index funds which are super low cost and giving you all those benefits, tax efficient, so forth. But there is going to come a graduation point like most things where your life gets more complicated and it doesn’t matter if we’re talking about VOO for life, three funds or even index target retirement funds. I think that there will come a time where you’ll need to have that sit down like we talked about the questions we ask our clients where we talk about risk profile, intersection point of goals, risk capacity, not only just risk tolerance. Those things are important and yes, you will outgrow and we will be there waiting for you. That’s why we can load you up and give you all this free advice is because we know just naturally success is going to create the complexity that requires you to take the relationship to the next level. So I would challenge you and encourage you go to moneyguy.com/resources. Take advantage of all of our free stuff. But if you resemble some of the complexity because you’re trying to land the airplane, don’t be shy. Come and talk to us about taking the relationship to the next level.

Closing (43:26)

Brian: I’m your host, Brian Preston. Mr. Bo Hanson, Money Guy Team out.