Perfecting profitability

More jaded of investors may roll their eyes at another book offering up a formula for the “perfect portfolio.”

Veteran portfolio manager Peter Lazaroff, based in St. Louis, and host of the Long Term Investor podcast understands the scepticism around his recently published book The Perfect Portfolio: a Proven Guide to Smart Investing for Long-Term Success.

Yet the chief investment officer at Plancorp Wealth Management, which has about US$10.2 billion in assets under management, has a caveat to the notion of the perfect portfolio.

“The perfect portfolio on paper is probably a lot different than the perfect portfolio for you in real life because what’s ‘perfect’ is a formula you can stick with for decades on end.”

It’s straightforward and sensible: implement a long-term investment strategy, be patient, don’t change course dramatically and watch your money grow.

Yet that is often much more challenging to do in practice than in theory.

Lazaroff knows this well, working with his own clients and through discussions with do-it-yourself investors in the United States.

Canada and the U.S. may have differences regarding wealth building — notably differing government-sanctioned savings vehicles (i.e. RRSP v. 401k). But the tenets portfolio construction, investor psychology and markets are much the same regardless of nation.

The Perfect Portfolio is indeed about building a solid portfolio that aligns with your particular goals.

It is also a response to many podcast listeners and other investors asking for recommendations about which investment books to read to learn more about the alchemy of turning money into, hopefully, more money.

Lazaroff often provides essential reading recommendations like The Intelligent Investor, by Benjamin Graham, considered the best book on value investing, a style made popular by Warren Buffett.

Or he’s suggested A Random Walk Down Wall Street by Burton Gordon Malkiel, which makes a strong case for passive index investing.

Winning is a Loser’s Game by Charles D. Ellis is another, suggesting trying to outperform the rest of the pack of investors is likely to backfire.

“My book aims to take all of the classics’ best ideas and package them in a shorter, more modern prose version that is easily digestible and perhaps more relatable to someone who isn’t thinking about investing all of the time.”

Lazaroff also includes a healthy dose of behavioural finance in The Perfect Portfolio because you cannot “take the human out of what is a human activity.”

He adds he has no particular investment preference. He is not a proponent of passive or active investing. Both have their pros and cons.

What’s important is understanding the advantages and disadvantages of different styles and then selecting strategies that ultimately allow you to stay the course and grow your wealth.

“The book tries to provide education that will give you background for making choices, but it also seeks to help you be more aware of behaviours that get in the way of good investing practices.”

Lazaroff notes, as an investor, he would rather miss out on a few great investments to avoid making major mistakes that are often more costly.

To illustrate, he dives into market history describing how markets peak with euphoria just before a fearful crash repeatedly over the last 200-plus-years.

“How do you resist your human impulses because, from an evolutionary perspective, we are just not hardwired to be good investors?”

That historical perspective helps, he adds.

Yet Lazaroff also prescribes having guardrails to protect your portfolio from yourself, which include understanding behavioural finance.

He also addresses more theoretical investing concepts like asset pricing theory that helps measure returns through the lens of risk and time horizon.

“You have got to know how markets work a little to be able to keep a portfolio on its strategic course for long periods of time,” he says. “It’s easy to stay the course when times are good, but when things feel fearful,” it’s much harder to control impulses.

In turn, The Perfect Portfolio aims to assist investors in sticking with their portfolio construction and not frequently changing directions — including selling investments in falling markets.

“I have a mechanism called ‘probabilistic decision protocol,’” Lazaroff says. “It’s a four-question framework to establish a high bar for making a decision to change your portfolio.”

The questions are:

● Why do you expect positive returns from this investment?

● Does this investment meaningfully improve your portfolio?

● Does it introduce unnecessary complexity?

● Are you extrapolating recent success (i.e. chasing returns)?

Asking these before buying or selling an investment forces your brain to slow down, which helps avoid impulsive decisions.

Lazaroff isn’t suggesting portfolios should never change. They must be rebalanced regularly, paring back highly profitable investments and allocating that capital to investments that may be flat or down in value but are likely to grow as conditions change.

Investors should be open to new ideas, but they must be thoughtful about their process.

“There are two reasons, for example, that an investment would improve your portfolio.” Lazaroff adds a new investment should enhance overall returns or improve diversification.

If your portfolio is well-constructed from the start, most of the time, answers lead to staying the course and saying ‘no’ to a new idea that wasn’t part of the plan.

Remember: just because your friends and neighbours are doing something different doesn’t mean it’s appropriate for you: “There is no such thing as a universal one-size-fits-all perfect portfolio,” Lazaroff says.

But you can find the perfect portfolio for your needs founded on a grasp of how markets work, their history, a little investment theory and splash of behavioural economics.

This holds true, he adds, even when working with an advisor because you will ask better questions. “Being an educated consumer, regardless of what you’re consuming, makes you a good consumer.”

Joel Schlesinger is a Winnipeg-based freelance journalist

joelschles@gmail.com