5 Reasons to Simplify Your Investment Portfolio

Several clients have worked with other advisors. Some come with collections of high-cost actively managed mutual funds, annuities, and life insurance products they were sold. Others come with dozens or more mutual funds and ETFs. Some have hundreds of individual stocks. It’s almost like I could predict how their advisors were paid by looking at their investments.

Some people have been DIY investors. Portfolios often look like a walk down memory lane of recent investment trends: one or two I Bonds, shares of ARKK ETF, a handful of individual tech stocks, a few random cryptocurrencies, etc…. And only vague explanations of why they own what they do and how the pieces fit together.

Some people admit they started investing, generally in their work retirement plans, with little education or guidance. They can be all over the place. One portfolio included every available target date fund in a 401(k) for diversification.

The common denominator in every client I’ve seen is that we spend significant time simplifying their investment portfolio. Here are five arguments for simplifying your investments.

Simplicity Works

Let’s start with the most important, and least intuitive, reason to simplify your investments. Simplicity works. This is not intuitive because it doesn’t work in virtually any other area of life.

Simple Investment Approaches Aren’t Intuitive

Want to improve your fitness? Eat well. Exercise regularly. Improve sleep. Manage stress. All must be done with ongoing diligence.

Want to improve your relationship? Work on communication. Make quality time for your partner. Never neglect the relationship.

Want to advance in your career? Increase knowledge. Develop new skills and refine old ones. Expand your social network. Sitting back and waiting for things to come to you virtually never works.

Want to get better investment results? Choose a simple strategy consisting of a few low-cost, tax-efficient, broadly diversified index funds/ETFs. Locate them in the most tax-efficient accounts. Automate it. Then go live your life. The less you do, the better!

Which of these things is not like the other? It makes sense why this is hard for investors to grasp.

Evidence for Simple Investing

Adding to investor’s skepticism of simplicity are two entire industries, investment “advisors” and the financial press, whose existence depends on the illusion of complexity. William Bernstein describes this as the fourth of his Four Pillars of Investing which he calls The Business of Investing.

Content that promotes complexity is never-ending. Despite this noise, evidence consistently shows that simplicity works in investing. 

SPIVA publishes an annual report comparing the performance of actively managed mutual funds against their index benchmarks. Year after year, across regions and asset classes, actively managed funds underperform. 

Played out over 15-20 years, the odds increase to greater than 90% in favor of the index. This is true across geographic regions and segments of the market.

Recent research shows that within the index, the vast majority of returns are derived from a tiny number of stocks. The top 4% of stocks create essentially all stock market returns. The bottom 96% cumulatively creates returns approximately equal to T-bills. The median stock has a negative return.

It seems logical to just pick those winning stocks. Yet this has shown to be elusive for the vast majority of investors.

All this supports John Bogle’s maxim, “Don’t look for the needle in the haystack. Just buy the haystack.” This can be accomplished with a simple investment approach of buying a few broad-market index funds and ETFs and calling it a day.

There Are Many Better Uses of Your Time

Complexity reigns in virtually all areas of financial planning. There are areas where you can improve outcomes by investing time, energy, and effort.

The US doesn’t have retirement, tax, or health care “systems.” Instead, each is governed by laws that were implemented piecemeal over time. 

That complexity has only increased with all of the legislation, much passed in haste, that came out of the pandemic. Efforts to understand key details are a good use of your time.

Even relatively stable and effective government programs like Social Security are complex. Effort is required to develop a framework to help decide when to claim benefits. Even if you understand the basics, the program contains a lot of jargon. Thus it is important to spend time understanding terminology to avoid unnecessary mistakes.

Developing a system to budget or track spending is vital. This gives insights into whether your spending is sustainable and aligned with your values. While not technically difficult, this takes ongoing time and effort.

Bottom line, many tasks require substantial time, effort, and energy to produce the best results. Investing does not. Why waste time on complexity that is unnecessary at best and often detrimental when that time can be better spent elsewhere?

Your Partner Doesn’t Care About Your Passion for Investing

A common pattern in couples I work with is for one partner to be an investing “enthusiast” while the other is largely disinterested. A simple approach of a few broad-based index funds is a perfect solution.

Both partners can understand and, if needed, implement this simple approach. Simultaneously, it will outperform most other investing strategies over the long term. 

The disinterested partner generally grasps this and is quick to buy in. Yet it is the investing enthusiast, typically the one who sought my advice in the first place, who pushes back against the recommendation of a simple portfolio. 

If you are that person in your relationship, I present a few questions:

• Do you understand that you are putting your financial goals, AND those of your partner, at risk based on your hunch about picking individual stocks, investing in your friend or neighbor’s project, or your thesis about cryptocurrencies?
• If something happens to you, what will your partner do with the complex portfolio you will leave them?
• Are both partners fully aware and comfortable with this?

What If You’re Right?

Some people like to set a small portion of the portfolio aside for speculative investments. It’s fun for them.

They can limit this to a small percentage of the portfolio they could afford to lose if they’re wrong. They argue that in doing so there is little downside and huge upside.

But what if you’re right….for a while? As noted above, beating the market is hard over long periods. It is less difficult for short periods.

A few years ago, ARK Innovation ETF (ARKK) had an incredible four-year run between 2017 and 2020. In 2020 alone it returned 153%. The fund and its star manager, Kathie Wood, attracted massive attention in the financial press and tremendous inflows of assets. Fund owners had to be feeling very smart.

Since then, returns have been a bit less stellar: -23% in 2021 and -67% in 2022. This led to massive losses for shareholders. Morningstar’s Jeffrey Ptak recently posted the following astounding statistics on this fund.

When you complicate your portfolio with speculative investments, one risk is underperformance. This can be controlled by limiting your exposure.

What if you get lucky, confusing that for skill? A bigger potential risk may be a short period of overperformance. 

Would you follow a disciplined rebalancing plan to harvest your outperformance? Or would you be tempted to double down on your strategies? Don’t underestimate this risk!

Future You Will Thank You

Rick Ferri has a saying about the phases every index fund investor goes through. In my short time working with clients, I’ve come to appreciate these insights:

People commonly come to me as they approach or navigate early retirement with questions about optimizing ACA tax credits or considering Roth IRA conversions. They’re surprised to learn that earlier investment decisions might limit their options.

Some people have collections of actively managed mutual funds or balanced funds in their taxable accounts. These funds kick off unnecessary taxable income in the form of capital gains and/or qualified dividends that fill their lower tax brackets.

Others come with a handful of highly appreciated individual stocks. These stocks present a significant concentration risk if they are not diversified, but create a tax bomb if they are sold off to diversify.

In either case, it can take years to unwind the implications of earlier investment decisions made (or sold to you) in what Ferri calls phase one and phase three.

If you are reading this blog and other sources like this, you are likely at least somewhere between phases one and two. Get yourself to phase four as quickly as possible. The future you will thank the current you!

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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to chris@caniretireyet.com. Financial planning inquiries can be sent to chris@abundowealth.com]

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